Peak Oil Review – May 11

 Quote of the Week
“The large oil frackers have spent $80 billion more than they have received from selling oil. Wall Street greased those skids by underwriting debt and equity securities that allowed them to garner billions in fees. The banks are clearly incentivized to enable the frack addicts. What’s less obvious is whether investors are furnished a clear analysis of the returns these companies actually generate.
 
“As oil prices rose, it seemed like the frackers should have been drowning in cash. But none of them generated excess cash flow, not even when oil was at $100 a barrel. In fact, the opposite was true.
 
“Recently, oil prices have declined. Because the frackers have less revenue, they’ve been forced to cut Capex. Though they will continue to spend more dollars than they take in, production is no longer growing.  A business that burns cash and doesn’t grow isn’t worth anything.
 
“On the $36 of revenues per BOE [barrel of oil equivalent], Pioneer [Pioneer Natural Resources] spends about $14 on field operating expenses and another $6 on corporate expenses. Subtract the historical $28 of Capex, and Pioneer loses $12 for every BOE it develops. That’s like using $50 bills to counterfeit $20s.”
 
All of the above is from a recent presentation by David Einhorn, cofounder of Greenlight Capital 
 
1.  Oil and the Global Economy
 
The battle between higher and lower oil prices continued last week with futures hitting 2015 highs on Wednesday of $69.63 in London and $62.68 in New York. Prices then fell to close out the week at $65.39 and $59.39 respectively.  London oil was down 1.6 percent for the week, its weekly drop in a month. As has been the case for several weeks now some observers are looking at the continuing decline in US drilling rigs – down by 11 last week — and some better US employment numbers which they believe will lead to an imminent decline in US oil production and higher domestic demand. Others, however, note that global oil production is still circa 1.5 million b/d above consumption; the global economy is not doing that well; and the US shale oil industry has such a large backlog on drilled but not-yet-fracked wells, that it still will be a while before demand catches up with supply.
 
Last week the Wall Street Journal delved deeper into these opposing views with interviews of two traders holding opposing views. One believes that oil will close out the year around $45-50 a barrel while the other sees oil at $75 to $80.  The low-price trader holds that shale oil production will not fall very much in the second half of the year; that the global economy, particularly from China, will continue to be weak; that more Middle Eastern production will be coming online with an Iranian treaty likely later this year. The higher price view holds that the US shale oil industry has cut back so much that there will have to be a steep decline in production in the second half of this year. This coupled with some economic growth will keep prices higher for the remainder of the year.
 
Increasing interest rates are also cited as a factor. Cheap and freely available money has been just as important as fracking and horizontal drilling to the US shale oil boom. When interest rates start to climb shale and other expensive forms of oil production is sure to find trouble financing – especially if it does not look profitable.
 
Looking ten years ahead our experts worry about unknowns. Will there be new technologies that cut into demand for oil?  Will world production peak from a combination of geological reasons and the high costs of production? Will the climate get so bad that world leaders agree to cutbacks in the burning of fossil fuels?  Will the global economy continue to grow as in recent decades or have we reached the limits to growth?
 
A prominent hedge fund manager recently highlighted the unprofitability of many US shale oil producers who “drill lots and lots of holes and burn through plenty of borrowed cash without increasing their reserves.” He recommended shorting several companies that exist on hype concerning their prospects.
 
The possibility that 2015, give or take a year, will see the all-time peak in global oil production is coming in for increased discussion as some prominent analysts make a “peak year” call.  It has been known for some time that the US and Canada have been the major source of increased oil production, which has kept global production climbing slowly in the last few years as the rest of the world fell.  Russia has been able to keep its 10 million b/d of production level by drilling some 8,000 new wells each year in their older fields and the Saudis have had to step up drilling to maintain production.  Iraq has increased production by allowing foreign companies into areas that have been closed to exploration for decades by geopolitics. With the Russians starting to acknowledge that production from their older fields is dropping and with little chance of seeing much foreign investment, which would allow the country to move into Arctic or shale oil production, Russia production is forecast to peak this year.
 
Non-OPEC oil production is seeing dramatic cuts in capital spending; and the political situation in the Middle East continues to deteriorate. When all these factors are taken together, many are concluding that this year may just see the all-time peak in global oil production. It will of course be many years before this prediction can be confirmed.
 
