Date: January 10, 2011
Author: Peter Tertzakian
Our calendars have flipped to 2011, but the market chatter hasn’t really changed: China’s insatiable appetite for commodities, European debt, a sputtering US economy, environmental issues, peak oil and the North American gas glut. But plenty could change or start to change in this New Year. Here are 11 big issues that stakeholders in the Canadian oil and gas industry should be watching in 2011:
China’s economy – This is the elephant in the room when it comes to growth in oil demand. Over 40% of the world’s incremental oil consumption is coming from China, so slight changes in their economy will amplify into big oil price movements. China will be celebrating the Year of the Rabbit in 2011, leaving behind the Year of the Tiger. Let’s hope the change in animals is not symbolic to oil demand.
The US economy – Oil markets still believe that US petroleum demand is rising with economic growth, so listening to the Fed and reviewing US economic stats is still important. Truth be known, secular growth in US oil consumption leveled out around 2006 after the commuter radius stopped expanding, biofuels started substituting for gasoline, and other demand-mitigating factors began kicking in. Maybe 2011 will be the year that the market finally realizes that US oil demand is no longer positively coupled with economic growth.
China’s energy policies – In oil circles everyone talks about China’s booming economy and how many cars the Chinese are buying. It’s all true, it’s daunting, it’s going to keep pushing up oil prices in 2011, but these bullish Chinese factors are only representing half the picture. Few are talking about the major innovations that are brewing in China’s “new energy” efforts. Having dominated solar and wind technologies in the span of a few short years, China’s energy policies are now targeting leadership positions in other new energy areas like efficiency, batteries, electric propulsion and nuclear power. The Chinese have realized that their hockey-stick trajectory for energy demand must change, consequently they are aggressively pursuing and subsidizing alternatives. Will western oil markets start recognizing that side of the story in 2011?
Electric vehicles – At least two leading auto magazines have named the Chevy Volt the Car of the Year. GM’s new-age vehicle that Automobile Magazine calls “genuinely an all new car,” is getting very favorable reviews as is the all-electric Nissan Leaf. This year will be a pivotal trend marker for plug -in hybrid and pure electric vehicles (EVs) as other big automakers announce several more new models. Adoption of EVs looks more tangible than many in the oil business would like to believe. Denying that gasoline can be substituted by electrons is not recommended, especially if oil breaks through $100.
North American oil production – Since peaking in the mid-1970s conventional oil production in Canada and the United States has been on a 35-year decline. The application of horizontal drilling and fracturing to tight oil reservoirs – a replay of the shale gas movie with different actors – is bringing meaningful quantities of light oil to market. For example, in North Dakota’s Bakken play, production has risen from zero to 250,000 B/d in a few short years. The Bakken can be viewed as a proof-ofconcept oil play much as the Barnett was to gas. Horizontal drilling targeting oil is extremely profitable at current price levels and so will continue to climb through 2011. As such, oil production from nascent plays in both the US and Canada is rising quickly. This year’s North American oil production growth is going to confirm the reversal of a 35-year decline and maybe even shake a few peak oil theorists.
Cost inflation – The likelihood of $100/B brings smiles to oil sands operators, but the joy may be short lived if costs can’t be contained. Inflation in the global oil and gas industry has a high probability of returning in 2011, which means the only group that will be smiling will be the oilfield service companies.
Geopolitics of oil – Over the past couple of years the oil markets have mostly shrugged off noise from Iran, Nigeria, Venezuela and other oil producers from where geopolitical antagonism typically radiates. That’s mostly because oil supplies have been ample every since the Great Recession. Nevertheless, the known unknowns of oil geopolitics are always lurking behind the trading desks of oil markets. Heading into 2011, it feels like the geopolitical front has been too quiet for too long.
Natural gas fundamentals – Winter is statistically at its coldest right about now and there is still too much natural gas in North America. When the January calendar flips gas prices will begin a usual weakening trend into spring. Sometime in April the markets will be looking for positive news again, trying to shore up prices. The reality is that natural gas prices can’t sustain below the true marginal cost of bringing new molecules to market, so something will have to change, it’s just a matter of when. Falling rig counts will be watched for closely. The market will also be keeping an eye on any growth in nonseasonal consumption. What we do know is that the annual decline rate on all US gas production has steepened from 21% in 2003 to over 30% now. So, when change comes it will come quickly, which always seems to be the case in this business.
Asian capital – Last year $10.2 billion of Asian capital flooded into Canada’s oil and gas industry. The pace of Asian investment is unlikely to relent in 2011. No one is going to refuse cheap capital (Confucius must have had a proverb about this), but too much money coming in too quickly will arouse unwanted cost inflation.
Government policy – Whether regulating carbon emissions, ensuring energy security, tightening environmental protocols, making changes to fiscal regimes, or intervening in financial markets, government policy is the most influential factor in energy markets. We are in an era when more legislation is likely; there is no reason to believe 2011 will be void of impactful policy surprises.
Virtualization – Last week the Consumer Electronics Show (CES) in Las Vegas was once again showcasing technologies that would even amaze the Jetsons. Bigger, thinner, brighter, crisper video screens are a big theme, now in 3D too. Social networking and video phones are changing the way we interact as well. These and a bevy of new digital technologies are all part of the virtualization trend that is quickly reshaping our day-to-day lives. Photos, music, books, magazines and newspapers have all been virtualized. We as people are starting to be virtualized too. How we ‘meet’ each other is changing, which means our transportation paradigm will change too. If film, paper and DVDs can be virtualized, are barrels of gasoline and jet fuel far off?
