BY G. ALLEN BROOKS, MANAGING DIRECTOR

 

Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that have potentially significant implications for executives operating oilfield service companies. The newsletter is published on a semi-monthly schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, we welcome your comments and observations.

Last Friday, the U.S. rig count marked its 22nd consecutive week of increases, with rigs drilling for oil matching that record.  That’s the longest streak since 1987 (we haven’t had time to check our 1949-1987 records).  Will the weakening of oil prices end this streak, or have oilfield economics changed sufficiently that it could go on forever?  We just returned from nine days touring Tibet, which opened out eyes to how a poor but tradition-rich country is slowly being absorbed by China – its “liberator” of some 50 years ago.

The upcoming parliamentary elections in Norway, the world’s leader in EVs, will feature political debate over the cost of the government’s electrification of its auto fleet efforts.  Scaling back subsidies could create another Denmark, where EVs could barely be given away following the elimination of their subsidies.  Even in China, the spiritual leader for EVs, buyers/owners are questioning their performance and economic value, while also trading back to internal combustion engine cars.  The cost of the battery-pack of a Chevy Bolt accounts for more than half of their subsidized $30,000 price tag.  Herein lies the conundrum for EVs – without cheaper batteries, subsidies can’t be dropped, and without subsidies, EVs quickly become expensive cars.  The logistics of a trip half way across America in a Bolt is explored, showing another challenge for EVs.

 

OPEC has decided.  A nine-month extension was the outcome, but the commodity market didn’t like it, dropping oil price by nearly 5%.  Although oil prices rebounded on Friday, WTI remains below $50, about $2 a barrel below where oil prices began 2017.  By extending the production cut agreement until April 2018, OPEC is betting its action, along with non-OPEC support, will lift oil to $60 a barrel by the start of 2018, in time to help the Saudi Aramco IPO.  Besides global oil demand, OPEC/non-OPEC compliance and U.S. shale output, there are other factors that will determine if OPEC’s prediction works out.

Peak oil demand is the new hot topic, but there are considerations about forecasting that should be considered.  The key variable in this debate is what happens to transportation fuel consumption as more EVs enter the fleet.  The latest optimistic EV forecast suggests a dire outcome for fossil fuels, but are its underlying assumptions grounded in reality?  Offshore well cost reductions, combined with the prospect of higher oil prices may finally revive the offshore sector, the one segment of the oil business yet to show signs of recovery from the oil price downturn of the past two years.  British Columbia’s provincial elections are now complete and the reality of a minority government creates uncertainty for major energy projects in the province that are critically important for Canada’s energy and economic progress.

 

 

 

It’s college graduation season and some newly minted graduates will be wrestling with the decision about joining the energy business.  If they read the financial or industry press, they might be scared to go to work for energy companies as commentary about daily oil price fluctuations create impressions of immediate booms or busts.  A look at long-term fundamentals suggests a more challenged future for energy, but still a future.  That is the more important consideration for grads.  Barack Obama, the Environmental President, gave a talk in Milan where he not only made confusing climate change claims, but actually aligned with the views of a climate skeptic.  Were his environmental views all about politics?

Trucks and weather dominated our drive from Houston to Rhode Island, see our observations.  It turned out to be our fastest trip ever.  We take a look at what happened in recent weeks to erase the 5-handle from oil prices, even now after Saudi and Russia agreed there should be a 9 months extension of the OPEC production cut agreement.  Anti-fossil groups now are targeting banks in an effort to pressure them to stop making loans to build pipelines.  If you can’t stop the building of pipelines, maybe you can prevent their financing.  With so much capital available for energy, it’s hard to see this strategy working.  Does it matter as we find that photosynthesis is much more efficient today removing tons of CO2 from the atmosphere.  Is this one of those climate unknowns that have challenged the climate change theology?

 

 

Are you worried about electric vehicles’ impact on oil demand?  Maybe you should be, then again maybe you shouldn’t worry.  We examine some of the broad trends that will determine how much impact there might be.  But a major study for the EIA on “connected and automated” vehicles shows why we aren’t sure whether to worry or not.  We examine the study in depth.  The political and economic drama unfolding in Saudi Arabia makes us wonder if we are watching a re-run of the 1960s TV western Bonanza.  The family leader and his three sons ruled their ranch and dealt with moral dilemmas of that time and place, much like in Saudi Arabia today.  However, this may merely be the next round in the latest Rumble in the Desert between OPEC and American shale producers.

Britain recently went a full 24 consecutive-hours without using coal-generated electricity.  This is being hailed as a watershed moment for renewable power.  Natural gas has been taking up the slack from coal, and biomass – wood – is also playing a role.  Coal will likely be used to meet the country’s power needs this next winter, just as it was last winter, and at considerable cost.  China is aggressively moving to boost EV purchases at a time when its citizens want SUVs.  The same seems true in the U.S. and Germany.  How will this policy clash work out?  Subsidy-free wind power for Germany is touted as opening a new era for renewables.  Upon examination, the successful bidder’s outs, for its 2021 FID may mean offshore wind still won’t be ready for level-playing field completion, even in a land of high electricity costs.

