Musings From the Oil Patch
June 2, 2020
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
U.S. Natural Gas Market Challenge With Weaker LNG Exports
The abundance of supply in the U.S. natural gas market for the past half dozen years has been tied to the growth of associated gas, primarily gas produced from Permian Basin shale oil wells that have been in a drilling frenzy. That supply fueled expansion of the nation’s capacity to export liquefied natural gas (LNG), as our production exceeded domestic gas needs, as well as pipeline export commitments to Canada and Mexico. The strong supply growth has contributed to declining natural gas prices, which reached a low in early April not seen in 25 years.
Exhibit 1. U.S. Natural Gas Prices Are Struggling
Source: EIA, PPHB
Although gas prices declined throughout 2019, the decline was interrupted by some brief rallies. Unseasonably cold temperatures at the end of August, coupled with hurricane supply shut-ins, created concern that we might not be building storage supplies quickly enough. Those forces contributed to an early fall price spike, which quickly evaporated as the underlying supply fears evaporated. There was a second price spike due to a blast of cold weather, but we then spent the balance of the winter with warmer than normal temperatures. As we exited winter, gas storage volumes were higher than normal, which depressed prices, as there was little need to build storage aggressively, especially given the assumption of continued rapid growth of associated gas supplies. The price decline continued in 2020, with the exception of two brief spikes, until gas prices hit rock bottom of $1.55 per thousand cubic feet (Mcf) in early April.
Natural gas prices suddenly reversed, driven by fallout from the explosion of the coronavirus and the early March failure of Russia and Saudi Arabia to forge a new agreement to limit oil output from the OPEC+ group. The combination of these two events, often preferred to as a double Black Swan, caused global oil prices to collapse. They fell fast and far. For a few hours in late March, April oil futures prices actually fell below zero for the first time ever.
The oil price collapse shocked the energy world. It forced producers to cut capital spending, stopping drilling new wells and completing recently drilled ones, as well as shutting down producing wells where the operating cost exceeded what they could earn. The lack of gasoline, diesel and jet fuel demand forced refineries to stop buying crude oil to refine. Particularly hard hit in this rapid industry readjustment was oil activity in the Permian, the industry’s most active basin. With oil production falling, so too did its associated natural gas output.
Exhibit 2. Associated Gas Plays A Major Market Role
Source: EIA, PPHB
Associated gas has gone from 15% of total gas supply at the start of 2015 to nearly 25% in March. The importance of associated gas, as well as gas from the Marcellus formation in the Northeast, is highlighted in Exhibit 2. As can be seen, associated gas output was already showing weakness in the early months of 2020, as Permian Basin drilling slowed. When oil prices crashed, the popular belief was that the primary fuel beneficiary would be dry natural gas, i.e., gas found in traditional gas deposits and not in oil reservoirs. It also was assumed this gas would cost more to bring to market, meaning that gas futures prices needed to rise to stimulate producers to drill for and produce more dry gas. Thus, we see natural gas prices suddenly reversing and rising from the $1.55/Mcf low that was reached at the start of April, to over $2/Mcf, barely a month later.
It was at this point that the outlook for LNG exports began to deteriorate. as cargo cancellations began in April and picked up in May and June. The current month has had 24 cargoes cancelled. Reportedly, the market has continued to deteriorate as Platts reported last week that, based on market sources, 45 July LNG cargoes have been cancelled, with over half of them coming from Cheniere Energy’s two Gulf Coast terminals. While Cheniere Energy has a very strong marketing arm, these lost cargoes are likely not going to be completely redirected to other customers. These cargo cancellation announcements came at the same time global LNG prices continued to fall.
Platts reported last week that North Asian spot LNG prices were falling due to ample LNG cargoes being available. The Platts JKM price for July dropped by 4.8 cents per million British thermal units (MMBtu) one day last week to $2.125/MMBtu, on lower pricing indications. In Europe, LNG prices have fallen to record lows. The Platts DES NEW/MED price (Europe and Mediterranean destinations) reached $1.371/MMBtu last Thursday, down $0.134/MMBtu, day on day. That is the lowest price since Platts began assessing these markets in 2010.
The result was that domestic natural gas prices quickly collapsed, falling 20% in a two-week period. Last week, the Platts Gulf Coast Marker price was assessed at $1.283/MMBtu, falling on bearish sentiment in the Northeast Asian market, which is currently the most lucrative market for U.S. LNG cargoes. The spread between this marker and Henry Hub front-month prices remains in negative territory, which it entered in late March. The negative price spread implies that margins on spot market cargoes are thin or negative.
A recent presentation by energy consulting firm Gaffney Cline and law firm Akin Gump on the state of the LNG market and contractual issues arising from its rapid deterioration highlight potentially serious supply problems. Given the oil price collapse in March, oil’s value (measured in $/MMBtus) in mid-April was rapidly approaching
Exhibit 3. Global Fuels Are Converging In Price
Source: Gaffney Cline
the value of LNG delivered to Asian and European customers. With higher oil prices in May, the convergence may be ending and the spread beginning to widen, which would be good for those markets where customers can switch from oil to gas, to capitalize on changes in relative fuel prices.
According to Gaffney Cline, U.S. natural gas had actually become the most expensive supply source in the world. As the chart shows, the period of being the most expensive gas was fairly brief, especially as Asian gas prices seem to have risen sharply in recent weeks. That increase reflects the stronger economic recovery in China. However, if U.S. gas prices begin climbing, these relative relationships might change again. The key point is that the clear price advantage of U.S. gas in the global LNG market is eroding. How much and how quickly the advantage erodes will depend on what happens with associated natural gas supplies and the gas industry’s need to develop more expensive gas resources.
