- Choking On Natural Gas, But Is It About To End?
- Crude Oil Prices Track Stock Market Performance
- Time To Bet On Natural Gas Or Short Crude Oil?
- Electric Vehicles And Their Role In Our Energy Future
- June Vehicle Miles Up – Return of The American Driver?
- Global Warming Lawsuit May Raise Temperatures
- Cash For Clunkers Impact On U.S. Energy Markets
Musings From the Oil Patch
September 1, 2009
Allen Brooks
Managing Director
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
The September 2009 natural gas futures contract expired last Thursday night with the price setting another 7-month low of $2.843 per Mcf. The October 2009 contract that became the new front-month contract was off 14.4 cents in early trading Friday morning, but still held above $3 per Mcf. It closed the trading day still slightly above $3. Whether the new front-month gas contract can sustain a price north of $3 per Mcf for any extended period of time, given the swelling supplies of natural gas in inventory, remains a huge question mark.
Estimates are that total natural gas storage capacity in the U.S. ranges somewhere between 3.6 Trillion cubic feet (Tcf) to 3.9 Tcf. Reports are that the U.S. Energy Information Administration (EIA) will be releasing an updated study on gas storage in this country either this week or next, and it reportedly will show about a 100 Bcf increase in domestic capacity. As of last week, the EIA said in its weekly gas storage report that the volume of working gas in storage, meaning gas available for consumption this winter, had reached 3.258 Tcf or anywhere from 83.5% to 90.5% of estimated industry storage capacity. That volume of working gas in storage would satisfy 54 days of average U.S. gas consumption, but only a small portion of gas storage volumes is used each winter day as there remains a huge supply of flowing gas to help meet the daily demand.
The problem for the natural gas market has been that gas production continues to remain strong due to the continued development of new producing wells from the highly prolific gas-shale plays sprouting up around the country. The increase in gas production volumes was thought to have been arrested by now as a result of the nearly 50% cutback in gas-oriented drilling since last fall. Unfortunately, E&P companies continue to drill highly prolific wells in the gas-shale basins due to their estimated lower finding and development cost allowing them to generate profits in a low-price environment and in order to retain expensive mineral leases signed in recent years. The impact of these new prolific wells, coupled with the decline in domestic gas demand due to the weak economy, has been greater than expected weekly gas storage injections. As shown in the accompanying chart, the weekly storage injections (in red) for 2009 so far have almost always exceeded the five-year average weekly injection figure (in blue). Injection volumes for the past two weeks have been below the five-year average, but still above Wall Street’s expectations.
Exhibit 1. Weekly Gas Injections Signal Full Storage Ahead
Source: EIA, PPHB
As the chart shows, if gas injections continue to average in the 50-55 Bcf range until the winter heating season arrives and when gas begins being withdrawn, storage capacity will reach full capacity. There are essentially 10 more weeks of injection season and at the current injection rate, the industry will be trying to stuff another roughly 550 Bcf of gas into the already jam-packed facilities around the country. The real problem as we approach full capacity is that storage availability in broad geographic regions and even in local areas can reach full capacity well before the entire system, causing supply system discontinuities and pricing anomalies.
The recent announcement by Newfield Exploration Co. (NFX-NYSE) that it was shutting in about 2.5 Bcf of third quarter gas production is a sign of the stress producers are under to avoid selling gas below finding and development costs while still trying to satisfy Wall Street and investors for growing corporate production metrics. As we have written about before, other producers such as Chesapeake Energy (CHK-NYES) have said they do not plan to curtail production and bear the financial brunt of reduced revenues while other producers benefit. Chesapeake expects production cutbacks to occur at some point, driven by industry-wide factors, and to be spread broadly across the E&P industry.
Exhibit 2. Gas Storage Capacity Comes In Various Forms
Source: EIA
The natural gas storage business is a challenging one in this country. The cost to build new facilities is not cheap. Additionally, it often takes a long time to construct new facilities. This means storage facilities may be constructed in response to a volatile pricing period and planned to capture some of that volatility, only to find that the market is changed by the time the facility is ready for operation.
There are five types of storage facilities as shown in the above exhibit and these facilities are spread across the country although there tends to be a greater concentration in gas-consuming regions since the facilities are planned to help gas pipeline and local distribution companies deal with winter demand surges.
Exhibit 3. Storage Near Consumers Or Pipeline Entry Points
Source: EIA
What can straighten out the natural gas market? Short of a surge in economic activity that brings back industrial demand previously destroyed by high and volatile gas prices, it is going to take greater capital discipline on the part of E&P executives. Yes, an early cold winter could also help, but that will merely create a short-term blip in gas prices as weather has a tendency to change rapidly. Additionally, it is difficult to envision Wall Street becoming enamored of an investment sector where E&P executives become weather forecasters. However, as the E&P industry draws closer to the expiration of gas futures hedges put in place when natural gas prices were $8 and above, which protected producer cash flows in this low wellhead price period, E&P producers may be forced to re-examine their future spending plans. Unless gas production falls quickly helping to boost gas prices, we expect to see another downturn in the rig count, or at least for those rigs drilling for natural gas.
