- Is Rig Count About To Rebound? Scenarios For The Future
- Natural Gas Trade Challenged By Commodity Focus Shift
- New Fed Global Warming Report Breaks No New Ground
- More Gas Than We Ever Expected – A Good Thing?
- Do Global Warming Models Have A Key Assumption Wrong?
- U.S. Oil Imports At Risk And At Odds With Obama Goal
- Laughs From Rhode Island
Musings From the Oil Patch
June 23, 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
Last week Baker Hughes reported that their rig count for active rigs in the United States increased by 23 rigs to 899 active rigs. While this count increased from the prior week, compared to a year ago, the rig count is down by over 1,000 rigs marking one of the worst downturns in the industry history. Our favorite chart shows the rig count for 2000-2009 compared to the rig count of 1973-1983. The similarities are stunning, but even more so if one plots the rig counts indexed to 100 at the start of the respective time periods.
Exhibit 1. Notice Rig Count Bottoming And Recent Upturn
Source: Baker Hughes, PPHB
Exhibit X. Indexed Rig Count Closely Mirrors 1970s Count
Source: Baker Hughes, PPHB
The rig count increase was the first since a four-rig gain experienced during the first week of the second quarter of this year. It barely shows up on the rig count charts. All the rig-count gain last week was onshore as the Gulf of Mexico rig count actually fell by one. Interestingly, the number of directional and horizontal rigs working each increased by 10 over the prior week with the number of vertical rigs up by only three. That would suggest gas shale drilling is continuing at a healthy pace, which could produce a greater problem for the natural gas industry later this year. So does this mid June rig count signal a turning point for the oilfield service industry?
The domestic rig count peaked at the end of August 2008 at 2,031 and has fallen steadily with the exception of that one week rise in April until last week, or for 39 out of the last 41 weeks. With oil futures prices hovering around $70 a barrel and natural gas futures holding somewhere around $4 per thousand cubic feet, producers are feeling better about spending money to drill more wells. If oil prices continue to rise as suggested by OPEC and Russian leaders and Wall Street analysts, then producers will probably have greater cash flows than they anticipated at the start of 2009 when oil prices were virtually half the price they are trading at now. That will provide ammunition for increased drilling.
Analysts have become much more confident about a recovery in natural gas prices during the second half of the year as they believe the current reduction in the rig count will result in a fall of 1.5 billion cubic feet per day to as much as 4.0 billion cubic feet of gas production by the end of the year. This production fall would essentially eliminate the estimated current surplus over demand. A hike in gas demand with a recovery of housing and automobiles would further accelerate the closing of that gap, but there are few signs of any significant near-term recovery for these industries. Also not factored into the supply/demand equation is the prospect of rising liquefied natural gas (LNG) shipments arriving on U.S. shores that could expand supplies and put downward pressure on natural gas prices.
Trying to forecast a recovery for the energy and oilfield service industries is a challenge given the inability to project future global economic activity and credit market conditions with any degree of certainty. Across the globe, countries have responded to the economic recession and credit crisis with massive stimulus efforts. Some efforts are more targeted than others and are beginning to show signs of possible success while others are lagging well behind and run the risk of pumping up domestic economies after they are well into their recovery phase. The debate ongoing in the United States reflects citizen concerns about the massive spending associated with Pres. Obama’s spending and stimulus programs along with his willingness to inject the federal government into American industries.
We found the following cartoon originally published in The Chicago Tribune in 1934 in response to the economic, political and social policies of President Franklin D. Roosevelt in his attempt to overcome the conditions of the Great Depression. Many critics of Pres. Obama’s action plans subscribe to the view that he is working to usher in an economic, political and social system more similar to those found in many European countries. These economies, however, tend to have slower economic growth, higher unemployment, higher taxation and a lack of entrepreneurial enterprise than found here.
Exhibit 3. Obama Agenda Resembles FDR’s Plan
Source: Chicago Tribune 1934, Minyanville.com
FDR’s plan of action outlined in the cartoon states: Plan of Action For U.S. Spend! Spend! Spend! Under the guise of recovery – bust the government – blame the capitalists for the failure – junk the constitution and declare a dictatorship. To many this will sound like Pres. Obama’s plan for America.
The impact of the economic and political debate is to hamstring American business with proposed regulatory changes that could radically alter how companies have operated for many years. Possible changes to corporate taxation, the introduction of “Buy America” policies, government introduction of corporate governance mandates and pay restrictions along with highly restrictive energy policies that mandate the use of fuels that are the most expensive rather than least costly will alter the business playing field. Until regulation begins to become clearer, which may take as long as another year, corporate leaders will be reluctant to rehire employees and step up capital spending. With this background, and without delving into the intricacies of the Obama administration policies, we assume U.S. economic growth will only slowly recover with positive gross national product growth in the fourth quarter and modest growth continuing through 2010.