Peter Tertzakian, Chief Energy Economist and Managing Director of ARC Financial Corp. is the bestselling author of A Thousand Barrels a Second and The End of Energy Obesity.
Retreating From the Ends of the Earth
Date: January 17, 2011
Author: Peter Tertzakian
Chapter 4 in my book A Thousand Barrels a Second (McGraw-Hill, 2006) was one of my favorites. Titled, “To The Ends of the Earth,” I spoke about the diverging trends of a growing, global appetite for oil and the industry’s diminishing ability to serve the hunger at the then price of around $50/B. After five turbulent years that hosted an intermission for a financial crisis the same script appears to be replaying. But the theatre is not the same as it was in 2006. Some themes need revisiting, notably that the oil industry must still go to the “ends of the earth” to find new barrels of oil for a hungry world.
The 150-year progression of the oil industry’s exploration activity from easy-to-find onshore oil, to progressively more challenging and deeper offshore regions, to increasingly inhospitable geographies, to more demanding, uncomfortable and constrained political locales, all constituted a costly migration to “The Ends of the Earth.” Against a backdrop of a voracious oil appetite from emerging markets like China the megatrends in play were a strong and correct argument for a rising oil price.
At the time I wrote in Chapter 4 that, “There are billions of barrels of reserves remaining on the planet,” but that “The real issue is that we are running out of reserves that provide enough economic incentive to produce with today’s technology and in our current geopolitical atmosphere.” But now oil is being priced at $90/B and ‘today’s technology’ has been surpassed with new innovations in drilling, well completions and a multitude of other related disciplines. Under these revised conditions, is it still true that the industry must continue going to ends of earth? In truth, we cannot ignore the possibility that lots of oil may be liberated from areas in North America that are not constrained by geopolitics and hostile geography. And the numbers could be starting to show it.
For over 100 years, since oil was first brought to market in 1859, production grew steadily across North America. In the United States crude oil output peaked at 9.7 million barrels a day in 1970, just before the great oil price shocks of that decade. Since then crude oil production in North America has been on a secular decline. Today, the United States only produces 5.5 MMB/d, down 43% from its 9.7 MMB/d peak. This forty year down-trend is embedded in the psyche of most oil industry professionals. In other words, those in the business are accustomed to watching oil production recede every year by about 150,000 barrels a day, a dynamic that has been as predictable as leaves turning colour.
But there are signs of change. For example, oil production from North Dakota’s Bakken play is yielding serious volumes, having grown to over 250,000 barrels per day in a relatively short period of time. Volumes from other “tight” oil plays are growing as the industry applies the horizontal drilling and fracturing formula that turned the natural gas industry upside down toward the oil side of the business. Now there are very early indications that liberating tight oil could reverse a three-decade trend of declining onshore oil production and shatter another energy assumption long considered immutable.
Figure 1 shows long-term US crude oil production from 1950 to 2010 (excluding NGLs). The upticks in 2009 and 2010 are undeniable, however caution is always advised when hypothesizing whether or not a new trend is emerging. For one thing, some of the recent production rise continues to be recovery from hurricanes that lashed the Gulf of Mexico five years ago. For example, the big Thunderhorse platform was finally brought online in 2009.
Nevertheless, a deeper dive into 2010 data does show noticeable growth in onshore US oil production, net of declines. In 2010, the onshore uptick was only 77,000 B/d, but it’s important to recognize that it’s the first meaningful, positive contribution in a long time. The Bakken, and dozens of other potential plays in the US, and also Canada, are potentially contributing to the start of a prolonged production trend reversal.
Let’s be objective. A couple of data points do not make a trend. But as anyone in the natural gas business would attest, denial that change is happening is inadvisable, especially in the face of new technology and profitable economics. The North American oil rig count continues to rocket upward, with many of those rigs drilling horizontal wells that are being hydraulically fractured. The first act of this oil script does not read all that differently from what happened to North American natural gas. First it was the Barnett Shale, then came the Haynesville, the Woodford, the Eagle Ford, the Marcellus and so on. The later natural gas acts are all history now, the early oil acts are just starting.
Here are some words taken from Harvey O’Connor’s 1955 book, The Empire of Oil, “The stream of automobiles pouring from the factories was unmatched by a comparable increase in domestic production. Calamity howlers predicted an early end to oil….. Such worries died down with the discovery of the great Seminole field in Oklahoma in 1926, accompanied by big finds in Texas. Then came Oklahoma City and the Kettleman North Dome field in California in 1928. It was a period of rapid expansion in production…..”
The interplay between price and technology has long driven the expansion of natural resource capacity, with periodic step changes or ‘break points’ happening every few decades. Oil prices above $75/ B is a step change. So too are new drilling and completion technologies. Together, both are providing plenty of incentive to bring oil that is not at the ‘ends of the earth’ to market.
Peter Tertzakian, Chief Energy Economist and Managing Director of ARC Financial Corp. is the bestselling author of A Thousand Barrels a Second and The End of Energy Obesity.