Exhibit 4. How Global Gas Prices Are Changing
Source: Gaffney Cline
The importance of cheap natural gas for the future of the U.S. LNG business can be noted by the growth of shipments since 2016. Exhibit 5 (next page) shows U.S. LNG exports by terminal through February, reflecting steady growth. Other data we have seen shows that on certain days, there has been more than nine billion cubic feet per day (Bcf/d) shipped.
Exhibit 5. How U.S. LNG Industry Has Grown
Source: EIA
At its recent peak of 9.5 Bcf/d of gas for LNG exports, that represented about 9.5% of current natural gas production. Importantly, this gas flow has dropped dramatically since April to only about 6 Bcf/d in May, or back to the volume of gas flowing in September 2019 (Exhibit 6). Pricing for any commodity is set at the margin, so if some of the LNG volume is lost due to U.S. gas being uncompetitive in the global market, then domestic gas prices could come under downward pressure as supply exceeds demand.
Exhibit 6. Weak LNG Market Is Hurting Gas Prices
Source: Platts
Besides competitive pricing pressures, there are other market pressures at work in certain geographic regions. When we look at cumulative LNG volumes shipped to various geographic markets, East Asia and Pacific have been the most important markets for the U.S. That was the target behind the entire LNG industry development, as the U.S. domestic gas price was a small fraction of the delivered price of LNG to that market, the world’s largest. When Japan and Korea LNG prices fell from double digit levels, as their markets became saturated, the U.S. LNG industry began exporting to other markets such as Europe and Central Asia, as well as Latin America. The latter market is particular important, as the seasons are reversed between North America and South America, meaning that U.S. summer LNG volumes can be shipped to Argentina and Brazil to help meet their winter heating demand. We see how Europe and Central Asia, as well as Latin America, are important markets for U.S. LNG exporters, as their cumulative deliveries represented 30.7% and 23.1%, respectively.
Exhibit 7. Importance Of Markets For U.S. LNG
Source: EIA
A new problem for U.S. LNG is the gas storage situation in Europe. Due to consecutive warm winters and a surge in storage injections last year as insurance against the possibility Europe might not be able to renegotiate its 10-year gas supply contract with Russia has left the continent saturated with supply. According to data from the Energy Information Administration (EIA), as of March 1st, Europe’s gas storage was 60% full. That is the highest March 1st storage volume on record, and marked the third consecutive month of record storage volumes. That makes it less likely Europe will be a market for LNG from any supply source, beyond contracted supply.
Exhibit 8. Europe Gas Storage Hurts LNG Market
Source: EIA
The convergence of oil and gas prices has been underway in the U.S. for a while. Just as we pointed out above with respect to international gas markets, higher oil prices may be changing the convergence. The same thing could happen if natural gas prices begin rising. At the moment, oil prices are rising and gas prices are falling, impacting the fuel price spread. This makes what happens with the LNG market important for the gas market and gas prices.
Exhibit 9. Domestic Fuel Price Convergence
Source: Gaffney Cline
The major fallout from uncertainty about domestic gas pricing and its impact on the global LNG market in Asia and Europe is concern over the pace of new liquefaction capacity additions. The LNG capacity that came online during 2018 and 2019, as well as the terminals that are currently in the start-up phase, is huge compared to projected capacity additions planned for 2021-2023.
Exhibit 10. LNG Phase 1 Ends, But A Phase 2?
Source: Gaffney Cline
RBN Energy recently wrote about the planned additions to the North American LNG industry. They identified all the terminals that have been approved but have yet to come into operation. The thrust of the article was that many of the planned terminals in the second wave of LNG capacity additions are being delayed. Several of those terminal projects had anticipated reaching their final investment decisions (FIDs) this year, but have now delayed the decisions to either later this year or 2021, meaning less gas will be needed.
Exhibit 11. Status Of North America’s LNG Terminals
Source: RBN Energy
A March report on the future of the global LNG industry by GlobalData, shows that the U.S. is projected to become the world’s largest supplier by 2025. According to this report, the U.S. will surpass Qatar, the second largest global LNG supplier, in 2021, and then pass Australia, the largest supplier, in 2022. Both Qatar and Australia have plans to expand their LNG export capacities. To deliver more gas, each country is finding it needs to target specific country customers, often those where they have long-term capacity arrangements that they can hope to leverage into more business.
Exhibit 12. Who Will Become LNG Supply Leader?
Source: GlobalData
The more interesting development was recent news that Qatar has taken interests in multiple exploratory blocks in Mexico’s offshore suspected of having gas resources, and in a gas development off the Ivory Coast of Africa. This news comes at the same time Qatari officials insist it is going ahead with its planned LNG expansion in the country’s North Field. It appears Qatar may be looking to diversify its supply sources to increase flexibility in delivering LNG to customers at a lower total cost due to more competition. By having gas supplies closer to customers than shipping LNG from the Middle East, transportation costs can be reduced. While the cost of these other gas supplies might be higher than the gas in Qatar, relative transportation costs, especially if the ship must transit a canal with its heavy tolls, can become a key factor in competing in certain regions.
We wonder which company or country will be the first to build a “white elephant” LNG liquefaction terminal. Yes, the world is demanding more natural gas in an effort to reduce carbon emissions, but the world appears to have substantial gas resources making it a cheap fuel. As we have seen, the growth of Russia’s natural gas pipeline capacity into China will alter that country’s need for LNG imports. At the same time, Russia is expanding its gas pipeline capacity into Europe and Central Asia, again something that will alter LNG markets. At the same time, Russia continues to be an aggressive player in the LNG market.
The global gas market is rapidly transitioning from a long-term contractual market to a spot market. This has been a long-term goal of many gas exporters, who see the opportunity to capitalize on competitive advantages and market dislocations in pricing. Expect to see even more turmoil in the global natural gas market, and in the U.S. gas market, in future months, and maybe even for years.
