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.

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The global economy is failing in its goal of limiting carbon emissions and the IEA, among others, has become concerned. Looking at the US economy, we find that over two-thirds of our energy is “rejected,” meaning it is wasted. Surprisingly, in 1970, a similar analysis showed we used more than half our energy, rejecting only 48%. Why the difference in performance? Think about how much money we have invested to improve the efficiency of our vehicles and power industry. Wasted money, or is there a great opportunity to reduce our energy use and carbon emissions? The Trump administration’s current effort to save older fossil fuel power plants has an Inspector Clouseau quality to it. Is it fair to make utilities buy this power, when states make them buy renewable power, if the fossil fuel power means a more stable grid? ISO-NE officials are concerned about what renewable power may do to their power grid reliability. A bumbling effort, or will Clouseau find the right solution?

The East Coast offshore wind business is kicking into high gear with two recent awards. The race to become the industry’s construction and support hub is on between Massachusetts and Rhode Island. The impact on the respective state economies is highly disproportionate. Residents are more focused on what this new power supply will cost, but they are being assured it will be “cheap,” whatever that means. Germany’s clean energy revolution has sent residential power prices to the highest in Europe, with taxes and fees (including support for renewable power) accounting for over half the typical bill. Now the country confronts older wind farms reaching the end of their government financial support, which will result in them being shut down. More windmills are needed! Based on the push by governments, which is driving auto company investment in new electric vehicle assembly and battery plants, the EV business will be growing at an accelerating rate over the next few years. That could translate into faster penetration of EVs in the global vehicle fleet than some forecasters, especially oil companies, are predicting.

 

 

EU carbon emissions rose surprisingly in 2017, although several major economies experienced noticeable reductions. Most of the member countries experienced emission increases, including a number of large economies. Germany, for example, will miss its 2020 carbon emissions target due to being forced to use coal in order to enable its renewables power facilities to function. A political battle is ongoing involving the creation of a commission to plan the shutdown of the country’s coal plants, which will create significant social and economic costs for three of Germany’s states. Last year, EU new car emissions rose, after years of decline, despite fewer diesel cars being were sold. EVs haven’t contributing much to reducing carbon emissions because they represent such a small proportion of the total EU vehicle fleet. We just finished our summer drive from Texas to Rhode Island. Yes, truck traffic was a major issue – even more so than in recent years. Our judgement is that the U.S. economy is doing well, if all the Help Wanted signs we saw are an indication. Other signs told us about highway driver attitudes with different messages.

Northeast shale gas exiting the region is growing, forcing a national gas-flow reorientation, at a time when it could be helping electricity users in the region who pay the highest prices in the nation. We examine why this situation is upending the domestic gas and power industries. On our trip north, we stopped to see the TVA’s Raccoon Mountain Pumped-Storage Plant in Tennessee, one of only a handful operating in the United States. A wonder to see and learn about. California is addressing its carbon emissions by mandating rooftop solar installations on all new residential and small apartment buildings constructed after 2019. Will it help? At what cost? East Coast states are racing to build offshore wind farms, but we are now learning that Northern European wind farms are facing significant repairs after less than five years of service. And those wind farms don’t face the similar wind and storm surges of hurricanes and tropical storms that race up the East Coast. Just how successful will these East Coast states be in delivering cheaper power to area residents?

 

 

April was a cruel month for natural gas storage as net injections for the month declined for the first time in years. The challenge is determining whether the gas industry can inject sufficient volumes to rebuild storage to a level that the market considers adequate for meeting winter demand. Gas prices suggest the market doesn’t think this will be a problem. EV sales in the U.S. and key European countries reached record levels last month. The volume of EV sales suggests the market is approaching an inflection point, and more EVs will be in our future. Whether EVs take over the entire auto industry is still highly questionable, as subsidies continue to drive sales growth. Can the EV market survive the elimination of government subsidies?