 

 

The oil industry recovery is on a breathtaking pace.  It has been driven by optimism for higher oil prices and reduced well breakeven costs.  Forecasters are grappling to understand how well costs have fallen, and what will happen to activity as oilfield inflation rises.  Will shrinking profit margins cause producers to slow drilling, or are we back in a world that worships volume growth over profitability growth?  Environmentalists and auto manufacturers are facing off over a potential Trump administration review of vehicle fuel-efficiency standards.  What could that mean for EVs?  The face-off is playing out against a backdrop of weakening auto sales, a glut of young used cars and deteriorating consumer credit standards?  With low gasoline prices, EVs are being shoehorned into the auto fleet, not because Americans are clamoring for them.  Will all of this change?

The latest summer weather forecast suggests little help for natural gas consumption.  Furthermore, the forces shaping the upcoming weather may not help trim gas supplies.  It may all come down to cheap gas for electricity and increased LNG exports to keep supplies from overwhelming storage and driving down prices. Germany’s green power revolution is coming at a huge cost for its residents, workers and the environment.  These forces have knocked the country off its emissions-reduction path, produced the most expensive household electricity prices in Europe and pushed more citizens into energy poverty.  Should this be a warning to Americans?

 

 

Understanding the dynamics of past oil cycles helps to gauge what forces will define the industry’s future.  Importantly, understanding what is different this time from the past should help people assess better corporate strategy shifts.  Equally important, people can consider events and trends that might become the next big cyclical industry driver.  Examples might include the failure of shale to deliver its miracle production growth, or how many electric vehicles will it take to disrupt oil consumption’s growth?.  Broad trend shifts are more important than near-term sentiment or short-term inventory fluctuations.  The natural gas market continues to struggle trying to establish sustained higher price levels in the face of low prices that have enabled coal to seize market share in the electric power generation sector.  After a mild winter, analysts are shifting their focus to what the summer holds for gas consumption.  All the while, support for gas prices comes primarily from lower gas supply.  Will increased oil shale drilling create more associated natural gas supply, hurting gas prices?

The oil price climb back above $50 a barrel has been driven by a more optimistic outlook for oil prices in the second half of 2017.  Comments about extending the OPEC/NOPEC’s production cut agreement, more positive global economic growth indicators, and continuing oil exporting country supply disruptions have overwhelmed the previous negative sentiment that had gripped the oil market in early March following a jump in U.S. weekly oil inventories.  Can the positive sentiment be sustained?  The greatest risk for the global oil industry is electric vehicles destroying gasoline consumption growth, and even causing it to shrink.  Just how green are EVs and what about their costs?  Moreover, if EVs continue gaining market share, will we eventually face a battery-disposal environmental hurdle?  Lastly, another test to use wind power to assist ocean tankers reminded us of the experiment offshore contract driller Rowan’s long-time CEO Bob Palmer tried during the 1980s.  Costs proved to be the ultimate bug-a-boo.

 

Support for crude oil prices has diminished with the surprise oil storage jump, domestic oil output growth coupled with continued oil rig count increases, and fears that global oil demand is being muted by higher oil prices.  The first event initiated the oil price slide.  The latter two issues continue to hold back any oil price recovery.  We look at some other indicators impacting oil prices and the sentiment surrounding them.  The great future for electric vehicles may have to await their ability to fulfill more tasks Americans ask of their cars.  We examine one woman’s 800-mile journey in her new Chevy Bolt.

Germany has declared it wants to outlaw ICE vehicles by 2030 and use 100% renewable power instead.  But with the current nuclear power plant phase-out, Germany has set itself up for increased, rather than lower carbon emissions.  How could that happen?  2016 was touted as a great year for renewable power in the U.S.  How much of that growth came from rational economic decisions rather than mandated actions?  Finally, we report one man’s analysis of the efficiency and economics of a BMW versus a Tesla.  The EV Tesla wins on operating cost, but loses on green power.  It makes for an interesting analysis.

One of the hottest topics in the energy world right now is carbon taxes.  We have been following the proposed carbon tax in Rhode Island along with the recent proposal from a group of leading Republican leaders headed by former Sec. James Baker.  The scope of these carbon tax proposals is widely divergent.  We examine some of their claims along with examining the experience of British Columbia, the shining example the tax proponents point to in order to justify the tax.  We also look at the current status of many of the factors that shape oil prices and will influence whether prices head higher or not in the near term.

 

A recent study examined how improvements in electric vehicle and photovoltaic technologies will crater oil demand putting substantial resources within the industry at risk of losing their value.  We examine the EV acceptance claims, along with the shifts underway in the European power market.  Some of these claims may be questionable.  Understanding how quickly and to what degree EVs will impact gasoline/oil use remains a highly speculative analysis and open to widely divergent assumptions.  We will be reviewing more studies in the future, as this is a serious question for energy policy makers and energy company executives, and making new forecasts has become a sport.  Lastly, a new study suggests that New York State may not need as many new renewable energy projects to replace the power it will lose when the Indian Point nuclear reactors are shut down.  Whether the proposed solution will work remains uncertain.  What it will cost is also unknown.

