Connect with us

Energy

Oil price and the potential impacts to the global economy

Published

on

It seems one cannot go a day without seeing a headline about the low price of oil and the potential impacts to the US and global economy and the oil and gas industry. In order to help make sense of the myriad of information available, we have broken down the issue into the following fundamental questions.

Why did oil prices correct so suddenly? Is the current low price environment due to lower demand or increased supply or a combination of both?

The answer is a combination of both. The correction is a net result of lower-than-projected demand growth and a remarkable increase in supply. On the demand side, in July 2014 the Energy Information Administration (EIA), International Energy Agency (IEA), and OPEC forecast 2015 global liquids growth to be 1.7 percent on average. However, these expectations declined to just 1.1 percent by December 2014, despite a low price environment that typically would have been conducive to boosting demand.i One reason for the muted demand response to the low price signal has been the increasing strength of the US dollar relative to other major world currencies. Notably, the US Dollar Index has risen nearly 15 percent to 97.4 since July 2014. A stronger dollar makes dollar-denominated crude more expensive for buyers using foreign currency. Consequently, while the United States is enjoying the full benefit of low prices, many other countries are only experiencing a portion of the price decline, giving them less reason to consume more petroleum products.

On the supply side, several years of $100/bbl oil drove tremendous production growth in many countries. US crude output, including lease condensate production, increased by over 2 MMbbl/d from 2012 to 2014. This domestic supply surge greatly offset US net crude oil imports, shrinking them from 8.5 MMbbl/d in 2012 to less than 7 MMbbl/d in 2014. Meanwhile, Brazil, Iraq, and Canada collectively added nearly 1 MMbbl/d over the same two-year period.

All told in 2014, production growth of 1.9 percent exceeded demand growth of 1 percent, leading to an inventory build-up of 500 thousand bbl/d with another 400 thousand bbl/d projected for 2015.

Is OPEC content to wait it out until high-cost producers fall by the wayside? Or, will OPEC cut production?

When oil prices first started to fall, many thought OPEC members might agree to cut production to support prices. However, members rejected that idea during their regularly scheduled meeting in November 2014, leaving OPEC’s official crude production target unchanged at 30 MMbbl/d. In light of the news, the market responded with an immediate 10 percent decline in the price of WTI crude.

Why couldn’t OPEC members agree on a strategic response despite the urgency of the situation? The opposing concerns of two different factions split the camp.

The fiscal breakeven cost is the price that OPEC producers need to receive for their oil in order to balance their government budgets, which are heavily reliant on oil revenue. When prices fall below the fiscal breakeven cost, oil-exporting economies must make up for the shortfall by drawing on cash reserves or reducing expenditures. Countries such as Iran, Venezuela, and Nigeria have high social costs and low cash reserves. The collapse in oil prices not only puts them under financial pressure but also potentially threatens the stability of their governments if transfer payments cannot be made. These fears make them more amenable to crying “uncle” and cutting production to boost prices.

Meanwhile, other OPEC members, such as Saudi Arabia, Kuwait, and the U.A.E., have cash reserves to finance the shortfall for many months. Their biggest fear is not near-term financial collapse, but instead long-term loss of market share. Here, the strong oil prices over the last few years have worked against them in some ways. Prices in the neighborhood of $100/bbl have facilitated significant growth in global crude production, particularly in North America. Today, the increasing volume of unconventional production in the US and Canada is changing import/export dynamics and decreasing western reliance on OPEC producers.

Rather than acting to defend prices, the Gulf producers within the organization, led by Saudi Arabia, are working to defend their global market share. In doing so, they are gambling that as the lower cost producers, OPEC members will ultimately prevail over more costly unconventional operators. Indeed, Saudi Arabia’s oil minister Ali al-Naimi has stated directly that the kingdom will not intervene to support prices. “Whether it goes down to $20, $40, $50, $60, it is irrelevant … it is not in the interest of OPEC producers to cut their production, whatever the price is”.

However, conventional oil field development generally requires years of planning and construction before the first barrels of oil are produced. Today’s low prices may not be enough to curtail the numerous development projects already underway.

What is happening in China, the leading contributor to global growth? Is it rebalancing its economy or has it started a painful correction?