On The Road Again During A Pandemic (Top)
After being stuck at home since late March, other than for food shopping, Texas reopened, allowing us to venture back to the office. Despite gaining access to the office for the past five weeks, we continued to participate in numerous webinars, Zoom, and Team meetings. What really had us focused was figuring out when it would be safe to head to our summer home.
Unfortunately, Rhode Island, where our home is located, has been a Covid-19 hot spot. New York, New Jersey, Connecticut and Massachusetts have experienced serious virus outbreaks and virus-related deaths, and they surround Rhode Island. To appreciate what we were about to encounter, here are some statistics as of May 22nd: According to Statista and based on reports by states and counties at the time of the chart’s publication, Rhode Island was sixth among the states (excluding territories and the District of Columbia) with 52 deaths per 100,000 population, while Texas was tied for 38th with Tennessee, Maine and South Dakota at five deaths.
Exhibit 13. How States Rank In Covid-19 Deaths
Source: Statista
The chart drove us to research the Covid-19 pandemic in Rhode Island versus Harris County, Houston’s home. As of May 22, the Covid-19 data showed Harris County with 10,090 cases and 210 deaths. This was 78% of Rhode Island’s cases (12,951) and 39% of its deaths (532). These are interesting comparisons. Harris County spreads over 1,702 square miles, some 40% larger than Rhode Island (1,212 square miles). Although larger in size, Harris County’s population of 4.713 million in 2019 was 345% greater than Rhode Island’s 1.059 million residents. These figures drove home to us the difference between a Covid-19 hot spot and a relatively unscathed region. Living in Houston during the outbreak distorted our view that we were relatively spared by the virus. Every death is regrettable. We also feel for those who have been infected.
As we pondered when would it be appropriate to head to Rhode Island, we were paying attention to the virus outbreak and the state’s response. Early on, Rhode Island shut down its state and imposed a 14-day quarantine for travelers coming from New York, the locus of the nation’s worst Covid-19 outbreak. At the borders, Rhode Island state police stopped cars with New York license plates and secured personal information and their local residence address. Rhode Island subsequently sent state police officers, along with National Guard troops, to visit these New Yorkers and remind them of the quarantine requirement. So outraged was New York Governor Mario Cuomo that he threatened to sue Rhode Island over its policy. In response, Rhode Island Governor Gina Raimondo expanded her quarantine order to include all out-of-state visitors. That order expired on May 21st, which keyed our departure date.
Over the past several weeks, we had observed the road traffic building as Houston, Harris County and Texas slowly reopened. We wondered how the reopening status of states would impact the traffic on our drive? Leaving at 6 am, we were shocked to be driving at 75 miles per hour on I-10, getting to the downtown exit after only 20 minutes, at least a 10- to 15-minute time-savings. Surprisingly, almost all the traffic was cars. Another surprise was losing two-thirds of the traffic at the 610 Loop. We gained more cars after the Loop, along with more trucks. The level and mix of traffic remained constant all the way to Louisiana. We did find more cars when we neared Port Arthur and Beaumont, reflecting more local drivers.
The increase in cars in the traffic flow around population centers was a constant throughout our trip. The other constant was the higher ratio of trucks to cars. For example, we estimated the car/truck ratio at about 45/55 on I-10 and I-12. When we turned north on I-55, the mix changed to 30/70, and the total traffic volume declined. The flow increased as we drove through Alabama and Georgia. It swelled in Tennessee until the sun went down, after which the truck traffic declined. This may explain why diesel sales held up while gasoline sales declined nationally during the economic shutdown.
We noticed that at every rest area and truck stop, the number of parked trucks was high – no matter the time of day. That speaks to the truck volume. Trucks were often parked on the entrance and exit ramps to these locations. In Tennessee, several of the truck rest areas were closed because they are being completely rebuilt – planning for the future. We suspect they are being enlarged and will have traveler facilities, not available in currently open parking areas.
Based on our food and accommodation experience on day one, we elected to push to make it to Rhode Island on the second day. Day two’s traffic was influenced by the road situation in Virginia, where the two-lane highway is often blocked as one truck tries to pass another on the rolling hills. For most of this day’s drive, the car/truck mix was about 50/50. That ratio went to 65/35 as we left Pennsylvania and entered New Jersey, and then New York and Connecticut.
The most shocking experience was exiting I-287 onto I-95 at the New York/Connecticut border. We reached I-95 at 5:30 pm – the height of rush hour. Traffic was incredibly light, something we only see late at night. The congestion we encountered was all road-construction related. That was another remarkable aspect of the overall drive – little road construction, only one major accident, but fortunately it was on the other side of the highway, and only a few police cars observing traffic.
Getting food was interesting. Our first attempt in Mississippi left us behind a huge drive-in line at a McDonald’s. After learning in-restaurant eating was not allowed, we moved on. Not knowing if that was a local or state restriction, we stopped at another McDonald’s in Meridien, Mississippi. We discovered only drive-in ordering was allowed. Even with limited menus, the double ordering lines contributed to longer waits.
Dinner was better. We decided to eat at a Cracker Barrel in Chattanooga, Tennessee. This meant stopping earlier than normal, but since we had been on the road since 6 am, had eaten little at lunchtime, and were concerned about the restaurant’s status, this seemed to make the most sense. Additionally, we needed to strategize about our sleeping arrangements.
As we drove into the Cracker Barrel, there were a handful of cars, but we were overjoyed by a welcoming banner announcing “We are open.” There were numerous signs about practicing “social distancing.” When we entered, all the staff had on masks, but no guests. Only a couple of tables were occupied on the far side of the restaurant. The dining room was set up for 25% capacity, although there were tables with six chairs, as opposed to five, as is required in Texas and Rhode Island. The latter only allows outside dining with reservations at the present time.
