1. Production and prices
The week started with oil trading at around $69 a barrel on periodic concern that the global recovery was running out of steam. This was helped by a forecast that the demand for gasoline would drop in the US and Europe over the next 10 years as more efficient autos become the norm and emissions controls are implemented. On Wednesday, however, the market’s mood shifted when the US stockpile data showed US crude inventories dropped by 4.7 million barrels vs. a 2.5 million barrel analyst forecast and an American Petroleum Institute report the night before showing that inventories had actually risen by 600,000 barrels the previous week. Much of the drop was caused by reduced crude imports as refiners cut back on production amid weak gasoline sales.
Little in the underlying fundamentals of the oil markets has changed since early summer, leaving oil trading in the vicinity of $70 a barrel. “Green shoots” and government bailouts in America, coupled with reports that China is leading a world recovery, continue to balance weak employment and real estate numbers in the US.
Natural gas prices moved higher last week closing on Friday at $3.76 per million BTUs despite record storage levels and several weeks to go before winter heating gets going. After reaching a 7-year low of $2.41 on September 4th, natural gas has now risen 56 percent in only nine trading sessions.
2. The crack spread
With the price of crude hovering around $70, a price which many say is not supported by fundamentals, refiners are having trouble making money by refining crude. The industry is faced with slipping demand for its various refined products – gasoline, diesel, heating oil, jet fuel, and bunker fuel. MasterCard reports that the average 4-week demand for gasoline in the US slipped by 3.2 percent over last year – the ninth straight weekly decline.
Cracking spreads vary with products, refinery efficiency and type of crude being processed. In January refiners could earn as much as $27.80 per barrel refining crude into diesel and heating oil. With crude oil prices doubling and product prices moving little, that number recently fell to $4.98 — near a two-year low. The gasoline crack, which was earning about $15 all summer, recently fell to $5.22 a barrel.
Refiners have little choice other than to cut back on processing, closing refineries for lengthy maintenance, selling off excess capacity, and delaying new projects. Valero recently announced a delay in a $250 million refinery upgrade in Louisiana due to poor refining margins.
European refiners which sell some 1 million b/d of gasoline to the US market are experiencing the same problems and reducing refining capacity, keeping downward pressure on the US gasoline market. One consulting firm has estimated that 2.8 million b/d of European refining capacity could be shut down over the next ten years. Over the longer term, should robust Chinese demand for crude or a weaker dollar keep crude prices increasing, the crack spread problem can only grow worse.
3. Ominous Forecasts
After the 2008 oil price spike, the deepening recession and the subsequent 2-3 million b/d drop in global demand for oil, many observers concluded that lower consumption would delay the “supply squeeze” which has become the euphemism-of-choice in the government and financial community for peak oil. In recent days, however, there have been several reports questioning whether peak production is not closer than generally accepted.
The general argument is that significant drops in investments during the past year, and relatively low spare production capacity, coupled with the widely expected economic rebound, will combine to leave us with global oil shortages and much higher prices in the next two-three years. There is also growing skepticism that many of the new deepwater finds announced in recent months can be produced quickly enough to make much difference.
Last week, such mainstream institutions as the Macquarie, a prominent Australian investment bank, Morgan Stanley, the Abu Dhabi Nation Oil Company, the Kuwaiti government, the Financial times, and the Executive Director of the International Energy Agency all released information or analysis suggesting that global oil shortages could develop in the next one, two or three years. As could be expected, all the forecasts start with the assumption that a rebound in demand for oil will begin shortly.
The most alarming of the reports came from Macquarie which sees global production capacity topping out at 89.6 million b/d during this year, spare capacity being wiped out by 2012, and world supply peaking in 2014 at 89.1 million b/d. [Macquarie turned down a request by ASPO-USA for an interview in London last week].
There is little new in these reports that has not been known by the peak oil community for some time, except that the imminence of the problem is starting to gravitate to a wider circle of organizations that are willing to talk about it.
More questions are starting to arise about the damage that $70 to $80 oil could do to economic recovery. Although these prices seem cheap in comparison with last summer, historical analysis suggests we are back close to a price point that has triggered economic setbacks in the past.
Quote of the Week
“Our medium-term global oil balance does not balance post 2013…(Oil near $150) would very soon create another set of global economic drivers which would spell much lower demand in the future…In the very long term we can see demand for oil falling quite substantially.” — Iain Reid, a senior oil analyst at Macquarie Bank
Commentary: Mission Critical: Can Shale Gas Save the World?
In late August the Vancouver Sun ran an article on the bullish prospects for Canadian shale gas. The piece began this way: “What energy crisis? Despite what you may be hearing about a global peak in oil production, waning reserves, and $100-plus oil prices, North America is suddenly awash in fossil fuel.”
The most arresting quote came from Mike Graham of EnCana, a Canadian company that holds dominant positions in British Columbia’s Montney and Horn River plays. “Natural gas will displace coal. It will displace oil. There is no reason North America shouldn’t be energy self-sufficient if we can displace a lot of the oil with natural gas.”
