The industrial revolution and ensuing growth of the great cities of the western world some 200 years ago was enabled by a change in primary energy supply – from wood to coal. Today it is said we are at the beginning of another period of change, from fossil fuels to sustainable energy – the move from black to green. However, this cannot be achieved all at once, it is a long journey and the first step is to change from burning highly polluting coal to cleaner natural gas.
Indeed to some extent this is already happening; coal-fired power generation in the US provided 39% of electricity production in 2014, down from 53% 1997, mainly as a result of the move to lower cost natural gas. In the European Union between 2000 and end 2013 coal consumption fell by 11%. However, the world still burns huge amounts of coal, accounting for some 30% of global fuel consumption. Even in the UK, where the industrial revolution began, on Christmas day 2014, 38% of electricity still came from burning coal.
In the run-up to the United Nations Climate Change Conference ‘COP21’ in Paris in December 2015, green activists are already embarked on a campaign calling for disinvestment from the oil & gas industry. In April the Guardian Media Group announced it will divest from fossil fuel companies. Academia has joined the campaign with sit-ins underway in a number of universities.
Much of this rhetoric is misdirected. There is a major gap between the realities of oil & gas and the public understanding of its fundamental importance to society. To many, filling the car tank is just a tax on driving and natural gas a monthly charge on home ownership. Few realise the sheer scale and importance of the oil & gas industry, not just in the supply of fuels but also its role as a provider of a huge range of products essential to our daily lives, from plastics to pharmaceuticals, from fertilisers to house paint.
The industry should be recognised a part of the solution in providing the natural gas that can enable step one of the journey, to stop burning coal.
John Westwood, Douglas-Westwood London
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While the latest revisions to the terms for shallow water areas in Mexico’s first licensing round have increased the attractiveness of the Production Sharing Agreement terms by improving the contractor’s upside potential, the benefits remain significantly limited at higher prices compared to other fiscal regimes in the Americas, says an analyst with research and consulting firm GlobalData.
According to Will Scargill, GlobalData’s Senior Analyst covering Upstream Fiscal & Regulatory Regimes, even with revised terms, Mexico has yet to appease initial concerns that the adjustment based on pre-tax Internal Rate of Return (IRR), combined with royalty rates that adjust according to price, offers exploration and production companies too little upside.
Scargill explains: “The fact that royalties adjust to prices means the regime is relatively competitive in a low-price environment, insofar as a 30% bid for the state’s initial share of profit oil would be comparable to the fiscal regimes of Colombia and the US Gulf of Mexico at $50 per barrel (bbl).
“However, as prices rise, the royalty and profit oil adjustment mechanisms kick in at an increasing rate, meaning that in order to be comparably attractive to the Colombian and US regimes, the bid would have to be around 25% at $70/bbl, 15% at $90/bbl and 0% at $110/bbl.”
The analyst states that despite competitive economics at lower prices, companies will likely be reluctant to bid at levels that would give them little upside potential and the effect that the government can have with further revisions to the mechanism is limited.
Scargill continues: “Two possible options would be to base the mechanism on post-tax IRR rather than pre-tax, or to further increase the IRR thresholds by 5% each. However, the result of either of these options at a $90/bbl oil price would only be to increase the bid that is comparable to Colombia and the US to 20% rather than 15%.
“A 20% bid would mean that the state’s share of profit oil would range from 20–80% and contractors will pay royalties, taxes and fees on top of this. If the round is to be successful, the government will need to avoid setting an overly high minimum bid while striking a balance between market conditions and public sentiment,” the analyst concludes.
NYC-based PIRA Energy Group reports that Saudi Arabia opts for market share over price. In the U.S., commercial stocks reach new record level even as surplus falls. In Japan, crude runs slightly higher, but lower crude and product stocks. Specifically, PIRA’s analysis of the oil market fundamentals has revealed the following:
Playing with Fire, Lessons from the 1980s
The recent decision by Saudi Arabia to opt for market share over price, at least temporarily, is similar in many ways to the decision reached in the mid-1980s. However, there are important differences as well, particularly with regard to the level of spare capacity. In the 80s the change in behavior was not instituted until spare capacity built to over 10 MMB/D. This time, the change was made in advance while spare capacity was still historically low. If the demand and non-OPEC supply responses to lower price are similar to what was experienced in the 80s, the very low level of spare carries a risk of a price spike in the not too distant future.