In 2014, the Chinese economy officially grew at a rate of 7.4 percent, down from 7.7 percent, which represented the slowest rate of growth in 24 years.ix In the fourth quarter of 2014, the economy was up 7.3 percent from a year earlier, a figure that was a bit better than what investors had expected, but still indicative of a continuing slowdown.x Moreover, the IMF now predicts that GDP growth will fall below the psychologically important 7.0 percent level in 2015.

This raises questions about China’s future oil demand. In the past, China’s focus on infrastructure and capital projects made it the second largest consumer of crude oil in the world, and it imported large volumes of it at market prices—however high. But its transition to a more consumer-oriented economy might make it more price-sensitive in the future. Regardless, industry stakeholders should stay abreast of economic developments in China, since the nation has been responsible for 55 percent of total growth in oil consumption worldwide between 2005 and 2013.

How much new supply is poised to come online in 2015 and 2016?

In 2014, new non-OPEC large-field projects (i.e., those producing over 25 thousand bbl/d each) collectively brought on 2.3 MMbbl/d in new supply. These efforts spanned diverse geographies and production methods, ranging from Brazil’s offshore projects in the Roncador, Parque, Iracema, and Sapinhoa fields to Mars B in the Gulf of Mexico, and to Russian and Canadian oil sands projects. Notably, these supply additions excluded the numerous shale oil fields being developed in the US. OPEC also contributed to the expanding large-field supply picture, adding another 1.4 MM bbl/d of new oil production capacity in 2014.

For 2015, a Deloitte MarketPoint analysis suggests large-field projects could bring on 1.835 MMbbl/d in new supply (i.e., 1.2 MMbbl/d from non-OPEC producers and 0.635 MMbbl/d from OPEC members). These projects are well underway and are unlikely to be halted, even in the current low-price environment. Taking this momentum into account, the analysis further forecasts large-field production additions of 2.676 – 3.434 MMbbl/d from non-OPEC producers and 0.759 MMbbl/d from OPEC members in 2016.

For the past two years, US tight oil production has grown at an annual rate of approximately 1 MMbbl/d. This growth is expected to continue in 2015, but at a slower rate.xvii While the recent drop in crude prices has squeezed the capex budgets of shale producers, some reportedly have been able to lower their operating costs to below $40/bbl through efficiency gains and better economics in the “sweet spots” of the shale plays. As a result, production growth is expected to continue in the short term despite low prices, albeit more slowly than in prior years. While there is no consensus on the extent to which growth will slow, many analysts expect declines of 300-500 thousand bbl/d off the 2014 pace.

It is important to note that the world experiences a four to five percent production loss per year just from normal depletion. So the added production has to equal this amount if we are to stay even with no additional growth.

Will the industry stabilize and balance after 2016?

Based on current data, demand should grow faster than supplies starting in 2016. Low prices over the next few years will likely inhibit investment in new projects—especially those in the early stages of discussion or in the engineering and design phases. It should also bolster demand, due to price elasticity,much faster than otherwise would be the case.

What does the future look like in 2020?

By simulating how the aforementioned variables could affect market conditions, the Deloitte MarketPoint World Oil Model (the Model) provides some insight into where prices might be headed. The findings from the Model’s output include the following:

•     Based on the EIA’s estimates, production is expected to continue to outpace demand in 2015 by approximately 400 thousand/bbd. This assumption is driven largely by continued production growth through the first half of 2015 as many producers strive to complete projects falling into the “too late to turn back” category and as yet-to-expire hedging contracts allow them to continue producing despite uneconomic market conditions.

•     On a half-cycle basis, oil prices could fall below $40 bbl. There have been several periods in the last 25 years where prices have dipped well below this level. However, in the current market environment, some of the very low prices witnessed in the past are unlikely to reappear, at least on a sustained basis. Since oil markets are self-correcting, market forces should trigger an adjustment, mainly through low prices that engender more demand, decrease marginal, high-cost supply, and encourage supply depletion. This suggests that historically low prices could not be sustained for more than 3 to 12 months, absent other drivers affecting demand.