We will not attempt to describe how the E&P industry came unglued from its frothy environment of pre-September 2008, but a picture is worth a 1,000 words. We have superimposed the 2008-2009 Baker Hughes active rig count on the rig count experienced in 1981-1987. Clearly today’s rig count is but a fraction of what it was at the end of the industry boom of the late 1970s, but that reflects the greater drilling productivity the industry has achieved from drilling rigs today versus those in the past. There is also a substantial difference in the number of E&P producers and drilling rig companies operating in the two periods. But the recovery we are witnessing in today’s rig count is eerily similar to the pattern that occurred in late 1982.
Exhibit 4. Current Rig Upturn Could Be Short-lived
Source: Baker Hughes, PPHB
The late 1982 rig activity recovery was followed in 1983-1985 by periods of both rig recoveries and downturns as oil prices steadily slipped out from under OPEC’s control and U.S. natural gas remained under price regulations. The industry then seemed to find stability in drilling until the oil market entered a freefall in early 1986 as Saudi Arabia elected to not only stop supporting the OPEC posted price at the time but the Kingdom elected to open up its wells to teach “cheating” fellow OPEC members a lesson.
Talk about a “teachable moment” in history! It took the global energy industry more than a decade to recover from that moment and Houston was particularly hard hit by its fallout. We certainly are not suggesting we are headed for a repeat of that era, but the current rig upturn could prove to be short-lived and followed by another downturn if natural gas prices continue to fall. We present this scenario merely as food for thought, but it is enough to keep us awake at night.
Green shoots or not, the stock market and crude oil futures have developed a symbiotic relationship over the past year. In fact, many Wall Street sages remark on how oil prices seem to have merely followed the daily movements of the Dow Jones Industrial Average (DJIA) since the middle of 2008. Since the broad stock market is known to be a leading indicator for economic activity, it is not surprising that there would be a relatively close relationship between these two measures.
As shown in the accompanying chart, the stock market, as measured by the DJIA, essentially traded sideways from the beginning of 2007 through to the fall of that year. During that time, crude oil futures were steadily climbing from slightly under $60 a barrel to the $80 threshold. At that point, the stock market peaked. After oil prices traded above $80 and then pulled back to that price point suggesting that there was real support in the market for oil prices to hold at that level and probably move higher, the stock market began a course of setting lower highs and lower lows – a notoriously bearish technical trading pattern. As oil prices moved from $80 a barrel into the $90s, the stock market began sliding, but it rallied when crude oil fell back toward the high $80s.
The stock market rally was snuffed out as crude resumed its upward march and touched $100 a barrel. Another oil price retreat followed by a sideways move in the $90 a barrel range helped the stock market to stabilize. At that point, both the stock market and oil prices rose in concert until oil was solidly across the $120 a barrel threshold. It was at that point in late spring that Bear Sterns collapsed and credit markets began to come under significant stress. As the stock market fell, crude oil price continued to rise marking another period of disconnect. The last surge in crude oil prices probably reflected investor concern about the safety of financial instruments and the value of the U.S. dollar so the move into commodities as a hedge gained greater credibility and desirability.
While it took a little while for oil prices to correct and catch up with the falling stock market, the pattern of oil prices following stock prices seemed to be established. That pattern appears to be well entrenched today as one can see the almost daily movements of the DJIA being mirrored in the action in crude oil futures prices.
Exhibit 5. Stocks and Oil Have A Symbiotic Relationship
Source: Yahoo Finance, EIA, PPHB
Given this lockstep pattern of crude oil futures following the stock market, it becomes much more important to be watching those factors that may influence the stock market’s future trading than the daily machinations about crude oil supply and demand and inventories. If so, then the recent analysis by Morgan Stanley of bear market trading patterns becomes important.
Exhibit 6. Morgan Stanley Says Market Rally Has Legs
Source: Agora Financial
Morgan Stanley analyzed 19 different bear market trading patterns (they also looked at one gold market) and determined that on average market prices fell by 56% over a 29-month period in the first stage of the bear market and then rebounded by 70% over the following 17 months. (Numerous charts and financial industry
stories use the Morgan Stanley chart. Why the data on the chart differs from the data in the table they published we cannot explain, however the conclusions remain the same.)