Are we all of a sudden “awash in fossil fuel?” On the road to “energy self-sufficiency?”
You may have your doubts, but when talking with key gas industry insiders, it’s clear they believe shale gas has changed the game. (We’ll explore the topic in depth at the upcoming ASPO conference in Denver, October 11-13th. To register: http://www.aspo-usa.com/2009denver/ )
For example, Aubrey McClendon, CEO of Chesapeake Energy, believes the Marcellus shale, which underlies Appalachia, holds as much gas-in-place as the U.S. has used in its entire history. Production from the Marcellus is still negligible, and not all of that gas is recoverable, but the belief that America’s gas future is much brighter than we thought a few years ago is beginning to take root.
Ignoring the ubiquitous hype, let’s presuppose for a minute that increased domestic drilling, combined with large hikes in LNG imports, could lead to big increases in U.S. gas supply. What would be the highest and best use of that new gas?
To reduce the trade deficit and lessen U.S. dependence on foreign oil, you could launch an effort to use compressed natural gas in vehicles. (After decades of half-hearted efforts, there are still way fewer than one million CNG vehicles on American roads, out of a fleet nearing 250 million.) If the goal is to save money and enhance national security, this would be the smartest strategy.
But if the goal is to save carbon, you would use the natural gas to displace coal in the electric sector. This idea seems to be gaining traction. For example, in July Colorado governor Bill Ritter addressed hundreds of natural gas executives at a conference in Denver. A year ago Ritter was in the midst of a bruising battle with the industry, as he championed aggressive new standards for drilling and wildlife protection. Now, facing a tough re-election challenge, he struck a conciliatory note.
“Natural gas is a vital part of the new energy economy – not a bridge fuel, not a transition fuel, but a mission-critical fuel,” the Governor proclaimed. “We can’t begin to address climate change in a meaningful way without using more natural gas.”
In recent months clean energy advocate Robert F. Kennedy, Jr. and former Colorado Senator Tim Wirth have echoed similar sentiments. “Climate disruption is real,” Wirth told the Denver conference. “We are in very deep trouble, the edge of catastrophe. The gas industry must play a major role in saving the world.”
In Colorado, as in China, the question is what to do about coal. Each day 10,000 hopper cars heaped with coal – enough to fill a train 110 miles long – trundle out of the Rockies, bound for power plants as distant as Florida. (One insatiable coal plant near Atlanta owns 35 complete train sets, which trundle incessantly back and forth to Wyoming. That’s necessary since a trainload takes five days to get there, and is burned within eight hours.)
Ritter is one of many governors who have called for a 20 percent reduction in greenhouse emissions by 2020. This is a very tall order, in no small part because his state may add one million people by then. Population is rarely broached in climate discussions, which is unfortunate because growth is a big deal. Reducing emissions while people are increasing is like running down an up escalator. To hit Ritter’s target, all growth in demand would need to be met through conservation and a multi-billion investment in carbon-free wind, solar, or nuclear. Simultaneously, you’d have to retire nearly one-half of Colorado’s coal plants, and somehow replace their output.
Could conservation fill the entire gap? That’s unlikely. The potential for energy saving is enormous but getting it to happen on such a large scale in such a short time would be difficult. Efficiency may be the new apple pie, but the inconvenient truth is that the typical household is using 10 percent more electricity than it did a decade ago, due to the proliferation of air conditioning, plasma TVs, and other gadgets. That leaves burning more natural gas, a lot more, nearly twice as much as the state burns for electricity now.
The politics of fuel switching are difficult, because it would raise electric rates and because coal’s markup rivals that of Fiji Water. Each year, the nation’s utilities spin $40 billion worth of coal into $160 billion of electricity. Thus, although the average coal plant is nearly 40 years-old, there’s no incentive to retire it, even though it produces three times more carbon dioxide than a modern gas turbine. If the nation was really serious about addressing climate change, the “cash for clunkers” program would have targeted those ancient coal plants, not F150s.
Does Colorado produce enough natural gas to support such a strategy? Yes, plenty. One-fifth of the state’s current exports would suffice. The math is much more difficult at the national level.
If the goal was to displace half the coal now burned in the power sector, the U.S. would have to increase its annual gas consumption from roughly 20 trillion cubic feet to 28 trillion cubic feet. That’s a big lift, since U.S. gas production peaked 35 years ago at 21.7 trillion cubic feet, and is today 5 percent lower.
Right now, the Rockies gas industry is suffering through its worst year in recent history. Due to the recession, commodity prices have cratered. Not a single coalbed methane well was drilled in Wyoming’s Powder River Basin in June, welcome news to local environmental groups.
For the next year or two, the nation is likely to indeed remain awash in gas. But if the country were to embrace fuel switching, as it may need to do to reduce greenhouse gas emissions quickly, the glut would disappear and boatloads more LNG and dramatic increases in drilling would be needed.
Indeed, to displace half the coal we now use with gas, we’d need to complete 30,000 to 50,000 new wells a year for decades to come. If that’s our strategy for averting climate disaster, then we’ll need to put somebody like Sarah Palin in charge of drilling.