•     If the low-price environment continues as expected through the first half of 2015, it should trigger a demand response that will likely be felt in the second half of the year. This is the same time period when cut-backs on the number of shale drilling rigs in operation, expiring hedging contracts, and other production-related belt-tightening should start to have a more prominent effect on production growth and market perception.

•     As a result, Deloitte MarketPoint forecasts crude prices to rise in the second half of 2015, elevating the average annual price above present levels. Additionally, the forecast expects the average 2015 WTI price to reach $62/bbl and then to rise gradually over the next few years until it reaches a new steady range of $75-$80/bbl (i.e., combined WTI and Brent world crude price) as early as 2018. This new equilibrium price is approximately $20/bbl lower than the steady state achieved in previous years, because it reflects two new circumstances in the marketplace:

Prior to the “shale revolution,” there was a scarcity premium of $10-$20/bbl in place. With the newfound abundance of tight oil in the US and potentially in other areas around the globe, that scarcity premium has been reduced.

Producers in high-cost regions, such as the Canadian oil sands and certain tight oil plays in the US, have continued to improve their margins through technological innovation. While their margins will be lower in the new equilibrium-price environment, they should still be able to operate profitably.

The Deloitte MarketPoint price forecast is only one possibility among a multitude of potential outcomes. Changes in key assumptions, such as the magnitude of the demand response as well as the trajectory of tight oil production growth, would greatly change this picture. With only negligible shifts in demand or production in the next 12 to 18 months, the average price could likely be lower, and the recovery would likely be “U” shaped, reinforcing the price signal to shale producers to decrease production.

Forces that could potentially make upside price scenarios more likely include any number of black swan events affecting supply or the perception of supply scarcity. However, since oil markets are highly cyclical, they tend to overshoot or undershoot most long-term outlooks. The current price environment has, or soon will, curb many development plans. These can be restarted in the future once the pricing environment becomes more favorable, but the lag could just be the catalyst for pushing the market back into a scarcity mindset sooner than expected.

History has demonstrated that the oil and gas industry is resilient. Oil prices are rarely stable for extended periods of time, and the industry has shown a remarkable ability to adapt and thrive as cycles change. Even after analyzing market fundamentals and other variables, the questions keep coming: Will demand continue to moderate or grow in the face of lower gasoline prices? Will companies become more efficient, leading to lower breakeven prices for US shale plays? How will global/political circumstances change?

While forecasts can be helpful for thinking about possibilities, the future is never entirely visible. However, one thing is clear: Many oil and gas companies will need to retrench and determine how they can best adapt and manage change in this challenging environment. Enlightened companies will use this time as an opportunity to improve their organizations by continuing to focus on:

•     Enhanced efficiency and performance through business process and/or supply chain optimization

•     Strategic and operational improvements

•     Reduced and/or refocused capital expenditures

•     Portfolio upgrades through acquisitions and/or divestitures

•     Talent acquisitions

Continue Reading
Comments

Energy

How ASEAN should step up to accelerate sustainable energy within the region

Published

on

ASEAN is favored to be the 4th largest economy in the world by 2030 after showing impressive economic growth in the last decade. However, to reach that goal, ASEAN member states need to make sure that they can provide reliable access to energy to support industrial development. Unfortunately, as the region still imports 40% of its primary energy supply with fossil fuels becoming the largest share, the promise of ASEAN economic growth is currently at stake.

Over the years, ASEAN has been known for its heavily reliant on fossil fuels to meet domestic demand. ASEAN Center for Energy has reported that more than 80% of ASEAN’s energy mix in 2017 was fueled by fossil energy with oil accounting for 38,2% of total share and followed by gas (23.2%), and coal (22.3%). Vietnam and Indonesia, as the largest oil and coal producers respectively, have become important players for energy-importing countries such as Thailand, Philippines, and Malaysia. This long historic record on fossil consumption has posed a threat for Southeast Asia to become the slowest region in the world to shift to renewables.

But even so, it doesn’t mean that the ASEAN member states haven’t made any efforts at all. Vietnam might have shown the greatest accomplishment in accelerating the energy transition compared to other countries. Between 2016-2020, Vietnam has successfully doubled its production of renewables from 17.000 to over 35.000 megawatts. The rapid growth of solar panels in just four years has even made Vietnam become the third-largest solar market globally by 2020. Furthermore, ASEAN has also witnessed promising growth in the use of hydropower. Lao PDR, as traversed by The Greater Mekong, has powered 98.8% of its national electricity with hydropower generators in 2017. It even exports its energy to Thailand, Vietnam, and Cambodia through the transmission lines and is looking for expansion to Malaysia and Singapore, aiming to become Southeast Asia’s battery.