We figured that we could make it to Bristol on the Virginia/Tennessee line, so we checked the Hilton app for the Hampton Inn where we have often stayed. It had rooms available, but before booking, we called to see if we could reserve a room that had not been used recently. We thought the longer a room had been unused, the safer it would be. We called, and after being placed on hold for a few minutes (wondered if we would learn they were suddenly full), had a conversation with a lady at the front desk. She said they had some rooms that hadn’t been used for a while. It took her a while to find one that hadn’t been occupied for three days. She said it was on the highway side of the hotel with more road noise, which was why it didn’t get rented as often. We were fine with that. We gave her our name and said we would book via the app (one click takes care of all the details) when we hung up. Everything worked fine – we had our guaranteed reservation.
We arrived at the hotel at 11 pm, right on our projected timeline. That was when we confronted the clash between travel and Covid-19. The parking lot was empty – something we have never experienced before at this hotel. We signed the paperwork and took our room key from the lady we had talked with earlier (7 pm). We discussed some issues with the Hilton app and our reservation process. It wouldn’t allow us to use our standard discount membership, but did take a different one. The discounts were the same, so it didn’t make a difference. However, we couldn’t check-in remotely. She told us that other guests had mentioned issues with the app, such as checking-in and being assigned a dirty room. She then told she was off-duty at 2 am, and then back again at 8 am! She said she would call Hilton headquarters then to discuss the web site issues. It was then she told us that we were the last guests to check in. We were number 17!
We found out that there was no daily breakfast, but there would be “to-go” bags available. The juice machine worked, and they were just starting to offer coffee. It required placing an order at the front desk, which the staff would brew in the back. All the accoutrements were available from the staff. She said she didn’t have any idea when they would restart breakfast. She said they have averaged 12-15 room-nights since the shutdown began. They had 91 in the hotel. All but four of the staff had been let go. She was sad about her co-workers, but glad to have a job. She told us this Hampton Inn was usually fully-booked, and often overbooked, something we could testify to, as we have been turned away in the past.
While we would have enjoyed having a longer discussion, we knew we were headed for a short night. However, we have done some calculations to see how the economics of the Hampton Inn have been impacted by the Covid-19 shutdown. If we assume an average of 15 room-nights with an average rate equal to our $116 bill, the hotel’s daily revenue is $1,740. Based on Payscale.com, the average wage in Bristol is $13.99 per hour. Assume the fully-burdened wage is $20 per hour. Since a hotel requires 24/7 coverage of the front desk, that means $480 of wages per day. If one housekeeper works eight hours, that is $160, bringing total labor costs to $640, or 37% of revenues. There is also the cost of “to-go” breakfasts (maybe $2 each, or $30 total?), plus the daily electricity and heating/AC bills. There are also franchise fees, as most Hampton Inns, like this one, are independently-owned. Presumably, the hotel property and building are financed, meaning interest expense and loan amortization expenses. There are also property taxes, as well as liability and facility insurance expense. All of these expenses are before the owner earns any return on his investment. By contrast, if the hotel averaged 85% utilization, its daily revenue, assuming the $116 room rate, would be more than five-times the current daily revenue. At that utilization, we suspect the average room rate would be higher, too.
Hotels that are not located by highways often won’t generate the same level of occupancy. Therefore, many of them are closed. We have no idea how many Hampton Inn employees were let go, but one could see the impact on these types of jobs by the long food lines we saw in Houston, often including people who lost their good-paying jobs. This economic analysis, while very crude, highlights why so many Americans are suffering due to the economic shutdown, in particular, those whose jobs depend on hospitality and entertainment. This was the saddest aspect of our drive to Rhode Island. Economic conditions in Rhode Island are weeks behind Houston, with extensive human suffering. Hopefully, it will end soon.
Oilfield Service Industry Recovery Depends On Oil Demand (Top)
Everyone wants to know when the petroleum industry will return to “normal.” Normal usually means economic life as it existed before Covid-19 and the Great Shutdown swept the world. An alternative version of normal might be when oil and gas companies can earn a
Exhibit 14. The Dynamics Of Oil Prices In This Cycle
Source: EIA, PPHB
profit from drilling, completing and producing new shale wells. In other words, oil prices in line with those last seen in December 2019 and January 2020, when they were in the high $50s and low $60s per barrel. That time period, however, seems like ancient history.
Many oil industry investors, as well as many company executives, long for the days of $100 a barrel oil, which were last seen in mid-2014, nearly six years ago. The problem with longing for those days is that their existence is what drove capital into the oil business to its long-term detriment. After falling to $28 a barrel in February 2016, OPEC and Russia agreed to collaborate to boost oil prices. That agreement, coupled with continued global economic growth, pushed up oil demand and led to oil prices returning to the $50 to $70 range. The top end of the range came when supply concerns increased due to geopolitical tensions.
Oil prices in the $50-$60 a barrel range sustained economic activity, while providing incentives for producers to explore and develop new offshore and shale resources. Oh, to return to that environment.
Figuring out when normal will return to the global oil market has analysts and energy executives anxiously scrutinizing economic data from around the world for signs of a demand pickup. Given that 55% of global oil use is for transportation, learning what drivers are doing in reopened economies, as well as how many planes are flying daily, has become imperative. Only then can one begin to measure the degree of economic recovery. Vehicle tracking data available from Apple and Tom Tom, as well as flights from Flightradar24.com, has given people the ability to see in virtual real-time what is happening on the world’s roads and in its skies.