Exhibit 7. Morgan Stanley Data Supports Lower Rally Life
Source: Plexus Management
In the current bear market, the broad market fell by 57% over 17 months from the October 2007 peak. It subsequently rebounded by 49% over the five months from the March 2009 lows to the initial rally end of August 7th. By historical measures, the current stock market rally, while temporarily in a pause, is not over and could last into early 2010. If so, then the stock market might be signaling that crude oil prices, after a consolidation period in the low $70s a barrel, have further to rise, maybe solidly back above $85 or even possibly toward $100 a barrel. If this doesn’t give one heady thoughts about energy stocks and future energy company earnings then probably nothing will!
For most of this year, the Wall Street view has been that natural gas is the Rodney Dangerfield of commodities – it gets no respect. On the first trading day of 2009, the ratio of crude oil prices to natural gas prices was 7.8 times, not significantly off from the actual heat content ratio between the two fuels of 5.8 times. Moreover, the January 2nd ratio stood well within the range of 6–8 times that investors had come to see as the general range for this ratio of oil and gas prices.
As January progressed the price ratio began to drift lower with it falling to 6.8 times, but largely due to crude oil prices falling by almost $9 a barrel, or almost 20%, while natural gas prices fell by only about $0.50 per thousand cubic feet (Mcf), or by about 10%. Of course America was in the heart of winter when natural gas demand is strongest, as summer’s heat-driven air conditioning load has yet to equal the winter heating demand for natural gas.
The track of natural gas prices so far this year has been interesting. On January 2nd, gas prices were $5.97, but then steadily declined until early March when the price fell below $4.00 per Mcf ($3.95 on March 6th). For roughly the next six months, natural gas prices fluctuated between the low $3 to slightly over $4 per Mcf range. Gas prices seemed to always strengthen when the media and investors focused on “green shoots” of global economic recovery. Natural gas prices were above $4 per Mcf as recently as early August, but the continued absence of gas demand and the relentless arrival of new supply despite gas-oriented drilling dropping in half have pushed natural gas inventories to near record levels for this time of the year. With barely ten weeks of the gas storage injection season left, expectations are that storage will soon be full and gas production will be forced to be reduced. As this report is written, Newfield Exploration (NFT-NYSE) announced it was shutting in 2.5 billion cubic feet (Bcf) of its third quarter production volumes from the Midcontinent region. Chesapeake Energy (CHK-NYSE) has also announced Midcontinent gas production shut-ins. The net effect is that these companies will have lower production than they would have had otherwise, but their cutbacks will barely slow the pace of the industry approaching full gas storage.
While natural gas prices have been in essentially a steady decline, crude oil prices have been rising for most of the year. The net effect has been that the crude oil to natural gas price ratio has soared. From the theoretical heat ratio of 6:1, it has soared to over 26:1 and was at 25.5:1 as this article is written. As the nearby chart shows, the current oil to gas ratio is literally off the charts with respect to modern history.
Exhibit 8. Crude Oil To Gas Price Is Highest Ever
Source: EIA, PPHB
We calculated the average ratio of crude oil to natural gas prices from January 13, 1994, through March 31, 2009, which averaged 8.43. From April 1st through August 25th, the ratio averaged 17.11, or more than twice the ratio of the prior 15½ years. That would certainly argue that something is about to change – either natural gas prices will rise, or crude oil prices will fall. Which will it be and when might it happen?
Exhibit 9. Crude Oil To Natural Gas Ratio Set To Change
Note: Crude oil price in black; natural gas price times 6 in blue.
Source: Econbrowser.com
James Hamilton of Econbrowser.com did some work on the relationship between crude oil and natural gas prices. In the above chart, he plotted crude oil prices (the black line) from 1998 through mid July, and natural gas prices multiplied by six to reflect the estimated energy content relationship between the two fuels (the blue line) for the same period. He then went on to explore the relationship between oil and gas prices in an effort to see whether crude oil prices would fall to close the gap between the two fuel values or whether natural gas prices would rise.
We will not bore you with the formulas, but Mr. Hamilton’s regression analysis work suggests that if you try to forecast crude oil prices from their own lagged values and the lagged oil-gas price gap, a positive gap between oil and gas prices such as exists now tends to pull down slightly oil prices. The problem with his analysis, which he acknowledges, is that the regression coefficient is not statistically significant, meaning that you can’t state categorically that the downward move is the direct result of the variables used in the regression equation.
What he did find, however, was that the cost gap does help to project where natural gas prices might be headed. At the time he did his analysis, the cost gap, which is defined as the percentage gap in cost between the two fuels, was 1.13. The historical regression might lead one to project natural gas prices climbing by 10% a month until the gap is closed. Even with this optimistic outlook, Mr. Hamilton sees problems, several of which include the successful development of gas-shale formations and a lack of gas demand. We could add some additional issues for the natural gas business like potential low-cost liquefied natural gas (LNG) supplies, falling coal prices, and possible expanding natural gas supplies from Canada. You also may have to contend with government intervention in the fuel markets through regulation.