To us that suggests a modest recovery in global oil prices but only modest price increases for natural gas prices. Strong oil prices and weaker gas prices mirrors structural factors in the global oil market versus the U.S. natural gas market. Drilling activity, which is about 70% dependant on natural gas, will slowly recover. We forecast a recovery from now into early 2010 at an average of five rigs per week. We then expect the pace of increase to double and reach about 1,500 rigs by the end of 2010. The challenge is that this is not the only scenario we can develop – some better and others much worse.
We have plotted the Baker Hughes domestic rig count since 1949 along with our forecast. On the chart we have circled several time periods – two in red, one in blue and one in green. As can be seen, the sharp fall in the rig count over the past 10 months compares to the fall in 1985 and 1986. The question we have is: Will the rig count rebound mirror the period of volatility experienced in 1982-1985 and in the 1950s? There were various petroleum industry regulatory changes that occurred in the 1980s period that gave the business periodic jolts of optimism and thus stimulated drilling. These included lifting price restrictions on interstate natural gas and opening the Gulf of Mexico up to area-wide leasing. The subsequent collapse in world oil prices brought down the entire global petroleum industry. The volatility of the 1950s was driven by exploration successes that created pricing problems due to oil oversupply conditions and production restrictions in the United States.
Exhibit 4. Which Historic Period Will Rig Recovery Mirror?
Source: Baker Hughes, PPHB
The big question on our mind is what will be the longer term future trajectory for the rig count. We anticipate there will be a near-term rebound as producers restore some capital spending after overly aggressive earlier budget cuts due to the uncertainty during last fall’s global credit crisis. To try to answer this question we examined the modern history of domestic rig count for patterns caused by industry conditions that might prevail in the future.
The 1990s rig count pattern (in the green circle) reflected a time of low natural gas prices and relatively low crude oil prices. These low commodity prices existed despite accelerating economic growth. Prices were depressed largely because of new global oil supplies and existence of adequate surplus oil productive capacity that held prices in check.
The more sinister rig count pattern was that of the 1960s (in the blue circle) that reflected the time period when the U.S. had surplus oil production and was forced to restrict production (Texas Railroad Commission regulated the number of days of the month and volume of a well’s production) to prevent prices from collapsing. Low oil prices coupled with very low (due to regulatory restrictions) natural gas prices made being in the oil and gas exploration and production business a high-risk occupation. This period was when many of the mid-sized domestic oil companies commenced international exploration efforts in an effort to earn greater profits. Midcontinent oil producers such as Marathon Oil, Continental Oil, Phillips Petroleum, Hess and Occidental Petroleum all began foreign exploration efforts, often teaming up in partnerships in places such as North Africa. The companies evolved into larger and more successful companies as a result of this global expansion driven by the economic squeeze on the domestic oil and gas business.
As we look to the future, we are torn by conflicting views about the pace of the economic recovery. If it begins to accelerate and we experience meaningful recoveries in the domestic auto and housing sectors, then energy demand will grow, commodity prices will solidify, if not rise further, and profitability will return to the E&P business. On the other hand, a slow, protracted global recovery will keep pressure on commodity prices and further pressure E&P company profits and the number of attractive exploration and development projects. This environment could result in producers continuing spending constraints, partly as a way to push oilfield service costs down. While the industry will remain profitable, profit growth likely will be anemic.
The biggest question mark in our possible scenarios is the issue of regulation. We have the issue of carbon regulation, which is well on its way to being implemented in the U.S. But will we have anti-oil regulations in the form of higher taxes, restrictions on the application of technology (rules limiting the use of hydraulic fracturing) and restrictions on access to promising exploration and development locations, to name just a few.
As we suggested above, our best guess is a slow, but steady increase in the rig count until it reaches a peak at about 1,500 rigs by the end of 2010. From that point forward we expect the rig count to go sideways, albeit with seasonal and price-volatility induced ups and downs. If natural gas prices, the principal driver of domestic drilling activity, languish due to growing gas shale production, increased LNG shipments and flagging demand, then we could be looking at a retreat from the 1,500-rig peak to something more like 1,200 to 1,300 rigs followed then by a sideways pattern. We also could envision a pattern that sees the domestic rig count slowly decline from the peak to a level closer to 900 as oil and gas industry profitability is steadily eroded.