For transportation fuel demand, what happens in the United States is very important, as we represent about 20% of vehicle fuel use. The latest data from the U.S. Department of Transportation on the number of vehicle miles traveled (VMT) has been quite revealing.
Exhibit 15. How Shutdown Killed Driving In March
Source: FHTA, PPHB
Admittedly, the government’s data lags by a month, so the most recent data available is only through March 2020. As one would expect, as the U.S. entered into a state of economic shutdown, road traffic fell during the month. The march data minimizes the magnitude of the driving decline, which will become even more acute when April data becomes available.
When we look at VMT data since the start of 2000, we see it rose steadily until 2007, ignoring the economic fallout from 9/11 and the resulting recession. The first VMT peak coincided with the start of the Financial Crisis and Great Recession. Those events sent driving into a decline, which then moved into an extended flat period until 2013. From that point forward, there has been a steady increase in VMT, as the economy grew at a faster pace and employment rose. In March 2020, VMT collapsed with the closing of the economy. The seasonally-adjusted VMT data shows how much it dropped in March, taking it below the January 2000 starting point.
To gain additional perspective on the market, we plotted the 12-month cumulative moving average of VMT since 1996. What is seen clearly is the long history of rising VMT that was interrupted in 2007 by the Financial Crisis. We can also see the decline due to the crisis and the extended period of flat VMT data. The final stark reality in this chart is the downward spike in March.
Exhibit 16. How VMT Have Driven Oil Demand
Source: FHTA, PPHB
What is of great interest to energy executives is whether VMT will experience a V-shaped recovery, or whether the growth from the bottom, which will likely begin in April, merely parallels the 2016-2020 trend. In other words, do we snap back or merely resume growing from a substantially lower base? Our view is that there will be a V-shaped recovery, but it will not return to the level it would have been at had the historical growth rate continued. Our view is shaped by our belief that a certain amount of driving will be deferred until people become more comfortable living in a Covid-19 world, or at least until there is a proven vaccine.
When we look at the mobility data since January 13, 2020, as reported by Apple Mobility, we find there is a much sharper recovery than many people expected. In Exhibit 17, we show the daily data, along with a 7-day moving average. This data is plotted against weekly gasoline supplied data. It is not surprising that gasoline demand was high, as well as driving, until the economic shutdowns began. The low in driving occurred in mid-April, from which point it is has steadily climbed, along with gasoline demand. We were surprised the mobility data showed the recovery back to February levels. However, as seen from the data in Exhibit 15 (page 16), driving in the early months of each year is low. Thus, excitement about the mobility recovery should be tempered. In fact, driving during summer months is about 30% greater than that done in the early months of the year. To reach summer-level driving, a level reflective of history, the index needs to reach around 160, the top end of our chart.
Exhibit 17. Gasoline Demand Follows Mobility Higher
Source: Apple Mobility, EIA, PPHB
The picture of recovery around the world, as shown by Apple Mobility, suggests a mixed bag. Some countries have seen fairly rapid upturns, while others are struggling to show any recovery. These divergent trends are evident in the charts showing mobility trends for countries in Europe, South and Latin America, and Asia. Japan, in the Asia chart, stands out by having been the last country to experience a decline in mobility, but has spiked in recent days.
Exhibit 18. Europe Countries Showing Recoveries
Source: Apple Mobility, PPHB
Germany’s decline was not as deep as the other European countries, but its recovery has been strong. Surprisingly, France has experienced a sharp recovery since early May. The U.K. and Italy are also experiencing strong recoveries in recent days.
Exhibit 19. The Southern Hemisphere Recovery Lags
Source: Apple Mobility, PPHB
The declines and recovery of countries in Latin and South America seem to be very much in sync. What we found interesting was the recovery in Brazil, given it has recently become a top Covid-19 hot spot, and has had travel with the United States banned. These countries still have a long way to go to get back to the levels experienced earlier in the year. Given that South America has an inverted weather pattern compared to North America, we wonder how its recovery will progress, as the continent moves into the depths of winter, which is more conducive to the spread of viruses.
Exhibit 20. Asia Is A Mixed Bag Of Economic Recoveries
Source: Apple Mobility, PPHB
Asia is the most interesting region, as Japan has shown an unusual pattern, commented on earlier, but the jump in mobility in Vietnam at the end of April was a surprise. The lack of real recoveries in India and Indonesia, so far, suggests that oil demand will be slower to recover in this region of the world than maybe other regions. That is not surprising given the uneven exposure of countries to Covid-19, and thus the speed and timing of their recoveries. The key question for these recoveries is how high they will take demand. Will it be back to the levels that existed in the months before Covid-19, or to some percentage of that earlier demand? The former dynamic is key to how quickly oil prices recover, but the latter question is critical for understanding how the fortunes of the energy business may unfold long-term.
Flying has shown a slower recovery, despite more people traveling today versus just a few days ago. The number of passengers processed by TSA is about 87% below a year ago, but considerably better than a few weeks ago when passenger traffic was off 98%. However, as the data from Flightradar24.com shows, there has been an uptick in the number of flights flown from the lows seen in April. People may be surprised by the number of flights, but they fail to appreciate that airfreight volumes are higher, as planes are carrying cargo not only in their holds, but also in the empty passenger seats. Surprisingly, airlines also require a number of cabin staff to monitor the cargo on flights, which helps the airlines to keep some staff employed.
In Europe, we were surprised to read that two low-cost, tourist-oriented airlines are returning to flying. While the extent of their flying is limited, it has to be perceived as a positive sign of pent up demand, as well as confidence that Covid-19 is in decline. At the same time, we learned that several major U.S. airlines have abandoned some short-haul, low volume routes. Additionally, some of these airlines have experienced several of their regional carriers,
Exhibit 21. Air Travel Is Slowly Recovering
Source: Flightradar24.com
who operate under the large airline’s banner, closing. Lastly, the airlines have announced substantial passenger capacity reductions through the summer travel season. They have yet to indicate what their fall capacities will be, likely waiting to assess the air travel recovery during the next few months before making a decision. Overall, the airline business will be smaller for the next 1-3 years.