Seeing these potentials for sustainable energy deployment, the next question would be whether it is enough to push ASEAN to phase out the fossil fuel industry. Unfortunately, the same report from ASEAN Center for Energy has estimated that fossil fuel would still provide the majority of energy supply in 2040 even if ASEAN member states adopt a progressive scheme such as APAEC Targets Scenario. This is because energy security still presents a sensitive issue for Southeast Asia, where fossil fuels are perceived to be more reliable and cheaper than renewables. In consequence, while ASEAN will witness an enchantment of renewables in the following years, it will also see the growing trend in the use of clean coal technology, especially in major producer countries like Indonesia and Malaysia. Even Vietnam, which is considered the most successful country in accelerating renewables, will continue to rely on coal due to such perception of fossil fuels. As long as fossil fuels are still reckoned to be the main asset  of energy security, ASEAN won’t go far with its transition.

The incapability of ASEAN member states to undertake adequate transition on their own, makes regional cooperation becomes crucial. So far, the two most noticeable cooperation that promotes energy interconnections within the region are ASEAN Power Grid (APG) and Greater Mekong Subregion (GMS) Program. APG has been run under APAEC since 1999 to facilitate cross-border electricity trade and enhance the integration of Member States’ power systems. To date, 7 of 16 power interconnection projects have been completed mainly in The Upper West System (or in the Greater Mekong Subregion) and The Lower West System which covered Thailand, Peninsular Malaysia, Singapore, and Indonesia. However, most interconnection projects are still based on bilateral agreements and thus have no integrated regional power architecture. One program conducted on a multilateral basis is Lao PDR-Thailand-Malaysia-Singapore Power Integration Project (LTMS-PIP), yet the trading is still limited to a unidirectional flow of electricity. The energy cooperation under GMS also presents a similar problem where all projects still occur on bilateral deals.

Although bilateral cooperation carried out under APG and GMS has helped the member states to fulfill their domestic demand, implementing a more integrated power grid with a multilateral trading system will enhance the region’s energy security. This is because a regional power transmission grid with multilateral exchange offers more alternative resources and geographic diversification that will lower the systemic risks on renewables infrastructure. For example, countries with abundant clean energy like Lao PDR can transfer their hydropower to areas of deficit such as Malaysia and Singapore. Whilst, at the same time, surplus energy from one country can be sold to another through the power grid. This is where the multilateral trading regime becomes relevant to improve the accessibility and stability of energy consumption. Additionally, an interconnected power grid can also attract more investment as large-scale renewables will become more profitable.

It is therefore very timely for ASEAN to step up the game by accelerating the construction of an integrated power grid across the region. Without a strong commitment and sufficient transition, Southeast Asia’s economy could plummet by 11% by the end of the century. An integrated power grid might be the best possible scenario to prolong ASEAN’s economic growth in the future.

Continue Reading

Energy

The Insane Energy Policies of the Biden Administration

Published

on

With the projected loss of over 5 million barrels of oil a day due to sanctions against Russia, as a result of Russia’s invasion of Ukraine, the world faces an artificial energy crisis.  This crisis will throw the world’s economy into turmoil, and possibly throw the world into a prolonged economic slump. 

With the United States now relaxing sanctions against Venezuela in order to increase oil flow into the world energy market, and going hat in hand to the right wing Saudi Arabian government, the past policies of the United States are in a state of disarray.  By appealing to right wing governments in Saudi Arabia and Venezuela, the Biden Administration is allowing these governments to benefit from the Russia-Ukraine War, and punishing the American people by refusing to develop the ample supplies of shale oil that is in the United States.

What is glaringly absent from the Biden Administration’s energy policies is ignoring, and refusing to allow oil companies to develop the massive oil shale deposits in the Green River Formation.   The Green River Formation contains up to 4.3 trillion barrels of shale oil, which could be easily developed, and at a cost far below the average cost of developing either the current shale oil fields or the normal method of extracting oil from other traditional oil fields.