While it looks like natural gas prices should rise to close the gap with crude oil prices, Mr. Hamilton’s analysis suggests there might also be some help from the downward tug on oil prices from low gas prices. To us, the big issue, and overriding issue, for the trends in crude oil and natural gas prices is the pace of economic activity. Without a significant economic recovery, we think there will be greater downward pressure on crude oil prices given current inventory levels in this country. Higher global economic activity may help boost oil prices, but on balance it seems there is too much oil sloshing around the world. Natural gas, on the other hand, is dependent on the U.S. economy, which despite all the euphoria in the stock market looks like it continues to struggle to regain its footing following the credit crisis and economic collapse of late last year. Without a snapback in the economy, it may take a hurricane, another drop in gas-oriented drilling that undercuts new production supplies or an early cold winter to boost gas prices.
That said it is interesting to watch the movement into natural gas investments by Wall Street. As mentioned earlier, the conventional trade has been to go long natural gas futures and short crude oil futures in response to the divergent moves in their respective prices. For those investors who made that trade, it has been a trying, and losing, proposition. As demonstrated in the adjacent chart, from their low early this year, crude oil prices have roughly doubled while natural gas futures have been cut in half since the start of the year.
Exhibit 10. So Far This Year: Oil Is Up and Gas Is Down
Source: EIA, PPHB
To demonstrate how investors reacted to this investment wisdom, one can look at the pattern of the two most popular ETFs representing crude oil (USO) and natural gas (UNG). The volume of trades, both buys and sells, began climbing in December of last year when crude oil was making its bottom from the 2008 correction. The volume of trades peaked on a spike in early February (the 12th) about the time crude oil established its low price for 2009. One of the triggers for this surge in oil buying was the fact that the February low price of $33.98 failed to fall below the December 19, 2008, low price of $33.87 a barrel. That trend gave investors confidence that the low of late 2008 marked the bottom in this cycle’s oil price correction.
Exhibit 11. The Crude Oil Trade Has Worked Well So Far
Source: BigCharts.com
The bet on natural gas has not been as successful as demonstrated by the trading pattern for the natural gas ETF. Other than some volume spikes in late March, the move into the gas ETF didn’t begin to build until late May reaching a crescendo in early June, just prior to the drop in gas futures prices below $4 per Mcf. As gas prices subsequently rallied back over that $4 threshold before collapsing ultimately to below $3, investor interest began to pick up as demonstrated by the surge in UNG volume in July. So far, all those UNG buyers have seen their investments shrink in value as natural gas markets have deteriorated rather than recover as most had expected.
The most interesting phenomenon underway now in the gas market is selling by investors in the commodities market and likely the UNG and other gas-oriented ETFs out of fear of prospective changes in regulations dealing with commodity trader position limits. These changes have been proposed by the Commodities Futures Trading Commission (CFTC) after a series of hearings about speculators
Exhibit 12. The Natural Gas Trade Has Failed So Far
Source: BigCharts.com
and distortions in oil and gas prices. As we have seen investors wanting to play the closing of the gap between oil and gas prices being forced out of their commodity holdings, we are seeing increased investments by these funds in natural gas-oriented E&P stocks, especially for those companies with substantial exposure to the better gas-shale development plays. The view is that if one cannot invest in the commodity, the next best thing is to first derivative – the stocks of producers who will directly benefit from an increase in the price of natural gas.
Will this trade be successful? It would appear that even a modest economic recovery coupled with increased capital discipline by E&P companies will lead to a recovery in natural gas prices. That conclusion assumes there is no tinkering with the natural gas or energy markets that would create the sort of environment that kept natural gas prices depressed for most of the 1980s and 1990s. Since we cannot rule that event out completely, it reinforces our view that the key to oil and gas prices will be the pace of the economic recovery and regulation – both of which are unknown and exposed to possible shock treatments.
The Obama administration came into office with definite views about the future course of America’s energy use. Their vision is that our future energy supplies will be influenced by greater reliance on renewable fuels such as solar and wind. They also want to have cleaner air, which the Supreme Court helped along with its ruling that the Environmental Protection Agency (EPA) could regulate CO2 emissions under the 1977 Clean Air Act. The EPA, with the administration’s support, has pushed the Corporate Average Fuel Efficiency (CAFE) standard to 35.5 miles per gallon (mpg) blended car fleet average in 2016. Cars are also supposed to only emit 155 grams of carbon dioxide per kilometer.