Commercial Stocks Reach New Record Level, Even as Surplus Falls
Total commercial stocks built last week to a new record high level. However, the stock build was half of last year’s, so the total commercial stock surplus versus last year narrowed for the first time during 2015. It was that week last year that U.S. commercial stocks started their long march up, from the low end of the range to the high end.
Japanese Crude Runs Slightly Higher, but Lower Crude and Product Stocks
Crude runs increased slightly, with crude imports staying low such that stocks drew modestly. Finished product stocks drew a similar amount. Gasoline and gasoil demands eased, with gasoline stocks modestly higher and gasoil stocks modestly lower. Kerosene demand rose and stocks drew 31 MB/D. The indicative refining margin eased on the week but still remains statistically strong.
Fracking Policy Monitor
BLM issued rules for fracking on federal lands, though unlikely to impact production. EPA methane rules are still awaiting proposal. Bottlenecks are possible: in the Bakken due the state’s crude processing standards; and in the Marcellus due to state and federal regs limiting options for wastewater disposal. Seismic events have caused restrictions on wastewater disposal, while also causing friction between the state government and the insurance industry in OK. The Denton, TX fracking ban seems destined to be overturned.
U.S. NGLs Follow Crude Prices Higher
Mt Belvieu LPG prices rose in line with WTI, with May propane prices increasing 7.2% to 57.5¢ and butane +6.6% to 68¢/gal. prices in Conway, KS also rose, but continue to be pressured by high stocks with discounts to Belvieu in May increasing to over 6¢ on both C3 and C4. Gulf coast ethane outperformed Henry Hub natural gas, increasing nearly 1¢ to 17.3¢/gal.
The EPA Will Issue the Proposed Mandates for 2015 by June 1
The EPA announced a proposed settlement with the API and AFPM regarding deadlines for issuing the annual requirements under the RFS program. The Agency will propose the mandates for 2015 by June 1.
U.S. Ethanol Output Drops to a 25-Week Low
U.S. ethanol production fell to a 25-week low 924 MB/D the week ending April 10 from 936 MB/D in the preceding week as several plants were down for spring maintenance. Inventories increased by 162 thousand barrels to 20.6 million barrels, with all of the build occurring in PADD I.
The information above is part of PIRA Energy Group's weekly Energy Market Recap - which alerts readers to PIRA’s current analysis of energy markets around the world as well as the key economic and political factors driving those markets.
2015 may well be remembered as the year when natural gas truly announced itself as the major energy fuel source. With the announcement that Shell are targeting a $70bn deal for BG Group, and in doing so increasing their current LNG capacity to around 33 million tons per annum, the big dollars to secure gas capacity are coming into sharp focus. Should the acquisition complete, Shell will have access to gas resources from Trinidad & Tobago to Tanzania. BG’s Queensland Curtis LNG project could also provide a viable option to develop the major Arrow coal-seam gas development in Australia.
Elsewhere in Australia, Chevron is expecting to see first production from the defining Gorgon project by Q3 this year. A massive LNG project with estimated capacity of 15.6 million tons per annum, Gorgon is expected to boost the company balance sheet for 40 years. Described as a black hole for Capex following well known cost overruns – expected to approach 50% of the initial $37bn budget – safe and timely execution this year will be critical not only for the company but for the future of Australian supply capacity. Similarly, 2015 is a big year for the Wheatstone LNG sister project as major modules are completed and project integration continues prior to 2016 operation.
After much anticipation, the world’s first floating LNG vessel is also expected to begin operations for Petronas in Q4. The FLNG 1 represents a major technological advancement in the monetization of offshore gas assets. The success or otherwise of this unit, along with that of the under-construction Prelude (to begin operations for Shell in 2016), could signal the beginning of an era where stranded gas, marginal fields and major offshore gas discoveries can be processed offshore.
Acquisitions, major capital projects and large-scale technical developments suggest that 2015 is a fulcrum year for global gas supply.
Matt Loffman, Douglas-Westwood Houston
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