Many important developments have radically changed the oil and
gas outlook over the past several weeks. Prices look likely
to stay high, or even rise further.
Iraq and Roll
The fast and deep advance by the forces of Islamic State of Iraq
and Greater Syria or Iraq and the Levant, ISIS or ISIL for short,
into Iraq has already made the London based 'Brent' world oil price
leap up to over $110 per barrel. To make matters worse, the
regime in Baghdad may not be able to hold its own, even with
American air power and other international assistance.
In response to ISIS's actions, President Obama agreed to send a
small contingent of special-forces, technical specialists, aerial
reconnaissance equipment, and additional armaments.
Prior to this year, Iraq had made strong progress toward its
goal of producing over nine million barrels of oil per day.
It was approaching four million in real capacity when ISIS
attacked late last year, taking the western city of Fallujah with
local disgruntled Sunni Muslim insurgent assistance.
Most of Iraqi capacity is in the far south and east, in and
around Basra, and the rest is nearly all in the ethnic Kurd region
centered in Erbil, and bordered by Kirkuk, which the locally
autonomous Kurdish armed forces, called Peshmerga, have taken.
One major refinery in the area, Baiji, is under siege by ISIS,
but it is unlikely they would destroy it, as they would want to use
its product output, and the revenue it could bring them.
Prized by both the Kurds and the central regime in Baghdad,
it is important regionally, but not in a global context.
The International Energy Agency, among other bodies and
analysts, had made the assumption that Iraqi production could
continue its steady progress towards six or more million barrels
per day by as soon as next year. However, the escalating
conflict has made this unlikely. Foreign capital and
expertise, both of them essential to increased production, will not
be deployed in oil fields due to security issues.
More Political, Security Risk Around the World
Aside from Iraq, Libya and Egypt are still not producing at
previous levels, and Syria will not return to the markets for a
long time. The nuclear deal the western powers reached with
Iran will run out shortly, and that regime has not, according to
observers, complied with the full letter of previous agreements.
Potential new sanctions could not only be imposed, but be
tightened, taking more oil off world markets.
Nigeria's stability is in question, too. A major exporter
of crude, it is not able to effectively deal with a growing
Islamist insurgency in its northern states. While this has
not come close to affecting oil producing areas, yet, it has
resulted in a loss of confidence from foreign investors who are
working in its oil patch. Another African oil producing area,
South Sudan, is offline, as a civil war rages.
Venezuela is descending into chaos, but the regime in Caracas
has managed to keep a lid on the violent dissent so far this year.
But the regime has minimal cash flow to reinvest in oil
production to forestall an oil production decline. This lack of
infrastructure improvement will eventually lead to a reduction in
production, and a boost to crude prices.
To this point, the reforms to the energy industry in Mexico have
only brought one tentative major investor to its Gulf of Mexico
fields: Total of France. However, it will take years
for any substantial improvement to production or reserves.
Shocking Reduction in Estimates for Monterey
New U.S. federal government assessments of the potential
reserves of the promising Monterey Shale formation in central
California were a shock. More than 90% of the potential
billions of barrels of oil equivalent gas and liquids of the
geologically complex area were determined to be either nonexistent
or not commercially viable. State regulators and politicians
were warming to licensing more exploratory drilling and hydraulic
fracturing, perhaps even in a major Bakken-level way.
However, the attractiveness of the whole oil province has now
radically declined. On the possible positive side, it could
result in the state government becoming more lenient and
encouraging in its approach, to entice reluctant companies to take
some wildcat bets and try their luck there.
Much Shale 'Oil' Not Really Oil at All
It turns out, depending on the formation, and the producer, much
of the tight oil being produced from shale beds is not, after all,
really oil in the normal sense at all. As much as 40% of this
production is highly volatile, light liquids more akin to what has
been called 'Natural Gas Liquids', or 'NGLs', than normal crude
This material cannot be processed easily in most U.S.
refineries, which have been configured, over the past several
years, to take much heavier grades of oil from Canada, Mexico, and
Venezuela. It has been mixed in with regular crude, used as a
diluent to transport Canadian oil sands bitumen, and sent by train
cars, but is reaching its limit of demand, causing a discount to
develop for shale-produced liquids. There are some new
refinery capacity being built to handle this material, but it will
be a catch-up situation; which could cause the discount to
Little Known Alaska Gas Pipeline Moving Ahead
While there has been a lot of attention paid to pipeline
controversies in the Lower 48 and in Canada, but lesser attention
has been given to a major pipeline in Alaska, which is currently in
the design stage. This project will bring billions of cubic
feet per day of natural gas from the North Slope to tidewater on
the Pacific Coast. The natural gas will then be processed for
liquefaction into LNG, then exported to East Asian markets.
This project will compete with others in Canada and the U.S. in
the important, and lucrative, Chinese, Korean, and Japanese
markets. However, it still will take many billions of dollars
and several years to complete, while demand in those Asian markets
will continue to grow, leaving abundant demand for many suppliers
Canada Supreme Court Ruling Benefits First Nations, LNG,
Hurts Oil Sands
Last week, Canada's Supreme Court ruled that aboriginal groups,
or 'First Nations', which have not already signed treaties with
provincial or federal government bodies are assumed to have
original ownership rights over their traditional lands. While
they may not have total ownership rights in the normal common law
sense, they do have pre-emptive rights over major resource
development or disruptive transit initiatives across these
This has major implications for the pipeline companies intending
to build or expand oil or gas pipelines from Northern Alberta (oil
sands oil) and Northeast British Columbia (shale oil and liquids).
First Nations are determinedly set against the
heavy-oil-bearing Northern Gateway project, and this ruling will
give them the means to fight it in court.