2.  The Middle East & North Africa
 
Syria/Iraq: Heavy fighting has been taking place in the Qalamoun region northwest of Damascus along the Lebanese border where rebel forces were driven out by Hezbollah and government forces last year. The region is critical to the future of the Assad government and Hezbollah’s position in Lebanon as it controls a major border crossing, allowing Hezbollah forces to move freely into Syria, and Iranian arms flow to Hezbollah. Permanent loss of this region would be a major blow to the prospects for the Assad government. The downfall of Assad would have serious consequences for the future of Lebanon, Jordan, and Iraq, which in turn could eventually threaten oil exports or revive the prospects for foreign intervention.
 
It was a mixed week for Iraq. The good news was that Baghdad came up with the April budget payment to the Kurds, which will keep Erbil on the reservation for another month. Iraq’s oil exports were up in April, but other than that the news was mostly bad for Baghdad’s prospects.  A big car bomb went off in Baghdad, and there was a bloody jailbreak in which ISIL attacked a prison, possibly freeing as many as 200 of its residents. Numerous prisoners and guards died in the attack.  Such attacks show the increasing weakness of the government and raise the possibility that increased foreign intervention may become necessary. Another sign of growing trouble was a clash between the Iraqi President’s Kurdish bodyguard and Shiite militia last week.
 
The major oil refinery at Beiji was partially overrun by ISIL forces last week, although the besieged government garrison was reinforced last week. The Pentagon still fears for the refinery, which has not operated since the ISIL siege began last June, and is on the road to Mosel which the government seeks to recover.
 
A bill going through the US Congress designates that the 25 percent of US military aid go to the Kurdish Peshmerga. The bill, which calls that Kurds a “country” rather than a province in Iraq, has outraged Baghdad which does not like foreign involvement in this sensitive issue. The Obama administration is attempting to get the offensive language out of the bill.
 
Libya: As of Friday Libya’s oil production was running at about 380,000 – 400,000 b/d, down from about 600,000 a couple of weeks ago and 1.6 million b/d before the uprising. The oil port at Zueitina is still exporting oil drawn from local storage tanks as the pipelines to the port are still blocked by protestors seeking jobs.  Zueitina is one of the few oil export terminals still operational after major terminals at Ras Lanuf and Es Sider closed in December. The western El Feel oilfield is still shut by a security guard strike, as is the El Sahara field which is still closed due to a pipeline blockage. The loss of significant oil revenues has caused the central bank to spend down its substantial reserves accumulated during the good years. In 2014 reserves dropped by 25 percent.
 
The refugee crisis in which Libya is used as a jumping off place for thousands of African refugees seeking to make their way to the EU is coming to a head. The EU will seek UN approval for military attacks on smuggler bases in Libya to disrupt the flood of refugees being rescued or drowned in the Mediterranean. The attacks would be under Italian command and would involve forces from 10 EU countries including Britain, France, and Italy.  Some of the human trafficking seems to involve Libyan militias and Islamic groups, which may resist EU efforts to contain or destroy trafficker boats and facilities.  Getting UN Security Council approval may be difficult as Moscow holds a veto in the Council.
 
Iran:  Tehran has its fingers in so many pies at the moment it is difficult to keep them all straight.  The nuclear talks continue with no news of progress before the 30 June deadline. In Washington, the Congress is on the verge of passing a bill that will give it a say in deciding whether the congressional mandated sanctions will be lifted after they look at any nuclear agreement that evolves from the talks. This move makes the successful outcome of the talks still more problematic. Tehran clearly wants the sanctions lifted and is busy running around trying to set up deals to help its economy in a post-sanctions world. 
 
The US is trying to structure an possible nuclear agreement so that China and Russia cannot use their security council veto as a way to prevent the re-imposition of sanctions should any agreement be violated. Other than optimism over a possible nuclear treaty, it was a bad week for Tehran. The fighting in Syria, Iraq, and Yemen did not go particularly well for the Tehran-backed surrogates last week. 
 
Some are saying that the 10-year nuclear agreement which leaves Tehran free to expand its nuclear facilities after the treaty’s sunset is simply establishing a goal for other states in the region such as the Saudis, the Turks or the Egyptians to develop their own weapons — likely with Pakistani help.
 
Saudi Arabia/Yemen: Over the weekend, the Houthis accepted a Saudi offer of a 5-day ceasefire starting on Tuesday that would allow humanitarian supplies to the increasing desperate Yemenis who must import 90 percent of their food. The Saudis and their allies have accused Iran of trying to smuggle arms to the Houthis and their allies as they have no other source of resupply.
 