The success of the shale revolution has altered the state of the U.S. energy market, the country’s role in the global energy market, and importantly, the functioning of every significant industry dependent on energy. With all of these relationships are in a state of flux, it is virtually impossible to know how the changes will play out. What we do know, however, is that the pace of change in the energy world is accelerating. We do a survey of the dynamics within the energy industry today as a result of the shale revolution. In California, energy is costing more every year, and given the housing crisis, driving residents out. New rules that remove EV subsidies and that push housing costs up (mandated solar panels) will drive even more people to move out of the state. Has California Dreaming become Hotel California? Forecasting natural gas prices requires examining the changing role of gas exports in the market’s balance. Without increased exports, gas prices could be under pressure, unless production growth slows. Can LNG exports grow fast enough to push gas prices up?

 

We re-examined Shell’s Sky scenario for a net-zero carbon emissions world in the context of the company’s string of progressively cleaner world planning scenarios since 2013. We were prompted to look at this history by the announcement of a possible lawsuit against Shell by Friends of the Earth Netherlands for failing to work to reduce the company’s carbon emissions footprint. Will Sky be Shell’s defense that achieving a net-zero carbon world is unrealistic despite the best intentions of the company ($400 million in renewable businesses purchased) and the fossil fuel industry? Tracing the planning scenario history suggests it is a real possibility. Oil prices are soaring and forecasts for higher prices are proliferating. OPEC’s supply cut discipline is being credited with changing oil’s price trajectory. Higher price expectations are tied to continued strong global oil demand, but might that dynamic be at risk, based on history, if oil prices remain above $60 a barrel? We look at the history of pricing and demand growth.

Higher oil prices have done little for the share prices of oil and oilfield service companies since 2017. Will that change? We look at the market liquidity aspect of the oilfield service stocks, which has become an impediment for institutional investor buying. Of course, market sentiment can change quickly, especially when we least expect it. The promises of wind energy seem to be coming up short as sharply rising electricity costs are becoming the rule in those countries and U.S. states that are embracing renewable power. If wind and solar are so cheap, why are electricity costs rising? Are we finding that the promises of clean, cheap and reliable electricity from wind are really less in reality? A Washington name from the past, someone who tormented and forever altered the offshore industry, has resurfaced in the Trump-Russia saga. We reveal who it is, and revisit his interaction with the offshore energy industry.

 

In the battle of climate change and government regulation, Shell executives recognized that the future trajectory for the oil and gas business may not be as certain as they previously assumed. That realization underpins their latest energy planning scenario called Sky, which envisions the world meeting the Paris Agreement goal of restricting carbon emissions sufficiently to keep global temperatures from rising by more than 2o C by 2100. We examine Shell’s view for its impact on oil and gas demand, and importantly, the growth in the use of renewables. In the end, Sky highlights the reality problems for such a scenario occurring. This year’s never-ending winter, especially for those living in the northern reaches of the U.S., continues to empty our gas storage facilities, yet it has had little impact on natural gas prices. We examine why this has been the case, and why continued gas output growth will limit prices from rising materially higher. However, it is also possible these forecasts could be wrong.

We now have predictions for the upcoming hurricane season from all our favorite storm forecasters. While 2018 is being characterized as likely to be more active than normal, climate condition uncertainties could alter the number of storms, their intensity, and more importantly, where they deliver their havoc. Kinder Morgan Canada has suspended essential work on its Trans Mountain pipeline expansion until the politicians work out an agreement to allow the legally-approved project to be built. The battle between British Columbia, Alberta and the Canadian governments is spilling across the western plains with potentially long-range problems, not only for oil and gas, but for all extractive industries and agriculture that constitute the economic strength of that region of Canada. A new paper announces the discovery of a previously unknown supply of nitrogen that is feeding the earth’s plants and trees. This means plants will be able to remove much more carbon dioxide from the atmosphere than assumed by the climate models projecting devastating outcomes for the planet from increased emissions. This discovery has the potential to alter the entire climate change paradigm.