On the other hand, these same First Nations have been more
equivocal, and often positive, on the gas pipelines, which will go
to various Pacific ports, mainly Kitimat, in the north.
Environmental groups are opposing most new energy projects,
and are fundamentally opposed to all oil sands, hydraulic
fracturing, or, indeed, most any hydrocarbon development,
production, or consumption.
With the pipeline and energy firms now compelled to deal, they
could end up simply making straightforward monetary settlements,
which could be very lucrative to these mostly un-populous and
impoverished communities. There are few real environmental
issues with these projects, unlike with Northern Gateway, or the
Kinder Morgan-owned TransMountain expansion to Burnaby from
Edmonton (which may end up getting done, as it is an existing route
General Electric on Brink of Drastic Reduction in LNG
General Electric's energy research division is reported to be in
the testing stage of a new process for the liquefaction of natural
gas, which reduces the costs of making LNG by an order of
magnitude, or in the neighborhood of 90%.
While still in the testing stage, this breakthrough, if true,
could radically reshape and restructure energy markets worldwide.
Not only will it reduce the cost of shipping LNG to Asia from
North America, it could make many more projects viable all over the
world. Right now, producers take a big discount, since
liquefaction and shipping can cost over $5 per million BTU, whereas
pipeline gas may only get charged $1 or less per thousand
It could also mean not just experimental, tentative,
pilot-project-like efforts at use of LNG by transport fleets of
trains, trucks, buses, and delivery vehicles in North America and
elsewhere, but faster and more widespread deployment and demand for
LNG and gas in general. This could mean that the apparent
'hard floor' of more than $4 per mBTU in North America could
U.S. Government Eases Export Restrictions
In a somewhat surprising move, the U.S. federal government gave
approval for quantities of lightly processed oil to be exported,
relieving pressure on the oversupply of light shale liquids being
produced in ever-growing abundance. These liquids are already
close to being usable as-is by customers overseas, so some very
simple refining not requiring full refining capacity is apparently
enough to qualify for export.
This will also relieve some pressure on other, conventional oil
and also oil sands oil producers in North America, and on
refineries configured to take heavier oil, not the lighter shale
U.S. Federal Government Enacts Restrictions on Coal
On June 2nd, U.S. President Barack Obama and the Environmental
Protection Agency announced that it would require the power sector
to reduce carbon emissions by 30% below 2005 levels by 2030.
The major effect of this will be to radically reduce U.S. coal
consumption and increase use of natural gas as a substitute, and in
new power plant capacity. While the current administration
wants to encourage more use of renewable energy, energy storage of
most renewables' intermittent nature means, in practice, that gas
will have to take up the supply gap.
Fortunately, there is abundant gas in Canada and the U.S., and
energy reforms in Mexico mean that country may eventually start
becoming a net exporter rather than an importer of the
Russia-China Deal Impressive, on Surface
Russia and China signed a major deal for the export of hundreds
of millions of dollars worth of natural gas from Siberian fields to
the energy hungry industry in eastern China. This deal is
very important for several reasons, which is why Russia had to take
a significant discount to its previous asking price.
Russia is further diversifying its customer array.
Previously, Russia has been mainly dependent on Europe as
their primary customer, and now with the sanctions enacted for the
subverting of Eastern Ukraine and the takeover of the Crimean
peninsula, Russia needed to have another outlet for its main
export, and another source of money, should Europe further
constrict its commercial arrangements with the Kremlin.
As for China, it gains another major source of supply, although
it already had one significant pipeline from Russia. This
will enable China to better manage its gas supply, which has been
highly dependent on Central Asian and Myanmar gas. There is,
as yet, no North American import gas available, and Qatari and
other Mideast sources are expensive.
Moreover, the horrible air pollution in most Chinese cities
means that the country can no longer keep adding coal-fired power
capacity to feed its growing economy. The pollution is a
major health hazard, and also a cause of increasing public
discontent. Gas use will grow, but only at a price acceptable
to Beijing. There has not been much news on the country's own
shale gas and liquids efforts. The geological conditions are
dissimilar to those in North America, and access to water is an
issue, so production growth will be slow.
Energy use is expanding rapidly in China, and has, thus far,
been mainly in the form of coal or oil. The shift to gas will
tend to keep a floor under prices, especially as demand for gas
picks up in major consumers such as India and Indonesia. As
for Indonesia, it is only very slowly reducing price subsidies to
domestic consumers of fuels, making it an artificially large
importer of oil and gas.
Africa Wrangling Keeps Continent on Sidelines
Uganda has finally made a deal which will bring its new oil
production to export markets via a facility on the coast of Kenya.
However, the contentious nature of the negotiations, which
required the producing companies to construct an uneconomic
refinery in Uganda, set a poor precedent for further exploration
and exploitation in central Africa.
Corruption and poor infrastructure continue to delay development
in Mozambique, while logistics, royalty regime uncertainty, and
other issues are slowing exploration offshore Tanzania, Namibia,
and South Africa. Production growth in Africa will be
important in future, but it will only partly offset declines
elsewhere in the world.
Conclusion: Oil and Gas Prices Likely to Stay
Aside from the potential lower costs of gas liquefaction from
GE, most other energy news has been neutral or negative regarding
the supply for the next several quarters, while demand for both gas
and oil continue to rise, not just in North America, particularly
for gas, but all around the world.
Therefore, even if there is not any major armed conflict (in
addition to all the current ones) in the near future, it seems
unlikely that either natural gas or
will decline in the near term. The former could rise as coal
recedes in use, the economy continues to slowly grow, and winter
looms with storage levels below the long-term average. With
the U.S. economic expansion already tepid at best, higher energy
prices will depress growth even further.
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