With the Biden Administration freezing oil drilling on federal land, the energy policy by the Biden Administration is quite literally insane.

The Green River Formation

The Green River Formation is located at the Green River in western Colorado, eastern Utah, and southwestern Wyoming.

The energy resources of the Green River Formation are not a true oil, but a form of pre-oil called kerogen. Kerogen is insoluble in water and in other organic solvents such as benzene or alcohol. However, when the kerogen is heated under pressure it breaks down into recoverable gaseous and liquid substances resembling petroleum. It is possible to break down this substance into synthetic oil.

Unlike normal processes of extracting shale oil called fracking, a process called pyrolysis is used. Pyrolysis occurs in the absence or near absence of oxygen. The rate of pyrolysis increases with temperature. “Pyrolysis transforms organic materials into their gaseous components, a solid residue of carbon and ash, and a liquid called pyrolytic oil (or bio-oil). Pyrolysis has two primary methods for removing contaminants from a substance: destruction and removal.”

The Hydraulic Fracturing Method

Hydraulic fracturing is used to recover oil and natural gas in oil shale deposits, where traditional oil drilling methods are not capable of recovering the oil in the rock strata. Hydraulic fracturing is also known as “fracking.” In order to recover the oil using fracking, a well is drilled into the rock strata containing the recoverable oil and natural gas. Then water, sand, and chemicals are injected into the well under high water pressure to continue to fracture the rock strata.

This then forces the oil and natural gas out of the well and is recovered into holding containers for further processing.

A huge amount of water is used during the fracking process. This is called the water cost. In a normal fracking procedure, between 1.5 to 9.7 million gallons of water are used to complete the fracking process for just one well. The water used during fracking becomes too polluted to be able to be used for human consumption. While the water used in fracking can be treated to return it to a potable status, the cost of doing so is so high, that typically the contaminated water is pumped into an underground chamber and removed from the rainwater cycle.

The technology to develop the Green River Formation does not use typical fracturing methods, so the water cost for the extraction is minimal. Because of the dramatically lower water cost, the breakeven point for extracting the kerogen is much less than traditional fracking.

The Green River Formation is a national security issue

The economic and political consequences of Russia invading Ukraine are now becoming clear.

One of the more obvious consequences has been the rapid rise in the price of oil. As of June 13,  the spot price of oil was $121.60 a barrel. Despite pleas from the Biden administration to Saudi Arabia to increase oil production, the Saudis have refused to do so. The United Arab Emirates appears to be siding with the Saudis and have also declined to raise oil production.

The Saudis are unhappy with the Biden administration’s efforts to renegotiate the Iran nuclear deal. They are also convinced that they have more in common with Russia in the current international environment. The Saudis are also angered by the pullback of support by the United States for its war in Yemen. This would appear to be the death knell of the agreement between the United States and Saudi Arabia where the U.S. guaranteed the national security of Saudi Arabia, while the Saudis guaranteed a steady supply of oil.

With the world upended because of Russia’s invasion of Ukraine, and the need for Europe to have steady oil and natural gas supplies, it is essential that the United States tap its vast oil shale reserves in the Green River Formation. This would help stabilize the energy security of the United States and its European allies. It would also make the United States 100% energy secure and free the United States from the cauldron of Middle East politics.

It should be noted here that this type of action by the United States would not be adding to the use of fossil fuels in the world. The exploitation of the Green River Formation would simply be displacing the use of fossil fuels from other sources of oil.

The cost of extracting this energy source cannot be accurately estimated. However, since the current technology available consumes less water because of the volatilization of water effect, the water cost is minimal, and so the breakeven cost of extracting a barrel of oil is significantly less than conventional fracking methods.

Reuters has estimated that the breakeven point for shale oil produced by fracking is $50. As noted above, fracking has a high-water cost. Since the current technology has a much lower water cost, it can be safely estimated to have a breakeven point of between $25 to $35 per barrel. If economies of scale are used, the cost could fall to as low as $15 to $25 a barrel.