The EPA has been encouraging electric cars and plug-in vehicles as a way of meeting these more exacting fuel and environmental standards. It has been reported by Daniel Sperling, professor of civil engineering and the founder of the Institute for Transportation Studies at the University of California at Davis that at the Almaden Institute hosted by IBM (IBM-NYSE), the EPA is considering counting an electric car as the equal of three conventionally-powered cars and counting its emissions as zero.
Electric and plug-in vehicles don’t emit pollution at the tailpipe, but the electric power plants that will power them certainly do. Thus, the amount of environmental savings from these vehicles will depend on where they operate. In states heavily dependent on coal-fired electric power such as Ohio or diesel-powered plants such as Hawaii, the environmental savings will be small. In other states the savings will be substantially greater. The problem is that electric and plug-in vehicles may not save this country as much fuel as regulators believe.
John Petersen, a former battery company executive and director, has produced an analysis of the benefits of certain types of batteries on fuel savings and on the cost benefits of hybrid and electric vehicles versus conventionally powered vehicles. Mr. Petersen posed the question of why we should build one electric vehicle that would save its owner 400 gallons of fuel a year while using enough batteries to build ten Toyota Motor (TM-NYSE) Prius-class hybrids that could save their owners a total of 4,000 gallons of gas a year.
The highly hyped GM Volt plug-in electric vehicle that uses a gasoline engine for charging its battery is being matched by Nissan Motor’s (NSANY-PK) Leaf, a pure electric car that also will rely on lithium-ion batteries. Both vehicles are supposed to cost about $40,000 each. Each GM Volt will use 16 kWh of lithium-ion batteries while the Nissan Leaf is projected to use 24 kWh of lithium-ion batteries. Each vehicle would save its owner 436 gallons of gasoline over an estimated 12,000 miles of annual driving compared to the typical American car that currently meets CAFE standards of an average 27.5 mpg and that emits about 4.4 tons of CO2. But will the electric and plug-in electric vehicles hurt the American energy industry?
According to Mr. Petersen’s analysis, the Toyota Prius is the more dangerous car from the oil industry’s perspective. His study used the common denominator of 48 kWh of battery power to compare the three vehicles and found, as shown in the accompanying chart, the total annual gasoline savings for every 48 kWh of battery capacity used by each manufacturer. From this table, clearly the Prius is potentially the more dangerous car for oil companies interested in selling gasoline. So are electric vehicles the answer to this country’s future transportation needs?
Exhibit 13. Oil Companies Should Fear Prius Market Power
Source: John Petersen, Seeking Alpha, PPHB
Mr. Petersen also did an analysis of the undiscounted and discounted costs of owning various types of hybrid, plug-in and conventional vehicles over five- and ten-year periods of ownership. His baseline scenario was a conventional car costing $20,000, averaging 30 mpg, using 417 gallons of fuel a year, and being sold after five years for 35% of its purchase price or sold after 10 years with a 10% salvage value. The cost of fuel was escalated at 17.5% per year, the average rise in the price of crude oil over the past decade. The undiscounted five-year and 10-year ownership costs for this vehicle are $21,671 and $46,090, respectively.
The four models he compared to the conventional vehicle was a $21,000 micro hybrid that would improve fuel economy by 8%; a $23,000 mild hybrid that would improve fuel economy by 20%; a $26,000 full hybrid that would improve fuel economy by 40%; and a $32,500 plug-in hybrid (after tax credits) that would offer 40 miles of electric vehicle range and 30 mpg fuel economy from its internal combustion engine.
Exhibit 14. Electric Vehicles Have Mountains To Scale
Source: John Petersen, Seeking Alpha, PPHB
On an undiscounted basis, over five years the ICE vehicle has the second lowest ownership cost, losing out to the micro hybrid by $44. For the ten-year ownership period, the ICE vehicle is the most expensive to own due to the rising cost of gasoline.
On a discounted basis, using a 7.5% rate, the ICE vehicle was the most expensive to own and operate over the 10-year holding period while it was the least costly over the five-year period. The discounted analysis was most sensitive to the cost of gasoline, the discount rate used and the cost of batteries. The point of the study is that electric and plug-in vehicles are not big savers for consumers because they use low-cost electricity. Without government subsidies they are not competitive at all and they will be less convenient and reliable for their owners.
It appears that much remains to be achieved in the development of economical hybrid and electric vehicles before they are truly competitive. We remain optimistic that these improvements will happen, but we have no idea how long they will take.
The U.S. Department of Transportation’s Federal Highway Administration (FHWA) reported its survey of vehicle miles driven on America’s roads for the month of June. The preliminary survey data estimates that Americans drove 256.7 billion vehicle miles in the month, a 2% increase over last June’s total of miles driven, or an increase of 4.9 billion vehicle miles. Americans did roughly one-third of their driving on rural roads with the balance on urban roads, a not surprising statistic given the concentration of the population in metropolitan areas.