At this point we are hesitant to put any probabilities on the various scenarios. We will be using these scenarios as our benchmark outlooks while monitoring the many economic and political variables we have outlined. The next several years will be a challenging period for the energy industry – but we could have said that about almost any period in its history.
In recent weeks, Wall Street has been shifting its energy focus from crude oil to natural gas as the price of the latter has become historically cheap. The first signs of global economic recovery spurred investors to jump on the energy and materials stocks. The logic was that any increase in economic activity would require an increase in demand for industrial-related commodities and energy and their prices would rise. As we showed in our last Musings issue, industrialized commodities have been leading the recent rally in prices. The greatest price laggard of the 14 commodities we follow was natural gas, which through the end of May was down 44.3%.
The heat content ratio (British thermal units) between a barrel of crude oil and a thousand cubic feet (Mcf) of natural gas is 5.6-to-1. For ease of analysis, most energy pros and investors use a 6-to-1 ratio to translate volumes of oil or gas into the comparable fuel for purposes of estimating reserve values. This heat content ratio has seldom been achieved price wise in the marketplace as many factors interrupt the straight heat value proposition. For example, natural gas must move through a pipeline from its production source to where it is burned. The lack of adequate pipeline capacity or the absence pipelines to consuming areas can limit market opportunities for natural gas and depress the relative price comparison.
Other factors that can alter the heat-content price ratio include the lack of storage for competing fuels such as petroleum or coal; environmental restrictions on the burning of dirtier fuels; and concern about the availability and price of future supplies. All of these issues have at one time or another disrupted the pricing ratio from more closely matching the physical value of competing fuels.
Over a long history of gas and oil price competition in this country, the average ratio has been 9.3 times – meaning that crude oil prices were slightly more than nine times the price for natural gas. That historical norm is shown in the chart of the ratio of the wellhead price for natural gas compared to the first price paid for oil by refiners during the period from 1976 to May of this year based on monthly price data.
Exhibit 5 Natural Gas Prices Cheapest Since 1970s
Source: EIA, PPHB
What the chart shows is that natural gas is almost as cheap compared to crude oil as it has ever been in the past 33 years with the exception of the time of the first Gulf War and during the oil price explosion in response to the 1979 Iranian revolution, the holding of American hostages and the withdrawal of oil supplies from the world market. If one goes back to the mid 1970s, oil was more valuable because natural gas was under significant use restrictions. Those restrictions followed the supply crisis precipitated by earlier federal government limitations on the price of gas that caused companies to stop seeking supplies for the interstate natural gas market.
Exhibit 6. Natural Gas Is Currently Cheapest In Years
Source: EIA, PPHB
Today, natural gas is cheaper than it was in the 1980s and 1990s when supplies were plentiful and demand was restricted. Those years saw natural gas prices in the $1.50-$2.50 per Mcf range when oil sold somewhere in the mid-teen or mid-twenty dollars per barrel, or about a 10-times ratio. Since January 1994 to now, the average price ratio of crude oil to natural gas is 8.5 times. Today, natural gas is selling in the $3.75-$4.00 per Mcf range while oil trades for about $70, making the resulting price ratio closer to 15 -18 times, or nearly twice the 15-year average. While the current ratio is calculated by comparing the futures prices for crude oil and natural gas, they do not totally reflect the economic realities of oil and gas as in the long-term historical comparison reflected in Exhibit 5.
Why is natural gas priced so cheaply in today’s energy market? One has to conclude it is all about supply and demand. The imbalance between the two price determinants is behind the move to “Buy natural gas and sell crude oil” trade recommendations that started emanating from Wall Street brokers and commodity traders in the past few weeks. Part of the rationale for the trade was the belief that natural gas supplies would begin to decline as the downturn in the rig count curtails the petroleum industry’s drilling as many new gas wells, especially since natural gas prices are so depressed compared to their levels of last year. This means that less new gas should come into the market, slowing the supply growth until it eventually declines leading to higher gas prices.
Exhibit 7. Gas Production Growth Due To Shale Success
Source: EIA, PPHB
A chart on natural gas industry economics prepared by analysts at Bernstein Research tends to support the view that the rig downturn will lead to cutback in new gas production. As they show, spot natural gas prices have fallen below their estimate for cash costs, and well below their estimate of the marginal cost to find new gas supplies. In their analysis, there have only been a few periods when natural gas prices rose to levels that destroyed demand – and almost all of those times were during periods of conflict or natural disasters. On the other hand, for almost the entire ten-year span from 1993 to 2003, natural gas spot prices hung close to the estimated cash cost for creating new supplies. The chart helps demonstrate why it was so hard to be in the exploration and development business during the 1990s.