Continue Reading

Energy

Looking beyond the Energy Price Shock to China’s Low Carbon Transition

Published

on

st

Authors: Martin Raiser, Sebastian Eckardt

The conflict in Ukraine has caused a massive shock to the global economy. Crude oil prices in early March spiked to as high as $140 per barrel, levels that were last seen in 2008. While prices have since come down from these peaks, they remain elevated, fueling already high inflation and hurting consumers and economic growth worldwide. Faced with this shock, countries everywhere are reappraising priorities, putting resilience at front and center. A renewed emphasis on food and energy security has compelled governments to reintroduce fossil fuel subsidies and ramp up domestic oil, gas and coal production, seemingly placing efforts to curb climate change on the back burner.

These reactions are understandable. A tactical retreat in the short run may be the price to pay to maintain public support for the long-term goal. But the economic case for accelerated climate action remains as strong as ever. For a country such as China with the domestic policy space to act, there are three key reasons to stay the course on the low carbon transition and aim for an early peak in emissions.

First, accelerating the energy transition would strengthen Beijing’s resilience to the volatility of global fossil fuel prices by reducing its dependence on oil & gas imports. Last year alone, China imported fossil fuels – oil, gas, and coal – worth $ 365.7 billion – the equivalent of more than two percent of the country’s gross domestic product (GDP). This dependence on fuel imports is exposing the economy to global commodity price fluctuations. In contrast, renewable energy is essentially a domestic resource, especially for China, which is a major producer of key renewable energy technologies from wind turbines to battery storage.

Secondly, while higher energy prices may boost the short-term global supply of fossil fuels, in the longer-term outlook, higher and more volatile energy prices will push incentives for energy importers to diversify away from fossil fuels. This will likely catalyze individual and global efforts to decarbonize energy systems, boosting global demand for low carbon technologies and alternative sources of energy. China has the technological capabilities to benefit by anticipating and getting ahead of this all-important global shift.

Additionally, rising energy prices would challenge China’s investment and industry-led growth model, reinforcing the case for accelerated structural changes and rebalancing. High prices will increase pressures on China’s economy to diversify away from traditional investments and heavy industries, including iron, steel and cement production, which account for a disproportionate share of the country’s GDP but face diminishing returns and low productivity growth. The slowdown in the domestic real estate sector is already pointing in this direction. Higher energy prices could galvanize the shift toward an innovation- and services-based economic growth model.

Even as policymakers remain focused on mitigating the economic and social impact of recent sharp changes in relative prices, there are measures they can take today to prepare for the low carbon transition and reduce its costs. For example, rising energy prices will create incentives for more sustainable business models, but only if investors believe they are here to stay. This is why credible long-term guidance on the intended trajectory of carbon pricing and other policies to decarbonize China’s economy is so important. This would help investors anticipate future price increases and help bring clean energy investments forward without any immediate need to regulate or raise the price of carbon. The current period of high energy prices is the moment to provide such forward guidance, as market price incentives are already pointing in the right direction.

Fiscal policy can complement the role of price signals by supporting the necessary economic adjustment rather than trying to slow it down. The prospect of additional government stimulus to boost growth could provide the financing for a wave of green investments, including in the build-out and integration of more renewable energy capacity. In agriculture, rising fertilizer prices should provide incentives to reduce excessive usage. However, this shift would be thwarted if input-based subsidies remain in place. Instead, farmers could be compensated for higher input prices with subsidies that are tied to a shift toward resilient production methods. Field studies reveal that chemical fertilizers can be effectively substituted with animal manure, reducing agricultural greenhouse gas emissions at no cost to yields. To realize such a shift, greater investment in agricultural extension is required. 

Finally, rising energy and food prices would hurt the poor and more vulnerable households the most. But rather than providing subsidies across the board, a more robust and targeted social safety net could protect the vulnerable populations in urban and rural areas. Offering such targeted protection could ensure price signals are not diluted but the structural changes necessary for the transition to a greener and more innovative growth model don’t come at the expense of rising poverty and social inequality.

While adding headwinds to the near-term economic outlook, the current energy price shock reinforces the case for accelerating China’s energy transition. Policymakers should keep their eyes on the long-term target and use this opportunity to prepare the ground.

(first published on CGTN via World Bank)

Continue Reading

Publications

Latest

Trending