In the meantime the Saudis have intensified their attacks on the Houthis home province of Saada in retaliation for Houthi shelling of targets in Saudi Arabia. Most observers still are saying that the Saudis, who are not exactly a major land power, are unlikely to send ground forces very deep in Yemen for fear of getting bogged down in an endless morass.
 
The recent changes in leadership in Saudi Arabia under King Salman have concentrated political power in a small circle in one branch of the royal family. This move has given the King much more freedom of action to take bold policy moves such as the involvement in Yemen without the need to consider the views of other branches of the large royal family. In short, the Saudis have become less predictable than under former kings.
 
3.  China
 
Over the weekend, Beijing cut interest rates for the third time in six months in an effort to get its economy moving again. In a separate statement, the central bank said, “China’s economy is still facing relatively big downward pressure.”  The rate cut came just days after new figures show exports in April were down 6.4 percent from April 2015 and imports were down 16.2 percent. The industrial production numbers due this week are also expected to be low.
 
Some observers are noting that the series of rate and reserve requirement cuts do not seem to be doing much to revive the economy which is now thought to be growing at, for China, a meager 7 percent or less a year.  These observers believe that China will soon resort to state-finance infrastructure projects to revive the economy.
 
Despite the weaker import numbers, China’s crude oil imports hit a record last month as low prices encouraged the government to import crude for its strategic stockpiles. Imports in April were 7.4 million b/d which is about what the US has been importing lately and were 8.6 percent higher that in April of last year. The status of China’s strategic reserve is a state secret, but some analysts believe that the stockpiles are about to fill the currently available storage space and will slow shortly.
 
In recent years, China has embraced coal gasification, which involves treating coal with heat, steam and oxygen to turn it into methane gas that can be piped to cities to supply relatively clean heat and power in place of dirtier coal. Some 50 of these massive coal-to-methane plants are planned. The downside to this process is that it creates very dirty air and uses massive amounts of water in the rural areas where they are being built, not to mention that they end up releasing more carbon into the atmosphere than simply burning the coal.
 
Fortunately a reassessment of this plan, which was seen as quick fix for China’s dirty city air problem is now underway. New supplies of relatively cheap natural gas from Russia and Central Asia may be upsetting the economics of spending billions on these new plants. Interestingly, China’s policymakers often point to an early gasification plant that used to operate in North Dakota as evidence that the process is viable, without mentioning that the project went bankrupt and was bailed out by the US government in 1986.
 
4. Russia/Ukraine
 
The 70^th anniversary celebrations of the allied victory over Hitler did little to heal the deep gulf that has broken out between Russia and the West over the Ukrainian situation.  At a time when the world should be remembering the horrors of WWII which cost the Soviet Union the lives of some 28 million of its citizens, the growing animosity between Moscow and the West led to a virtual boycott of the victory celebrations by western leaders, and military parades designed to warn foreigners that Moscow is still a major military power.
 
The split is also driving global energy policies with the EU making efforts to replace Russian gas in its fuel import mix as Moscow turns to China as its favorite trading partner. Moscow’s efforts to build a new gas pipeline through Turkey and Greece to Europe, thereby avoiding Ukraine, has Washington pushing Athens to embrace a western-backed project that would bring gas to the EU for Azerbaijan instead.
 
Russia and China signed a new economic deal last week that would provide up to $25 billion in Chinese financing for Russian companies that can no longer borrow from the EU. Moscow is also working on deals with Iran, which has suddenly become Tehran’s “natural energy partner” rather than export competitor.  Fears are rising that Moscow will use its UN Security Council veto to harass the West by undercutting efforts to slow migration into Europe or by messing with sanctions pressure on Iran.
 
The bounce in oil prices in the last two months has given Moscow some economic breathing room, but this year does not look to be good for its economy. There are indications that Russia’s oil production may be peaking soon; however, it will be many years before the scope and pace of the decline becomes evident. For the immediate future, the global price of oil will be more important to Russia’s economic well-being.
 