Exhibit 8. Spot Gas Prices Below Cash Costs Will Cut Supply
Source: Agora Financial
The global recession and credit crisis along with the deteriorating economics of natural gas exploration and development in the face of a continuing rise in gas supplies has combined to send the U.S. rig count into a depression. Since the industry peak in late August 2008, the total rig count has fallen by 1,155 rigs (as of June 12th) for a decline of 57%. Rigs dedicated to natural gas drilling have fallen by a similar percentage amount or by 921 rigs in the period. The share of the total working rigs drilling for natural gas has fallen slightly to 78.2% from 79.1% at the peak. This would certainly suggest that operators have not been overly dissuaded by low gas prices to cut back by a greater amount their gas-oriented drilling activity.
Exhibit 9. Simple Drilling Off More Than Complex Drilling
Source: Baker Hughes, PPHB
In fact, the data for the types of drilling done since the peak in late August 2008 shows that vertical rigs drilling have fallen by 67% from 1,017 to 331. At the same time, horizontal rigs, mostly associated with drilling the prolific natural gas shale formations in this country, are down only 39% from 626 rigs to 381 rigs while directional rigs are down 58% to 164 from 388 rigs.
Based on the expectation that the prolific natural gas shale formation wells experience declines of 60% – 70% from initial production by the end of their first year of operation, the slowdown in complex drilling (horizontal and directional wells) suggests that by 2010 the U.S. should experience a decline in natural gas production. That would be a welcome development for natural gas producers who are struggling with low gas prices due to rising production, demand destruction due to the recession, and growing supplies of liquefied natural gas (LNG).
Since early 1999, the U.S. gas rig count was about 400 and daily natural gas production was around 63 billion cubic feet per day (Bcf/d). With the exception of the industry recession of 2001-2002, the gas rig count marched steadily higher reaching about 1,600 at the recent 2008 peak. The four-fold increase in the rig count has been only able to grow daily gas production by roughly 10 Bcf/d, or about 16%. But virtually all the production growth came in the period since 2007 as the technical success of the various gas shale plays around the country brought significant new production. This is the challenge the domestic gas industry faces – can gas production growth be choked off without destroying gas prices in the interim and setting up the country for a new price spike?
Exhibit 10. Falling Gas Rigs Offer Hope For Gas Price Recovery
Source: EIA, Baker Hughes, PPHB
While a drop in drilling and eventually a decline in natural gas production, the most important variable in the equation is the economy. If the U.S. economy experiences a recovery in both the housing and automotive industries, then the gas industry should be able to reach equilibrium sooner than many expect suggesting the natural gas trade could be very profitable. On the other hand, a weak economic recovery could doom the domestic natural gas and oil service industries to an extended, challenging and less profitable environment.
A new government report warning about the impact of climate change effects on the globe and the U.S. was issued last week by the United States Global Change Research Program, a joint scientific venture of 13 federal agencies and the White House. Under a 1990 law, the group is required to report every 10 years on natural and human-caused effects on the environment. The current study was started under President George W. Bush’s administration, but finished under the Obama administration. The report is based on the data and results of a number of climate models.
After reading through the report quickly, it did not appear to break any new ground in the debate about global warming or climate change as it has become more popularly known. It repeats the requisite scary scenarios about potential damage to the United States from global warming. We found it interesting that the report focused extensively on the climate for the past 50 years when data and media coverage has become much more extensive, but dismissed serious historical data that challenges the global warming assumptions. Importantly, one paragraph in the executive summary section makes the point that the pace of climate change will be so fast that people won’t be able to adjust as they have been in the past because the past was a “steady state.” We believe virtually every climatologist would say that the climate is always changing and never steady-state.
“Humans have adapted to changing climatic conditions in the past, but in the future, adaptations will be particularly challenging because society won’t be adapting to a new steady state but rather to a rapidly moving target. Climate will be continually changing, moving at a relatively rapid rate, outside the range to which society has adapted in the past. The precise amounts and timing of these changes will not be known with certainty.”
The key findings of the report are presented below:
“1. Global warming is unequivocal and primarily human-induced.
Global temperature has increased over the past 50 years. This observed increase is due primarily to human induced emissions of heat-trapping gases. (p. 13)
“2. Climate changes are underway in the United States and are projected to grow.
Climate-related changes are already observed in the United States and its coastal waters. These include increases in heavy downpours, rising temperature and sea level, rapidly retreating glaciers, thawing permafrost, lengthening growing seasons, lengthening ice-free seasons in the ocean and on lakes and rivers, earlier snowmelt, and alterations in river flows. These changes are projected to grow. (p. 27)
“3. Widespread climate-related impacts are occurring now and are expected to increase.