On a 12-month cumulative basis through June, miles driven by Americans were 0.4% lower than for the same period last year. But probably a more important statistic is that compared to May, Americans did not drive any more, nor less, despite the rise in average gasoline prices. The May driving totals, however, were revised lower by about 600 million miles from the 257.3 billion vehicle miles initially estimated by the FHWA for the month.
In previous articles discussing American driving habits, we produced a chart showing the 12-month rolling cumulative total of vehicle miles driven beginning in January 1983. We have compared the miles driven data to the average monthly unleaded regular gasoline pump price, which showed that as gasoline prices held around $1 a gallon in the 1980s and most of the 1990s, vehicle miles driven rose at a very healthy rate of increase. That pace actually accelerated in the late 1990s and into the early years of the current decade driven largely by the economic boom the country. Beginning about 2005, gasoline prices began to climb and as they crossed the $2.50 a gallon threshold, the pace of miles driven slowed appreciably. As gasoline prices climbed above $3 a gallon, the cumulative miles driven total actually turned negative as year-over-year monthly declines increased. The spike in gasoline prices above $4 a gallon in 2008, before the economy imploded due to the credit crisis, forced Americans to rein in their driving habits as high pump prices significantly impacted consumer budgets.
Exhibit 15. Gasoline Prices Impacting American Driving Habits
Source: EIA, FHWA, PPHB
To counter high gasoline prices, Americans have cut their driving by consolidating trips, switching to public transportation and/or carpools for getting to work or school, buying more fuel-efficient vehicles and ultimately electing to stay at home. It appeared by the end of 2008, and reinforced by early 2009 data that American driving habits had been altered – the unknown was whether the shift was temporary or permanent.
In December 2008, oil prices reached their low for the year, which was actually a low for a multi-year period. The average unleaded regular gasoline price in December was $1.687 per gallon. As year-end approached, gasoline prices began to recover following the recovery in crude oil prices. From December to January, average pump prices rose by about a dime a gallon, and then jumped by 13.5 cents in February. The pace of the price rise slowed appreciably in March as the average pump price increased by only about 3.5 cents per gallon. The pace of monthly increases picked up with April showing about a 9-cent rise, but then the pace greatly accelerated with May’s average price up over 10%, or 21.7 cents per gallon. The accelerating pace was followed with June’s average pump price jumping by 36.5 cents before falling back in July by 10.4 cents a gallon.
The impact of low gasoline prices on American driving activity became clear as the cumulative miles driven total flattened out and began rising. That rise was substantiated with the June FHWA data. But the most telling development will be whether the pace of American driving begins to slow again as gasoline prices have rallied above $2.50 a gallon. The future track for gasoline prices, as suggested by the reformulated gasoline future traded on the NYMEX exchange (August 25th), shows about a 4.25% increase between the September 2009 futures and the May 2010 ones. If we measure the difference in price between the October 2009 and May 2010 futures, it is 11.1%. The difference between the two measurement periods reflects the change in the fuel specifications – shifting from summer gasoline to winter gasoline. The latter contains more butane and is less difficult to produce partially explaining the roughly 12.5-cent per gallon spread between the September and October gasoline futures prices.
There have been reports in recent days that the Colonial pipeline, the principal products pipeline moving gasoline from the Gulf Coast to the East Coast, has been full and additional gasoline volumes have been rejected. The implication is that gasoline pump prices may have peaked for the time being and are headed down, which would likely take them back into the $2.50 a gallon or lower range that should help boost American driving. The big question is what might happen to gasoline prices in 2010.
Exhibit 16. Gasoline Generally Follows Oil Prices
Source: EIA, PPHB
As we know, petroleum product prices don’t get too far away from the trend in crude oil prices. That fact is shown in the accompanying chart tracking gasoline and crude oil prices since the start of 2000. However, for shorter periods we often see differences in the trend in gasoline and oil prices, as shown in the chart below. In the early part of this summer, refiners were under severe profit margin pressure as weak demand and rising crude oil prices squeezed what they could earn at the pump. Refiners seized on the recent pick-up in American driving to try to recapture some of their previously lost margin. They may try to hold pump prices up as we move into fall in hopes that stable or lower crude oil prices and cheaper blending components may further widen their profit margins even with current pump prices discouraging driving.
Exhibit 17. Lately Gasoline Has Not Followed Oil As Closely
Source: EIA, PPHB
While there is definitely a positive shape to the crude oil futures curve, between October 2009 and May 2010, the futures project only a 6% increase over this time period. There doesn’t appear to be much prospect for a meaningful drop or rise in oil prices over the next six months factored into the futures. A surge in economic activity or another financial downturn could significantly impact oil and gasoline prices and certainly American driving patterns. We remain unconvinced that Americans will get back on the long-term trendline in vehicle miles traveled suggesting further adjustments will be forced on the oil industry’s downstream business.