The impact of air travel on road traffic also needs to be assessed. First, many people who would have flown on medium-distance trips may opt to drive, to feel more comfortable traveling. Long-haul and international flights will suffer as people are hesitant to travel. The question of what will happen with business travel is key to airline profitability, as these travelers pay the highest ticket prices for both comfort and flexibility. Will they decide more business can be conducted remotely? The most interesting data came from an article in The New York Times outlining the disparate problems of the California economy coming out of its shutdown.
According to the article, 83 million people arrived last year in California on flights to participate in conventions, conduct business and enjoy tourism, more than Florida, Texas and New York, the next three states that rely heavily on air-travel. The state earned $145 billion from tourism, more than any other state. The decimation of the nation’s largest tourism market has led to 600,000 workers losing their jobs. Taxes related to travel are a significant source of revenue for California cities, amounting to $12 billion last year. Eight out of 10 visitors to San Francisco and five out of 10 in Los Angeles arrived by air.
One California region that has been particularly hard hit is Napa Valley, home to the wine industry. With the closure of wine tasting rooms at vineyards, some owners have lost 40% of their income. Even California wine sales are off 25%. The magnitude of the lack of tourism is shown by the fact that of the 5,500 hotel rooms in Napa Valley, only 328 were occupied, mostly by medical personnel and families isolating from infected relatives. We wonder how many of the hotels are even open?
As everyone scours the economic and mobility data for signs of recovery, they are slowly emerging. We need to be cautious in assuming the initial sharp mobility recoveries will continue. We fully anticipate there will be a pause and then growth at a slower rate than seen initially. This doesn’t mean recoveries will not be complete, but reaching 100% recovery may take longer than some people currently are anticipating. We will continue to monitor the recovery, as it will determine the future health of the oil and gas and oilfield service industries.
The Next Chapter Of The Sea Level Story Is Being Written (Top)
It’s that time of the year when we experience a wave of new studies about rising sea levels due to the melting of the glaciers and ice caps from hotter global temperatures driven by increased carbon emissions. Remember, we are heading into summer with hot temperatures, making it easier to make the case about climate change. Right on schedule, a new study published in Climate and Atmospheric Science claims that the sea-level rise will be considerably higher than the projections by the UN’s International Panel on Climate Change (IPCC) in its 2014 Fifth Assessment Report, and also in its special report on oceans and the cryosphere published in September 2019.
The authors of this study relied on a survey of opinions offered by 106 experts to estimate global mean sea-level variations under low- and high-emission conditions. Based on their answers to open-ended survey questions, the authors concluded that these experts believe that the upper-end estimates for global mean sea-level increases from their studies are more likely due to the faster melting of the glaciers and ice caps. This sounds a lot like the consensus of 97% of scientists about climate change.
According to Benjamin Horton, the lead author of the study, under a high-emission scenario, with a warming of 4.5 °C (8.1 F), the study predicts an increase of up to 1.3 meters (4.3 feet) by 2100 and up to 5.6 meters (18.4 feet) by 2300. Predicting sea level rises and understanding their uncertainties are crucial to making informed decisions about mitigation and adaptation actions necessary. Higher sea levels increase the susceptibility of cities and related infrastructure along coastlines across the globe to coastal erosion and flooding, potentially making the regions uninhabitable.
It is important to know that the study’s warming scenario is higher than the mean temperature for 2100 predicted in the UN’s IPCC Fifth Assessment Report’s scenario 8.5, which is the most extreme and assumes no further limits on carbon emissions beyond 2010. Despite being higher, the sea-level rise projected in the 8.5 scenario is only 1.2 meters (4.0 feet). The IPCC gave this a low probability of occurring.
About the same time this study was release, the BBC produced an article about a new study focusing on the problems of rising sea-levels for Miami in Florida. The article concentrated on how fast the sea-level has been rising. Quoting from the BBC story:
“Not only are sea levels rising, but the pace seems to be accelerating. That’s been noted before – but what it means for south Florida was only recently brought home in a University of Miami study. ‘After 2006, sea level rose faster than before – and much faster than the global rate,’ says the lead author Shimon Wdowinski, who is now with Miami’s Florida International University. From 3mm per year from 1998 to 2005, the rise off Miami Beach tripled to that 9mm rate from 2006….
“One graph compiled in 2015 by the Southeast Florida Regional Climate Change Compact, a non-partisan initiative that collates expertise and coordinates efforts across Broward, Miami-Dade, Monroe and Palm Beach counties, is especially revealing (see below). At the bottom is a dotted green line, which rises slowly. Before you get optimistic, the footnote is firm: ‘This scenario would require significant reductions in greenhouse gas emissions in order to be plausible and does not reflect current emissions trends.’ More probable is the range in the middle, shaded blue, which shows that a 6-10in (15-25cm) rise above 1992 levels is likely by 2030. At the top, the orange line is more severe still, going off the chart – to 81 inches (206cm) – by the end of the century.”
Exhibit 22. How Much Will The Sea Rise Near Miami?
Source: BBC
Rising sea levels are a global phenomenon caused by global warming. However, due to a variety of factors – including, for this part of the Atlantic coast, a likely weakening of the Gulf Stream, itself potentially a result of the melting of the glaciers and ice caps, Miami residents are feeling the effects more than many others. It is important to understand that a challenge for Miami is its topography. Its chief resiliency officer Susanne Torriente jokes that the elevation ranges between “flat and flatter.” Most of Miami Beach’s buildings sit at an elevation of 60-120 centimeters (2-6 feet) above sea-level.