Climate changes are already affecting water, energy, transportation, agriculture, ecosystems, and health. These impacts are different from region to region and will grow under projected climate change. (p. 41-106, 107-152)
“4. Climate change will stress water resources.
Water is an issue in every region, but the nature of the potential impacts varies. Drought, related to reduced precipitation, increased evaporation, and increased water loss from plants, is an important issue in many regions, especially in the West. Floods and water quality problems are likely to be amplified by climate change in most regions. Declines in mountain snowpack are important in the West and Alaska where snowpack provides vital natural water storage. (p. 41, 129, 135, 139)
“5. Crop and livestock production will be increasingly challenged.
Many crops show positive responses to elevated carbon dioxide and low levels of warming, but higher levels of warming often negatively affect growth and yields. Increased pests, water stress, diseases, and weather extremes will pose adaptation challenges for crop and livestock production. (p. 71)
“6. Coastal areas are at increasing risk from sea-level rise and storm surge.
Sea-level rise and storm surge place many U.S. coastal areas at increasing risk of erosion and flooding, especially along the Atlantic and Gulf Coasts, Pacific Islands, and parts of Alaska. Energy and transportation infrastructure and other property in coastal areas are very likely to be adversely affected. (p. 111, 139, 145, 149)
“7. Risks to human health will increase.
Harmful health impacts of climate change are related to increasing heat stress, waterborne diseases, poor air quality, extreme weather events, and diseases transmitted by insects and rodents. Reduced cold stress provides some benefits. Robust public health infrastructure can reduce the potential for negative impacts. (p. 89)
“8. Climate change will interact with many social and environmental stresses.
Climate change will combine with pollution, population growth, overuse of resources, urbanization, and other social, economic, and environmental stresses to create larger impacts than from any of these factors alone. (p. 99)
“9. Thresholds will be crossed, leading to large changes in climate and ecosystems.
There are a variety of thresholds in the climate system and ecosystems. These thresholds determine, for example, the presence of sea ice and permafrost, and the survival of species, from fish to insect pests, with implications for society. With further climate change, the crossing of additional thresholds is expected. (p. 76, 82, 115, 137, 142)
“10. Future climate change and its impacts depend on choices made today.
The amount and rate of future climate change depend primarily on current and future human-caused emissions of heat-trapping gases and airborne particles. Responses involve reducing emissions to limit future warming, and adapting to the changes that are unavoidable. (p. 25, 29)”
The report is presented with pictures and outtakes of various topics that are designed to heighten the global warming case, albeit without any facts. For example, there is much made about the flooding of New Orleans during Hurricane Katrina, without mentioning the problems of the levees. The report also talks about the rebuilding of the road to Fuchon, Louisiana because of its flooding. The primary reason for it being rebuilt is flooding. There was only slight acknowledgement of subsidence in South Louisiana as a contributory factor for the road’s increased flooding.
There was also a section dealing with the impact that warming waters in the Atlantic basin are having on hurricane intensity. The authors reference a study we had read some years ago that supported this view, and ignored all the work by Dr. William Gray of the Department of Atmospheric Science at Colorado State University. His work, which we have written about several times including in the April 14, 2009, issue of the Musings, which clearly shows that storm intensity has not increased in recent years. But more interesting was an excerpt from The New York Times June 23, 2008, blog, Dot Earth: Nine Billion People. One Planet. This blog is written by the paper’s environmental writer, Andrew Rivkin, who gained notoriety earlier this year for writing a highly critical column about conservative columnist George Will. In the excerpt, Mr. Rivkin said, “At the time, the basic notion that warmer seawater would fuel hurricanes was young and untested. Most scientists projecting many more, and stronger storms, including Kerry Emanuel (quoted farther down in my 1988 story), have since shifted to more nuanced projections. Enough time has passed that Dr. Emanuel and some other researchers say intensification has already been seen. But the hurricane-climate connection remains an idea in its formative stages.” Unfortunately, the report’s view on hurricane strengthening does not reflect any of these supposed nuances.
Exhibit 11. Fewer Storms Despite Warmer Temperatures
Source: Colorado State University, PPHB
As we read further about the issues the U.S. would confront, we were surprised by a chart and commentary about corn yields. We must assume that all the prior increases in crop yield are attributed to “dramatic technological breakthroughs” that the agricultural industry will not be able to replicate. Maybe that is true, but it is hard to accept the argument based merely on the opinion of the authors.