5.  The Briefs
 
Global investment in upstream oil production this year is down around $100 billion, almost 20 percent lower than in 2014 and the largest drop ever seen, the IEA’s chief economist Fatih Birol said. The biggest portion of this is in the US, Canada and Brazil, Birol told journalists in Doha. He said shale oil’s decline rates are very steep.  At the price level seen at the beginning of this year [around $45/barrel], there will not be many projects in North America that will be profitable,” he said.  “There is still a huge gap between the cost of shale and the cost of [crude oil] production in the Middle East.” (5/6)
 
The European Union, keen to lessen its dependence on Russia for energy supplies, expects to start receiving natural gas from Turkmenistan by 2019, European Commission Vice President Maros Sefcovic said in an interview. Russia currently supplies around a third of Europe’s gas needs, but Moscow’s annexation of Crimea and its involvement in the military conflict in eastern Ukraine has added urgency to the EU’s search for gas from alternative sources. (5/4)
 
Stranded oil?  Even as oil rallies back above $60 a barrel, obituaries are being drafted. Oil majors face questions from shareholders concerned the threat of climate change means some of the reserves underpinning the companies will never be produced. In a recent report, HSBC urged investors to plan for this risk of “stranded assets.” (5/7)
 
India’s capital city Delhi shows the results of an unhealthy bargain: the world’s dirtiest air in exchange for electricity. Its state-owned utility is now seeking to cut emissions across its facilities in India, starting with its oldest — the one in Delhi. NTPC plans to spend $189 million annually on technology upgrades to cut dirty emissions. (5/6)
 
South Africa used to be one of the few countries on the continent where most people had reliable access to electricity. But a lack of maintenance and investment has pushed state-run power provider Eskom Holdings  into a daily crisis as it struggles to meet demand. Blackouts are threatening to drive Africa’s second-largest economy off a cliff. (5/9)
 
In Nigeria, fuel shortages are set to worsen as international traders and local marketers back away from imports over fears that the cash-strapped new government will halt costly subsidy payments. Already, lines at petrol stations in the major cities are blocking traffic as Africa’s largest crude oil exporter runs out of domestic fuels. (5/9)
 
Venezuela’s complex currency system has led to exorbitant schemes by importers, who wildly inflate the value of goods brought into the country to grab American dollars at rock-bottom exchange rates. (5/6)
 
Alberta upset: An index of Canadian energy companies plunged the most in three months after the win by Rachel Notley’s NDP, which has pledged to boost corporate taxes, review the government’s royalty rates for energy producers and phase out coal power. (5/8)
 
In Canada, a growing share of oil-by-rail traffic is made up of tough-to-ignite undiluted heavy crude and raw bitumen as companies scramble to cut expenditures with the price of crude down more than 40 percent since June. Interviews with industry executives suggest undiluted heavy and raw bitumen shipments now make up roughly a quarter of the estimated 200,000 b/d oil-by-rail market. (5/6)
 
After the latest oil train derailment in North Dakota, the state’s governor called for the quick development of more pipeline capacity. Six tank cars carrying Bakken crude oil through Heimdal, N.D., derailed Wednesday morning. (5/8)
 
The number of U.S. oil drilling rigs dropped to 668 last week, down 58 percent from the peak of 1609 last October.  According to Baker Hughes, gas rigs were down one to 221 this week. The US offshore rig count is at 34, unchanged from last week and down 25 from last year. The combined total active US rig count is now 894. (5/9)
 
Layoffs deja vu: Just as the legacy of the 1980s-90s created a shortage of experienced workers – contributing to rising costs, execution challenges, and safety concerns – the numbers of lost personnel, both current and future, threatens the long-term capacity of the industry. To many in the business it feels like history is repeating itself. (5/5)
 
Refracking, the practice of fracking an oil and gas well a second time, is still too unpredictable to rely on as a way to slash costs and increase output during the oil price slump, top US shale oil executives said on Tuesday. Producers say the refracking technology, while promising, remains tricky. (5/6)
 
Gasoline prices have revved up just in time for the beginning of summer. Prices at the pump have soared 31 percent since hitting a nearly six-year low in late January. (5/9)
 
US gasoline demand is running around 300,000 b/d above last year’s level, as lower pump prices and continued economic expansion encourage motorists to use their cars more. The summer 2015 driving season is likely to be one of the strongest for US gasoline demand since the financial crisis seven years ago, but only if pump prices are favorable. (5/6)
 
Flared gas regs: Lawmakers in Washington this week called on Interior Secretary Sally Jewel to review federal policies on so-called flared gas, pointing to a report from the Government Accountability Office finding federal standards are behind the curve. UN Secretary-General Ban Ki -moon, the World Bank Group and European energy leaders, from Royal Dutch Shell to Norwegian company Statoil, endorsed a plan to eliminate routine flaring no later than 2030. (5/9)
 
Condensates: Federal law lacks a clear definition of condensate, a light form of oil found in shale and cleared for exports, a bill tabled by U.S. Sen. Lisa Murkowski read. (5/9)
 