Last week the U.S. Chamber of Commerce filed a 21-page petition with the Environmental Protection Agency (EPA) asking it to approve an on-the-record proceeding with an independent trier of fact who would allow the EPA and environmental and business groups to engage in a “credible weighing” of the scientific evidence that global warming endangers human health. This follows the two public hearings held by the EPA over its planned move to declare that emissions of carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride from new automobiles and their engines contribute to air pollution that endangers public health and welfare.
A representative of the Chamber of Commerce characterized the hearing as being similar to the 1925 “Scopes Monkey Trial” that pitted famous defense attorney Clarence Darrow against three-time presidential candidate Williams Jennings Bryan in a battle over the teaching of evolution versus creationism in Tennessee. The chance of this happening, in our estimation, is pretty slim. Why, because the “debate is over” but maybe also because a senior scientist in the EPA has reported that his study questioning the science used to justify the ruling was suppressed and the agency wouldn’t want to have that event questioned. An additional problem might be the resurrection of the inquiry into many of the claims made by Al Gore in his movie, An Inconvenient Truth, by a court in England. We wrote about that when we covered the battle in the House Energy and Commerce Committee over allowing testimony from the leading critic of Al Gore’s movie in England, Lord Christopher Monckton, The Viscount Monckton of Brenchley, to be heard after Mr. Gore addressed the committee.
Our commentary on the situation in our May 26, 2009, Musings said the following. “Mr. Gore’s antipathy toward Lord Monckton probably dates back to the High Court in London’s identification of nine “errors” in Mr. Gore’s award-winning movie, An Inconvenient Truth. Lord Monckton played a role in the case. The judge stated that if the UK Government had not agreed to send to every secondary school in England a corrected guidance note making clear the mainstream scientific position on these nine “errors,” he would have made a finding that the Government’s distribution of the film and the first draft of the guidance note earlier in 2007 to all English secondary schools had been an unlawful contravention of an Act of Parliament prohibiting the political indoctrination of children. Each of the nine “errors” identified by the judge has been admitted by the UK Government to be inconsistent with the mainstream of scientific opinion.”
This appeal comes at a time when a new study on hurricanes in the North Atlantic Ocean claims that there have been more hurricanes and tropical storms over the last decade than it has experienced since a similarly stormy period 1,000 years ago. The study, published in the journal Nature, tries to trace the pattern of storms along North America’s Atlantic and Gulf coasts back to 500 A.D. by examining layers of sediment collected from coastal ponds and salt marshes that tend to flood when hurricanes make landfall nearby. The researchers, led by Pennsylvania State University climate scientist, Michael Mann, one of the creators of the “hockey stick” chart of global temperatures used initially by global warming protagonists and that has been largely refuted, also used a computer model to simulate 1,500 years of Atlantic storms, feeding in data collected between 1851 and 2006 about weather and climate factors known to influence hurricane activity.
The study’s authors report that the two models produced similar overall results. They suggest that warmer temperatures produce more storm activity, meaning that the coming climate change that projects warmer temperatures could increase the frequency of hurricane activity. The results of this study have created the usual reactions – supporters who claim that this paper raises the flag about the potential for global warming to increase the number and intensity of hurricanes, while other climate scientists say that the paper’s very large levels of uncertainty and critical assumptions raises as many questions as it attempts to answer.
As this paper was being published, the National Climate Data Center said that the oceans’ waters worldwide averaged 62.6 degrees in July, 1.1 degree higher than the 20th century average and that it beat the previous high established in 1998 by a couple hundredths of a degree. This data has further raised concern about the impact of warm waters on hurricane formation this year, although the development of an El Niño in the Pacific Ocean has generated more shear winds in the Atlantic basin that undercuts tropical storm formation.
The primary concern about this data is that global warming is raising water temperatures, which is a more ominous sign of future problems because water takes longer to warm and is slower to cool. Countering this trend is National Oceanic and Atmospheric Administration (NOAA) satellite data that has been measuring natural microwave thermal emissions from oxygen in the atmosphere. The signals that these microwave radiometers measure at different microwave frequencies are directly proportional to the temperature of different, deep layers of the atmosphere. This data shows that the world has been experiencing cooler temperatures in recent years. This satellite data also shows that the 1998 spike, used by the global warming proponents to make their case, was the result of an El Niño warming, a natural phenomenon and not a man-made cause. The data is collected and published by the University of Alabama at Huntsville in conjunction with the Marshall Space Center.
Exhibit 18. Atmospheric Temperature Readings Show Cooling
Source: Roy Spencer, Ph. D.