Exhibit 12. Corn Yields Have Risen But May Not In The Future
Source: U.S. Global Climate Research report, June 2009
Another chart dealing with forest fires is used to make the same point that global climate change has contributed to their increase. Again, the authors fail to mention anything about the change in the Forest Service policy on burning undergrowth periodically to prevent forest fires. That strategy shift has been cited as a contributing factor for more and larger forest fires. Likewise, there was no comment about arson, which has been responsible for a number of the forest fires in California in recent years.
Exhibit 13. More Forest Fires Are Due To Global Warming
Source: U.S. Global Climate Research report, June 2009
As we came to the end of reading the report, we thought maybe it had been written by hypochondriacs. There didn’t seem to be any issue that wouldn’t be a catastrophe. What we realize is how much the Malthusian philosophy is driving the solution for global warming. As Mr. Rivkin’s blog’s subheading points out, there are nine billion people and only one planet. The Providence Journal ran an editorial cartoon originally published by the Seattle Post-Intelligence several weeks ago that summed up the climate change movement’s philosophy.
Exhibit 14. Malthus’ Dark View Of Civilization Dominates GW
Source: The Providence Journal, David Horsey – Seattle Post-Intelligence
The Potential Gas Committee has just issued its latest report on gas supply in the United States that is much more optimistic than its report two years ago. According to the study, all gas reserves (proven, probable, possible and speculative) have increased to 2,074 trillion cubic feet in 2008, from 1,532 trillion cubic feet in 2006. The proven natural gas reserves as determined by the Department of Energy are 237 trillion cubic feet, suggesting that a vast amount of the potential gas supplies are in categories lacking certainty.
Exhibit 15. Potential Gas Committee Optimistic About Supply
Source: The New York Times
The biggest change between the two reports is the growing role of gas shales and the technical success in extracting that supply from those formations. Gas shales were once thought to be zones of trouble when producers were drilling wells. Now, with the advent of more powerful and sophisticated hydraulic fracturing technology, these previous “junk” formations have become star producers. According to the Potential Gas Committee, gas shales are estimated to contain 616 trillion cubic feet of reserves or nearly a third of the total.
The study goes a long way in supporting the petroleum industry’s view that natural gas resources may be the bridge between the age of coal and oil and the next energy fuel era. The Energy Information Administration (EIA) forecasts that natural gas consumption will rise by 13% by 2030. It already accounts for roughly 25% of the nation’s total energy use and 22% of electric power generation. Natural gas is cleaner burning than either coal or oil, which helps in the government’s effort to reduce carbon emissions. Unfortunately, the Obama administration is more focused on growing the share of energy from renewables and green energy sources rather than the practicalities of managing an interim transition from more to less dirty fuels.
The significance of the potential gas assessment and its 35% increase over the 2006 estimate cannot be underestimated. The Potential Gas Committee, a 100% volunteer organization, was established in 1964 to address conflicting estimates of the amount of gas resources existing in the United States. The committee members go over the country basin by basin and examine the known geologic and engineering data for gas reserves. From this work they develop their assessment.
Without the gas shale reserves, however, the potential volume of gas in the U.S. would have been less than estimated in 2006. This is significant in that it means without the effort to unlock gas shale resources the amount of gas would have continued a pattern of a generally flat volume of gas resources since the start of this decade despite an active drilling effort.
Exhibit 16. Without Gas Shales Resources Would Be Lower
Source: Potential Gas Committee, The Wall Street Journal
If the report of significantly greater gas resources proves true, it does not necessarily translate into an increase in production. As pointed out by former EIA administrator, Guy Caruso, “There are some things to be cautious about and obviously one of them is cost, and the other is regulatory risk.” He estimates that natural gas prices need to be in the range of $4 – $6 per thousand cubic feet to be profitable. Gas prices have been trading at the bottom of that range for a while, and the outlook for a recovery in prices to a much higher level does not appear bright. The potential for cheap liquefied natural gas (LNG) to land in the United States at prices well below this target range is growing, at least in the next few years. Whether planned LNG projects become victims of the global economic recession and credit crisis is unknown, but probably a growing possibility. On the other hand, we continue to see new LNG projects being discussed around the world.
The other consideration Mr. Caruso highlighted was regulatory risk. That takes the form of both access issues to these gas shales and other gas basins, and restrictions on the use of hydraulic fracturing. A bill has been introduced in Congress to put hydraulic fracturing and its fluids under the control of the Environmental Protection Agency. What form of regulation, or whether there will be any, is unknown, so trying to anticipate the impact on the natural gas industry’s ability to develop these gas shale formations is highly speculative.