 

The vision for self-driving cars outlined by master futurist Walt Disney in a 1958 Disneyland segment, Magic Highway USA, has yet to be achieved, but not for the lack of trying by auto and tech companies. Unfortunately, like many exploration ventures in our history, people die. Usually, those dying are the explorers, but this time it was an innocent female pedestrian finishing a bike ride in Tempe, Arizona. She was hit by an Uber autonomous driving test car that failed to see her in the darkness and hit and killed her. We review what is known about the accident, the state of the autonomous technology, and offer our view of the event’s impact on the development of AVs. The week before last was the worst one of 2018 for stocks, while crude oil proved to be the second best performing asset category. The continuing underperformance of energy equities versus crude oil prices highlights the challenges facing the sector as it tries to win back investor support.

We review the first forecast for the upcoming hurricane season. If current climate conditions continue and the analog years prove representative, we may experience an active storm season, but one focused primarily in the Atlantic Ocean, and occasionally along the East Coast. That may be good news for the energy business. If tropical storms don’t disrupt coastal activity, then natural gas producers may be able to boost LNG shipments, providing needed relief for the industry. Although gas inventories have been drawn down sharply compared to past years, the analog year that scares gas producers has to be 2015 when prices fell throughout the year from springtime highs despite significant gas storage restocking. Neither industrial nor utility demand for natural gas is helping the industry, so it will have to rely on increased LNG shipments to fight off the lack of demand and lower prices.

Canada’s energy struggles continue, but now the courts are sending the pipeline objectors to the sidelines. This isn’t surprising, but it further complicates the political situation between BC and the rest of Canada. It further delays the industry from gaining access to critical global oil and gas markets. We also found out from a BC-First Nations’ report that indigenous people have had their positions on LNG and pipelines miss-represented by the environmentalists in an effort to buttress the green case against these energy projects. Did someone say: Fake News? Auto executives are among the most stressed businessmen as they contemplate how to manage and plan their businesses. How to meet increasing mpg-standards amid the turmoil and uncertainty of EVs and AVs is their challenge. These solutions suggest higher-priced vehicles are in consumers’ future. That comes at the same time interest rates are on the rise, raising consumer financing costs. Are the glory days of auto industry profitability over?

 

California has always been a social leader, and it is now enhancing its environmental leadership role. A new article examines the state’s effort in the transportation sector, and how its success may upend the petroleum industry. Many forecasts have attempted to define the particular moment when EVs overtake ICE vehicles in the fleet and send U.S. oil use down the chute. The article’s author, however, believes merely the shock of oil’s use inability to grow, outside of a recession, will mark a defining point for the petroleum industry’s future, for which it is unprepared. An equally dramatic reassessment of labor market trends – demographics, automation and inequality – signal a radical change for the U.S. economy. How does the loss of 40 million jobs sound? While it is too soon to quantify the impact and exact timing, there is little doubt such an economic shock will also jolt energy markets. While the performance of the U.S. economy and its energy needs, as it transitions to a decarbonized state, has always been of interest, we may be closer to hazarding an educated guess about the timing and impact on energy from these developments.

Contrary to the media’s view, and, unfortunately, some educated energy forecasters, all crude oils are not alike. There is much angst being expressed about shale oil’s output surge, leading to significant volumes being exported, and its impact on global oil markets. At the same time, the U.S. continues importing heavier crude oils to match our refinery needs. This oil quality imbalance is likely temporary, as the oil industry evolves. Shifts in the global refined product market may alleviate the concern about too much light oil. The diesel emissions scandal in Europe is translating into greater gasoline consumption, as well as stimulating EV sales. Light oil is better suited for producing gasoline. Exxon’s recent Gulf Coast refinery upgrade plans may mark the initial phase of refinery upgrades to handle more light oil feedstocks and greater light oil refined product. Autonomous cars are receiving much media attention, but now we are learning of the push to develop autonomous flying taxi services. If successful, these flying taxis will truly take us into the world envisioned by the Jetson’s cartoons. Will it happen? More importantly – when? EVs marked another year of progress in reducing pollution. As the nation’s power grid becomes cleaner, the emissions advantage of EVs over ICE vehicles grows. The advantages in certain regions and states are truly amazing, and may stimulate some EV sales.