The issue of how much new shale oil output can come from a revitalized U.S. drilling effort will determine future oil prices.  More drilling in response to higher oil prices, and hopes for even higher ones in the future, combined with reduced well breakeven costs due to better drilling and completion technology will help drive higher output.  Better rocks, greater rig efficiency and improved economic ultimate recovery metrics are powering this revival, but with they continue?  We explore how these developments could disrupt the march to higher oil prices.  UPS drivers studiously avoid making left-hand turns.  Surprisingly, driving further to avoid making left hand turns can actually save gasoline.  We look at the results.  Crude oil prices are more than just a reflection of supply and demand.  They are also influenced by measures of oil-price volatility as well as shifts in the value of the U.S. dollar.  The current environment for these factors resembles 2009-2010, at the time oil prices began heading toward $100 a barrel.  Could that happen again?

Commodity traders are starting to pull in their bullish horns, which shouldn’t be a surprise.  Interestingly, European oil traders/speculators, although still bullish, are less aggressive than they were in early 2014 as oil prices approached their peak and then collapsed.  Should we be watching what they are doing to forecast oil prices?  Crude oil prices have been supported by the historically high OPEC production cut compliance in January.  One forecaster sees U.S. oil output ramping up to record levels in the next five years without oil prices reaching $80 a barrel.  As Americans gain weight, car safety experts have to use larger crash-test dummies to study injury risks.  What would happen to small car demand in this country if Americans go on a diet?

The role of the automobile in the world’s future transportation system will determine the amount of gasoline and diesel fuel needed, and in turn the amount of oil required to produce the fuels.  Impacting this outcome will be the share of the global vehicle fleet represented by electric and other non-gasoline and diesel powered vehicles.  We examine both the BP and ExxonMobil views on this topic along with reviewing recent trends in the U.S. auto transportation sector.  In anticipation of higher oil prices later this year in response to the OPEC/NOPEC(non-OPEC) production cuts, crude oil traders have placed their most bullish bet on that occurring in the last decade.  Interestingly, in past periods of peak optimism, traders often faced falling oil prices shortly after their bullish bets were placed.  Will that happen this time?

Low natural gas prices are driving coal from the electricity generating market and will potentially drive nuclear out, too.  But there are other dynamics at work shaping the nuclear industry outlook such as the push for more electricity generated by renewables.  We examine the latest nuclear power battle in New York State where Gov. Cuomo is working to get the Indian Point nuclear plant located near NYC closed by 2021, 14 years ahead of its license expiration.  The problem for New York power consumers is that this plant accounts for 12% of the state’s electricity supply, an amount that wind and other planned green energy sources will be unable to replace, leaving customers facing skyrocketing electricity prices and at risk of an unstable grid ensuring increased blackouts, i.e., the worst of both worlds.  As with many issues impacting the power market, this battle over the future of 20% of America’s power that comes from nuclear is well below the radar screen.  Finally, we review the BP 2017 Energy Outlook as it offers some interesting and confounding views about the future of the energy business, and the oil and gas markets, in particular.

A key ingredient impacting 2017 oil prices will be the value of the U.S. dollar, something President Trump has focused on recently.  His comments drove the dollar’s value down by 1% last Tuesday.  It is interesting to see what the dollar/oil price relationship was during the 1980s and 1990s as a potential precursor for the future.  If we repeat that pattern, look for oil prices to remain in a fairly tight range for a number of years, contrary to a number of forecasts.  Two federal judges have slammed government agencies over their abuse of the “rule of law,” something likely to change under the new administration.  Both the EPA and BSEE were admonished to follow the laws they operate under and to stop making new laws.

Crude oil was the best performing asset class in 2016, but that didn’t lift it from last place for the 2007-2016 decade.  In fact, if you owned oil over that decade you actually lost money, the exact opposite of the prior decade’s results.  Where might crude oil rank in the coming decade?  A recent study showed that a handful of integrated oil companies generated more than the lion’s share of the entire oil industry complex’s free cash flow.  Are integrated oil companies the best (or safest) way to invest in the energy business?  With the Chevy Bolt being selected as the 2017 North American Car of the Year, auto industry thought-shapers (journalists) have unofficially designated this as the year of the Electric Vehicle.  Will it actually prove that significant?

With the holiday season and then traveling half way around the world, we wrote a slightly different Musings.  In keeping with our recent theme of cold weather being worse for humans than hot temperatures, the EPA is now focusing on shutting down Alaskans’ wood-burning stoves to address minor smog issues caused by wood-burning stoves.  This is the least costly and most used method for heating homes in an energy-disconnected infrastructure, but that doesn’t seem to bother the regulators.  At the same time, a respected Russian climate researcher has demonstrated with his acclaimed and highly rated climate model how a new Little Ice Age has commenced.  This is a media world obsessed with global warming.

The energy themes of 2017 will likely be the same ones we were focused on in 2016.  In that regard, understanding more about electric vehicles is helpful, but the scariest thought was expressed by the portfolio manager of the New Era Fund who says this commodity downturn could last for a decade!  Is his view what “lower for longer” means?  We also have a brief review of the crude oil and natural gas markets for 2016 and what 2017 might hold.