The take-away from the gas resource report is that the role of natural gas in the domestic energy supply can grow. It may give more support to the argument that natural gas can be used for more electric power generation at the expense of dirtier coal and as a transportation fuel displacing gasoline and diesel. This has been the dream of T. Boone Pickens and Aubrey McClendon. Maybe dreams do come true.
A new peer-reviewed paper to be published in the Journal of Climate by two meteorologists from the University of Alabama at Huntsville argues that the relationship assumed by virtually all climate models that temperature changes cause clouds to change and not the other way around could generate forecasts predicting greater global warming than actually will be experienced. The paper doesn’t attempt to disprove the theory of global warming being manmade. Rather it offers an alternative theory that our climate system has the potential for greatly reducing the estimated manmade impact on the Earth’s climate.
Quoting from an interview Dr. Roy Spencer, the principal investigator, gave to ScienceDaily.com, he said, "Our paper is an important step toward validating a gut instinct that many meteorologists like myself have had over the years that the climate system is dominated by stabilizing processes, rather than destabilizing processes — that is, negative feedback rather than positive feedback."
He went on to say, "Since the cloud changes could conceivably be caused by known long-term modes of climate variability — such as the Pacific Decadal Oscillation, or El Nino and La Nina — some, or even most, of the global warming seen in the last century could simply be due to natural fluctuations in the climate system."
Dr. Spencer commented, "Unfortunately, so far we have been unable to figure out a way to separate cause and effect when observing natural climate variability. That’s why most climate experts don’t like to think in terms of causality, and instead just examine how clouds and temperature vary together.” This simple assumption could be causing most global warming models to over-estimate the impact of manmade forces on the climate.
"Our work has convinced me that cause and effect really do matter. If we get the causation wrong, it can greatly impact our interpretation of what nature has been trying to tell us. Unfortunately, in the process it also makes the whole global warming problem much more difficult to figure out." So here we have a scientific review of a critical assumption built into the global warming models that could alter their results – not necessarily change the conclusion that manmade forces are having, and will continue to have, an impact on the future climate of the Earth.
So while many global warming alarmists focus on the accelerating view of the temperature rise and the maximum damage it might cause to our climate, quite possibly they are over-estimating that impact. Research such Dr. Spencer’s raises serious and legitimate questions about the global warming models underlying the proposed economic changes being debated. As Dr. Spencer suggests, “if we get the causation wrong” maybe we are misinterpreting the data we are getting. Maybe we should do more research and analysis before radically altering our economy. The climate debate, in our view, isn’t over – it’s really still in the early stages.
One of the objectives of the Obama administration’s energy policy is to reduce the dependency of the United States on imported oil. This has been a goal of virtually every previous administration starting with President Nixon in 1972. For most of this time, oil imports have grown as U.S. domestic oil production declined and oil consumption steadily rose. The average of the four weeks ending June 12th, the United States imported about 12.0 million barrels a day (b/d) of crude oil and refined product out of estimated daily demand of about 21.4 million b/d of consumption. Total imports represent about 56% of the total oil demand in this country. Our total demand estimate includes the volume of refined product exported from the U.S. since it demonstrates our total exposure to imports.
The latest data on crude oil and refined product imports by country is through March 2009. That month’s data shows a total import volume of 12.5 million b/d with Canada being our leading supplier with 2.4 million b/d, Mexico second at 1.2 million b/d, Venezuela third at 1.1 million b/d, Saudi Arabia fourth at 1.0 million b/d and Nigeria fifth at 0.9 million b/d. The interesting thing is that these top five countries have remained in our top five suppliers since at least 2000.
Exhibit 17. Top U.S. Suppliers Show Oil Production Problems
Source: EIA, PPHB
As we look at these five countries we are drawn to the point that at least three of them have serious long-term supply challenges that could result in their not being able to sustain their current exports to the U.S. That could mean the U.S. will become more dependent on other foreign suppliers or welcome increased volumes from our two most solid suppliers – Canada and Saudi Arabia. Each of these countries present policy issues that the Obama administration needs to deal with. But first let’s look at the supply challenges of the other three top suppliers.