Data for the past decade collected on land also supports the view that the earth’s temperatures have been cooling and not warming as proponents of global warming have been proclaiming. Anecdotal evidence of hot and dry weather in parts of the United States has been used to argue the case for global warming. Of course the cool summer months this year in the Midwest and Northeast were cited as due to the forces of climate change altering traditional weather patterns.
Exhibit 19. Recent Monthly Temperatures Show Negative Trend
Source: Spaceref.com
The data from NOAA compares favorably with the chart presented by Lord Monckton in his letter to Representative Joe Barton (TX-Rep.), minority head of the House Committee on Energy and Commerce, expanding upon his testimony and refuting claims of Dr. Karl, head of the Goddard Space Institute, about the manipulation of temperature data later acknowledged by officials there.
Exhibit 20. Global Cooling Temperature Chart Used At Hearing
Source: Monckton letter, Committee on Energy and Commerce, March 30, 2009
We suggest that readers of the Musings prepare to be inundated by articles and studies from both proponents and opponents of global warming. As the EPA legislation moves forward and we draw closer to the Copenhagen conference in December to design the global response to the Kyoto protocol for addressing global warming, the rhetoric will definitely escalate. We doubt anyone’s opinions will be swayed by the studies and articles. What may sway people is what China and India do about mandates to deal with their emissions. We think the argument that they owe more to their citizens economic and welfare development than they do to the governments of highly developed economies over controlling carbon emissions is a signal that little substantial progress is likely to be made at the Copenhagen conference.
The federal government’s “Cash for Clunkers” program was deemed wildly successful. So successful in fact that it ran out of money in its first few days and needed Congressional approval to re-load the program with an additional $2 billion. The program was highly successful if measured by its ability to generate sales of vehicles off dealer lots. Its success was further reflected in the program being suspended early as the total $3 billion commitment was about to be exceeded in less than a month. The program, signed into law June 24, 2009, and scheduled to run from July 1st to November 1st, didn’t get rolling until July 27th and then was almost immediately suspended as the $1 billion in funds initially allotted was exhausted. After about a week, Congress authorized an additional $2 billion in funds, which was nearly totally exhausted by the program’s end on August 25th.
Under the Clunkers program, according to the government’s web site, 690,114 new vehicles were sold with government incentives totaling $2.877 billion. Some 84% of the vehicles traded-in were reportedly trucks while 59% of the vehicles purchased were cars. Edmunds.com, a leading automobile web site, claims that there were many more trucks (light duty and SUVs) sold than the government is reporting, but we won’t know for sure until all the statistics are published at some point in the future. The government says the vehicles purchased had an average fuel efficiency rating of 24.9 miles per gallon (mpg) while those traded-in averaged only 15.8 mpg, or an efficiency gain of 9.1 mpg. If we assume all the vehicles involved are driven an average of 15,000 miles a year, then the annual fuel savings from the Clunkers program should be somewhere in the neighborhood of 239.6 million gallons, or about 5.7 million barrels. The savings from this fleet substitution will amount to about two-thirds of a day’s gasoline demand in the United States.
There was certainly an economic impact from the Clunkers program. According to the government, the Big 3 Detroit automakers sold about 38.6% of the vehicles purchased under the program, but that is well below their domestic market share that has averaged 45.3% through July, according to HIS Global Insight. The government proclaims the Clunkers program will boost 3rd quarter U.S. Gross Domestic Product by 0.3-0.4% and will stimulate the 4th quarter economic recovery as manufacturers crank out new inventory to offset the sales. The government says the program saved or created 42,000 jobs. The challenge now is for the automobile industry to use this jump-start to build sales momentum, something that may prove difficult.
Exhibit 21. Clunkers Pulls Sales Forward; Demand Still Weak
Source: J.D. Power and Assoc., HIS Global Insight, PPHB
IHS Global Insight has revised its U.S. automobile sales forecast to reflect the Clunker stimulus program. They raised their 2009 vehicle sales forecast by 500,000 units to 10.3 million units, but cut their 2010 forecast by 200,000 units to 11.1 million. Under IHS’s basic case, however, the U.S. automobile industry is not likely to return to its halcyon sales days of 2005 when it sold 17 million vehicles until 2014. At the same time, IHS Global Insight said under its worst case outlook for the industry, instead of reaching a 15 million unit sales figure in 2014, which is its base case, that target might not be achieved until 2014. As we have postulated, until the domestic automobile industry returns to sales volumes more like the late 1990s and early 2000s, or 15-17 million units annually, it will not be a major stimulus for energy demand. GM just reported its estimate for sales in 2010 of 12 million units, much more optimistic than all the other industry forecasts we have seen.
Contact PPHB:
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Houston, Texas 77056
Main Tel: (713) 621-8100
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www.pphb.com
Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