The BBC article based most of its conclusions about how bad the situation is for South Florida on data from the sea-level gauge located at Virginia Key, just south of Miami Beach. While the sea-level worldwide has been rising at a rate of a little more than 3 millimeters (mm) (0.12 inches) per year since the 1990s, the Virginia Key gauge recently measured a 9 mm (0.35 inches) rise, annually. What the BBC article left out was that the data for the Virginia Key gauge shows the annual increase over its history since 1931 at only 2.92 mm (0.11 inches) per year, plus-or-minus 0.22 mm/year (0.008 inches/year). The chart shows that the rate of the sea-level rise has accelerated in recent years when you look at the mid-points of the 50-year histories (the lower chart). It shows a mid-point of 3.52 mm/year (0.35 inches/year) for 1995. One of the problems in relying on this particular sea-level gauge is its relatively short history. But, for telling a tale of impending doom for Miami, which continues to experience street flooding more frequently, it is a powerful tool.
Exhibit 23. Rising Sea-Levels And Flooding Miami
Source: Paul Homewood
Paul Homewood, who maintains a blog in the U.K. that reports on climate change articles, actually presented other data leading to a quite different conclusion than the BBC article. He showed the history of the sea-level gauge located at Fernandina Beach, north of Miami Beach, which extends back to 1897. That gauge’s data shows a historical rate of sea-level rise of 2.15 mm/year (0.08 inches/year) plus-or-minus 0.18 mm/year (0.007 inches/year), which is considerably less than the Virginia Key gauge. Moreover, the Fernandina Beach gauge shows that the rate of increase now is no more than what was experienced in the 1930s, based on the mid-point calculations. The 1995 mid-point increase was 2.77 mm/year (0.11 inches/year) compared to the 2.83 mm/year (0.11 inches/year) mid-point increase in 1935.
Exhibit 24. A Different Assessment Of Rising Seas
Source: Paul Homewood
The fear of rising sea-levels has been a popular theme for a number of years, and was a particularly potent weapon in helping to sell the Paris Accord climate change agreement in late 2015. There were numerous news stories chronicling the plight of the populations of Pacific Ocean islands that would soon be overwhelmed by rising sea-levels. In fact, these populations became part of the United Nations’ narrative that by 2010 there would be 50 million climate refugees. For the island populations, the Paris Accord was a bonanza, as they would be on the receiving end of some of the UN Green Climate Fund’s $100 billion annual payments from developed economies to help developing economies overcome the costs of climate change. Covid-19 has ended that dream, and one wonders which countries will be willing to pay into such a fund in the foreseeable future given their financial conditions.
Covid-19 has ended another part of the islanders’ dream – tourism. The move to a net-zero emissions world that includes aviation requires “a substantial period of no aviation at all,” according to Julian Allwood, a professor of Engineering and the Environment at Cambridge University. For an island nation like Fiji, tourism (dependent on international air travel) contributes nearly 40% of its GDP. Tourism, directly or indirectly, employs over 150,000 of the nation’s 900,000 people. Additionally, the island is very dependent on airfreight to supply its economy. The economic shutdown is a “dry run” of what life would be like if the climate change proponents enforce their plan for net-zero emissions.
As a result of the shutdown, Fiji Airways, the country’s national airline, has grounded 95% of its flights. The Fiji Hotel and Tourism Association says 279 hotels and resorts have closed, with over 40,000 tourism workers either laid off or sent on leave without pay. Unfortunately, Fiji has no backup wage support program for laid-off workers.
While two dreams of the islanders have gone up in the smoke of Covid-19, the greater issue is the hypocrisy of the climate change promotors. One of the classic hypocrisies was the cover of Time magazine in June 2019, which showed United Nations head António Guterres standing in the water off the island nation of Tuvalu. Time called it “one of the world’s most vulnerable countries” to global warming. The photo was taken during Mr. Guterres’s trip to visit four Pacific island nations in May 2019.
Exhibit 25. Staging A Fake Narrative
Source: Time
What we know is that a 2018 study found that Tuvalu’s total land area grew nearly 3% from 1971 to 2014, despite rising sea levels. Satellite and aerial photos showed eight of Tuvalu’s nine atolls and three-quarters of its reef islands increased in size over the last four decades. The abstract for the study that reported this outcome stated:
“Summary: ‘Atoll islands are low-lying accumulations of reef-derived sediment that provide the only habitable land in Tuvalu, and are considered vulnerable to the myriad possible impacts of climate change, especially sea-level rise. This study examines the shoreline change of twenty-eight islands in Funafuti Atoll between 2005 and 2015 … Results indicate a 0.13% (0.35 ha) decrease in net island area over the study time period, with 13 islands decreasing in area and 15 islands increasing in area. Substantial decreases in island area occurred on the islands of Fuagea, Tefala and Vasafua, which coincides with the timing of Cyclone Pam in March, 2015.’”
It was particularly interesting that the only island decreases coincided with a cyclone in the region. To appreciate the conclusion and the region studied, a map detailing the outcomes was included in the study.
Exhibit 26. The True Story Of Tuvalu Sinking
Source: Hisabayashi et al., 2018
This wasn’t the only story about islands growing. Another 2018 study found that nearly 90% of 709 low-lying islands in the Pacific and Indian oceans either remained stable or increased in size over the decades. The details of this study are summarized in the abstract from the study.
“Abstract: Over the past decades, atoll islands exhibited no widespread sign of physical destabilization in the face of sea-level rise. A reanalysis of available data, which cover 30 Pacific and Indian Ocean atolls including 709 islands, reveals that no atoll lost land area and that 88.6% of islands were either stable or increased in area, while only 11.4% contracted.”