Exhibit 18. Over Time Canada and Saudi Have Grown Output
Source: EIA, PPHB
When we look at a chart of production by each of the five countries since 1965 through 2008, it becomes clear that Saudi Arabia and Canada have been essentially on growth trajectories. Each of these countries has significant oil reserves, although Canada’s are from the tar deposits near Ft. McMurray in northern Alberta. Both Mexico and Venezuela have produced substantially more oil in the past then currently, but each suffers from problems that are contributing to falling production that endangers U.S. oil supplies. Mexico’s oil production is in a long-term, rapid decline as the giant offshore Cantarell field is being rapidly depleted. The ability of Pemex, the state-owned oil company, to overcome its technical shortcomings for deepwater exploration in the Gulf of Mexico and extract more oil from several large onshore fields with highly complex geology is in doubt. For the first five months of 2009, Pemex’s production has fallen by 7.9% to 2.65 million barrels per day. The Mexican constitutional restriction against any non-government entity gaining ownership of domestic hydrocarbons has made the country less attractive for major independent oil majors to become involved. While these western companies possess the knowhow for deepwater exploration, they are reluctant to enter into service contracts where there is no upside to the value of their technological knowledge and skills.
Venezuela’s case is quite different and reflects the political situation within the country. Since President Hugo Chavez assumed power, and was re-elected, he has strengthened his control over revenue generating businesses in Venezuela. Not only has he grabbed control over income, which he has used to build greater support among the poor in Venezuela through monetary grants and free services, he has driven the knowledge workers of the oil industry from the country since they were seen as his foes. Lacking the technological capabilities and with reduced reinvestment in the business, Venezuela’s production has fallen despite Pres. Chavez’s claim that the country is still producing at its much higher OPEC quota. Unless conditions change, and/or Pres. Chavez reverses his policy of giving cheap oil to neighboring countries to earn political support for his socialist agenda, Venezuela’s oil supplies are likely to continue to decline. The recent investment programs by China and other countries will make new Venezuelan oil supplies off-limits to the United States.
While Nigeria offers the possibility for increased supplies, the ongoing violence and terror reign in the country that has resulted in shut-downs of production and export operations makes the country suspect as a dependable source of oil. The long-standing corruption issues that have plagued western oil and oilfield service companies are also likely to make Nigeria a less attractive country for the petroleum industry to work in. These conditions could change, but much like subprime mortgages, Nigerian assets have a toxic quality to them.
There are clearly other countries that could step forward to replace the declining production from Mexico, Venezuela and Nigeria. However, the global oil production lost from these three countries, coupled with the general aging of producing oilfields around the world suggests that we will be looking at higher oil prices in the future. The easiest way for the Obama administration to achieve both its energy and environmental goals is to encourage the development of all types of alternative fuel sources, especially those for power generation. Unfortunately, this administration has fallen into the trap of picking energy winners and losers as it has with the banks and automakers.
Electric and hybrid vehicles offer promise for cutting petroleum demand. Compressed-natural-gas vehicles represent another potential oil-saver. The new diesel engine technology developed in Europe and slowly making its way to the U.S. offers another cog in the fuel-transition movement. The problem we perceive is that the Obama administration has little sense about how best to accomplish this transition in power-train technology. The transition will take time and is best driven by market forces, in our opinion. While we are not big fans of higher taxes, we think that only by raising gasoline prices along with developing a mechanism to rebate the higher cost to low-income people, can the transition to a more fuel-efficient vehicle fleet occur on any timely basis.
We were amused to read an article on the recliner chair phenomenon in the Home Section of The New York Times last week. The article focused a little on the history of the recliner, how it evolved and why it is recognized as the “man’s chair.” It turns out that the recliner was developed in 1929 by the founders of La-Z-Boy chairs. The writer described how the recliner has become the refuge for men worried about job security, shrunken 401k pensions and dealing with losing athletic teams. He also discussed how the recliner evolved in dealing with these purposes including one recliner that included a cooler in the armrest so the occupant doesn’t need to get up to get a “brew for the game.” But what we thought was very funny was one of the graphics accompanying the article that compared the Big Man’s chairs to a Mini Cooper automobile. It reminded us The Oil & Gas Journal editor Bob Tippee’s description of large SUVs as “barns on wheels” during a RMI Oilfield Breakfast presentation.
Exhibit 19. Recliners Are Beginning To Rival Small Cars
Source: The New York Times
We wondered how the Big Man’s chair would compare with the Smart Car. The Smart Car’s size dimensions are 60.7” x 61.4” x 106.1” and it carries two people. The car weighs 2,315 pounds and retails for $11,999.
Exhibit 20. Smart Car Could Hold Recliner 
Source: FreeFoto.com
We also got a good laugh from the following cartoon.
Exhibit 21. The Reality Of The Oil Industry
Source: Adrian Raeside, Creators.com
Contact PPHB:
1900 St. James Place, Suite 125
Houston, Texas 77056
Main Tel: (713) 621-8100
Main Fax: (713) 621-8166
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.
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