Oil exports: US Senator Murkowski said on Thursday she will unveil a bill next week that would reverse the 40-year-old ban on US oil exports. (5/8)
 
Seattle slowdown? Royal Dutch Shell’s quest to return to Arctic drilling for the first time in three years could face delays after Seattle ruled that the city’s port must apply for a permit for the company to use it as a hub for drilling rigs. Seattle’s Mayor Ed Murray applauded the requirement by the city’s planning department, saying it made “a bold statement about how oil companies contribute to climate change, oil spills and other environmental disasters.” (5/5)
 
LNG exports: The US Department of Energy reported that that it has issued a final authorization for Dominion Cove Point LNG LP to export US-produced LNG to countries that do not have a free-trade agreement with the US from its Cove Point LNG terminal in Calvert County, Md. (5/9)
 
Only five US. LNG export projects have gotten government approval and are under construction. Only one, Cheniere Energy’s first-out-of-the-gate facility at Sabine Pass, Louisiana, is on track to export any gas this year. Moody’s Investors Service, a ratings agency, warned last month that cheap oil could well kneecap U.S. and Canadian LNG export projects still in the queue.
 
In Pennsylvania, a proposed natural gas severance tax would have negative economic consequences for the state, according to a Natural Resource Economics Inc. study released May 7 by an in-state industry trade group. (5/9)
 
Chemical compounds used to extract natural gas were found in three water samples from Pennsylvania’s Marcellus Shale region, according to a study published in the Proceedings of the National Academy of Sciences. The contamination occurred at three Bradford County households whose owners settled a lawsuit with Chesapeake Energy Corp. in 2012 after natural gas polluted their well water. (5/6)
 
North Dakota’s new refinery—the Dakota Prairie—is the first of its kind in the country in nearly 40 years and will help drive the state’s economy forward. The refinery just started producing diesel fuel for a state which until now had imported more than two-thirds of the diesel fuel it consumes. (5/6)
 
Transocean Ltd. posted a first-quarter loss as the offshore oil driller logged more than $800 million in charges related to the downsizing of its fleet in response to lower crude prices. The Switzerland-based company, which boasts the world’s largest fleet of offshore drilling rigs, spent billions of dollars to expand its fleet right before oil prices dropped. (5/7)
 
Clean Energy Fuels produces a product called Redeem, which is the first renewable natural gas available in commercial quantities. RNG, or bio methane, can be created from sources such as decomposing organic waste in landfills. The RNG will be used in stations across California beginning this month to fuel tractors and delivery vehicles. (5/6)
 
Tesla is already building a 5-million-square-foot battery factory. It’s not big enough. That was the message from Tesla CEO Elon Musk this week while discussing, for the first time, the early response—roughly 800 in “reservation” orders—to his new product line of storage batteries designed for use in homes and businesses. (5/9)
 
Coal exports from terminals in Virginia’s Hampton Roads region totaled 2.5 million st in April, down 28.3% from March and 37.2% lower than the year-ago month.  (5/7)
 
CO2 historic high: The amount of heat-trapping carbon dioxide in the atmosphere averaged more than 400 parts per million globally for the first time ever in March, according to U.S. government measurements. The recording was based on air samples taken from 40 sites around the world. It’s the highest level of the gas in at least a million years. (5/7)
 
Climate action plan: The Obama administration’s far-reaching plan to address climate change would cause job losses and lead to higher electricity prices and even power outages, attorneys general from two energy-producing states—West Virginia and Oklahoma—said Tuesday. (5/6)
 
Nuclear decommissioning: At the edge of Humboldt Bay in northern California lies a relic from the heyday of US nuclear power. The reactor was shut down in 1976. The remaining cost to decommission the plant once and for all -– cleaning up lingering radiological dangers, dismantling the remains — will be about $441 million. The question is who will pay — for Humboldt Bay, and for dozens of other reactors that are in the process of closing or might soon. Nuclear operators like PG&E were supposed to lay up enough money to cover the costs. Turns out, most haven’t. PG&E’s Humboldt Bay trust fund, for instance, is currently $308 million short. (5/6)
 
California regulators on Wednesday adopted the first statewide rules for the permitting of seawater desalination projects that are expected to proliferate as drought-stricken communities increasingly turn to the ocean to supplement their drinking supplies. (5/7)
 
Chevron recycles 21 million gallons of oilfield wastewater each day and sells it to farmers who use it on about 45,000 acres of crops, about 10% of Kern County’s farmland. State and local officials praise the 2-decade-old program as a national model for coping with the region’s water shortages. (5/4)