The attention to sea-level rise was heightened by a recent article in the Science section of The New York Times dealing with the current study by the National Geodetic Survey determining “the heights of structures, landmarks, valleys, hills and just about everything else.” The article suggested that everything was going to get shorter. In fact, Alaska is supposed to shrink by six feet, while parts of the Pacific Northwest will shrink by as much as five feet. Seattle will be 4.3 feet lower than it is now. No one knows how much shorter Colorado’s mountains will end up. The reason for the shrinkage is that height is measured from a reference point. The revision process has required a decade and a half of work, and is referred to as “height modernization.” The new National Spatial Reference System, encompassing height, latitude, longitude and time, is expected to be rolled out in late 2022 or 2023. It will replace a reference system that was prepared in the 1980s, derived from calculations done before the advent of supercomputers or global navigation satellite systems such as GPS.
The United States has been measuring the height of the country since 1807, when President Thomas Jefferson established the Survey of the Coast, the forerunner of the National Geodic Survey. The early surveys were conducted by implanting stakes at uniform distances from the Atlantic Coast westward to allow the measurement of height from sea-level, which was assumed to be the coastline. As technology enabled the surveyors to improve the accuracy of the measurements, since 1900, there have been five surveys: 1903, 1907, 1912, 1929 and 1988.
The article goes on to explain many of the intricacies of conducting the surveys. One intricacy deals with the role of gravity. As the article states:
“Gravity matters to a geodesist. Height is distance measured along the direction that gravity points, and the strength and direction of gravity’s pull vary according to the density of what is beneath the terrain and near it. In other words, height is not merely distance or elevation above the
ground; it is tied to gravity. Gravity, in turn, is related to the distribution of mass. Geodesists therefore use the term ‘height’ rather than ‘elevation’.”
It went on to say:
“Geodesists will then use these gravity readings to make a model that best represents average sea level everywhere in the world, even on land. Because the pull of gravity varies everywhere, this model, called the geoid, resembles a lumpy potato. All heights will subsequently be measured taking it into account.”
Finally, it made the following point about how climate change is impacting the shape of the planet, which in turn will alter the sea-level and the height of everything.
“Even as geodesists get better at calculating the shape of the Earth, humans are changing it. As we warm the planet, we are melting glaciers and ice sheets. Their mass shifts from the land to the ocean, raising sea level and, eventually, changing height, which uses sea level as the reference for zero elevation. The shift in mass also has an impact on the configuration of the planet.”
One of the conclusions of the study is that the height of the United States will shrink. The shrinkage increases as we move across the country from the southeast to the northwest. The article included a map with dotted lines showing that only the tip of south Florida will not have its height change. The Southeast will shrink by upwards of half a meter (1.7 feet), while the Pacific Northwest will experience a full meter (3.3 feet) decline in height.
Exhibit 27. How The U.S. Is Going To Shrink
Source: The New York Times
One of the most interesting items contained in the article was about the problems in establishing the heights in several parts of the country. The article pointed out:
“But the 1988 version was short on accurate information for California and parts of Texas and North Carolina, said David B. Zilkoski, a geodesist who is the former director of the National Geodetic Survey. That is because the crust there has moved up or down considerably, as a result of tectonic plate activity and the removal of oil, gas and water from beneath the ground.”
Plate tectonics play a much larger role in how land masses rise and fall than people appreciate. We found the comment about California, Texas and North Carolina interesting. However, what we also know is that in many areas of the country people rely on underground aquifers for drinking water, or they are pumping oil and gas from subsurface reservoirs, and as a result, they often suffer subsidence. Because Houston tapped water aquifers and pumped oil and gas from nearby fields, the local government embarked on a plan in the 1970s to create surface reservoirs to provide drinking water and to help end subsidence, which was causing structural damage to homes and businesses throughout the region.
After reading The New York Times article, we are gearing up to be inundated with studies in a few years showing us how much our coast and the people who live there are at danger from rising sea-levels. What we understand is that there is a lot more involved in flooding coastal areas than merely melting glaciers and ice caps. We’d suggest you check the math of these future studies.
Things Of Interest We Have Recently Learned (Top)
The 9th Circuit Court of Appeals has been very busy. It ruled that the California climate change lawsuits against the oil and gas industry for creating a nuisance must be heard in state court. This entire legal venue issue is likely heading to the Supreme Court. The court also blocked the Trump administration’s request for a temporary stay of a lower court ruling that overturned a key nationwide water permit needed to build oil and gas pipelines. This means Keystone XL will need upwards of 70 permits to cross rivers and wetlands, adding possibly 1-2 years to the construction timetable.
The nation has lost hundreds of thousands of “green” energy jobs. The problem, as we have written about in the past, is the definition of “green energy jobs.” For example, the employees of the company that installed the solar panels on my summer home are clearly “green jobs.” But they were also the same workers who installed my backup gas-powered generator. So, are those “green” or “fossil fuel” jobs?
Haynes and Boone will shortly be releasing an update to their oil and gas and oilfield service company bankruptcy data. Preliminarily, it looks like the count of bankruptcies will grow by 11 E&P and five OFS companies, but the estimated additions are not finalized, and the energy bankruptcy business is very dynamic now.
There has been a massive cut in energy industry investment spending – both for fossil fuels and renewables. The International Energy Agency (IEA) believes the spending cuts are a harbinger of higher oil and gas prices down the road and a slower transition to a decarbonized economy.
Renewable energy investment portfolios have outperformed fossil fuel portfolios for the past five years and continue to outperform in 2020. The question is what makes up those portfolios?
We will be revisiting many of these points in upcoming Musings articles.
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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.