 

It seems that every new forecast for electric car and autonomous vehicle growth shows them gaining larger market share and faster than predicted in earlier forecasts. The result is a bad outlook for the oil and gas industry. Will the reality match the hype? As we are learning, ride-hailing services are leading to greater urban traffic congestion than ever predicted. Additionally, AVs must be hand washed to prevent damage to the multitude of sensors needed to make the car function. How can these trends promote rapid market share gains? Canada is confronting its oil and gas export bottlenecks, which are being exposed in the regional battle between Alberta and British Columbia over the Trans Mountain pipeline expansion. Surprisingly, wine drinkers in western Canada were the latest to suffer.

Electrified vehicles continue to gain market share in Europe. The latest sales statistics confirm two factors impacting sales growth – the need for continued tax credits and increased range are needed. Will incremental battery improvements support the rapid EV market growth forecasts, or is it only necessary to rely on lavish government subsidies forever? Russian LNG has arrived in New England to supply power plants dependent on spot gas purchases, burning oil or expensive LNG due to the blockage of gas pipeline expansions. Politicians in the region, obsessed with Russian collusion and meddling in our elections, seem to have no problem buying natural gas from our primary adversary, Russia, to keep their lights on. Hypocrisy? Spring is coming, but not good news for the natural gas market. Gas prices remain stuck in the $2.50 – $3.00/Mcf range as drawdowns and demand growth fail to spark fear about the ability of the industry to meet market and storage-build needs this summer.

 

Oil output recently reached an all-time high. The EIA is calling for further production advances, but the agency continues to struggle to match current oil market trends with its conservative long-term forecasts. Significantly higher oil prices in 2018 appear to coincide with a slowing in oil production growth in 2019. One wonders whether the EIA is attempting to cram today’s market dynamics into a small forecast box, resulting in a too conservative outlook? Utility and pipeline companies are fighting various states over the issuance of water quality permits, the lack of which is shutting down new projects. Executives of these companies have complained to Congress, seeking their help in getting the states to understand their proper role in the regulatory process. Now that a major permit proposal has been rejected, and risks upsetting Massachusetts’ clean energy goal, maybe the issue will gain a fair hearing.

Natural gas prices are swinging wildly as traders and producers focus on the latest weather forecast. This is particularly important as we march toward the shoulder months of weaker gas demand. Whether we have much colder than normal or merely normal winter temperatures for the balance of winter, which Punxsutawney Phil says will last another four weeks, will set the stage for how much natural gas supply will need to be injected into storage caverns to meet next winter’s needs, and in turn, summer natural gas prices. We never thought about the moral decisions, and potentially economic ones, too, that need to be weighed in the programing of self-driving cars. Who makes those decisions, but more importantly, on what basis, when programing these vehicles? We consider some of those moral questions. The clean energy battle is moving from the oilfield and parking lot to the restaurant and kitchen as controlling methane emissions has become the new gas industry battleground. While the oil and gas industry appropriately moves to reduce methane emissions, our eating habits be the bigger issue in controlling this greenhouse gas emission.

This time is different. Those four words have cost investors, corporations and governments untold sums over the years. Right now, oil and gas industry strategy is being driven by the mantra of “capital discipline.” A recent industry survey points to interesting trends about the industry with ominous implications for the future of the business. The industry structure is shifting with large companies increasingly driving activity. They are shifting their focus to reflect long-term positive trends for natural gas and renewables. Will the market reward those moves or urge embracing “animal spirits” one more time to drive activity? The world is supposed to be saved by the Millennials given their attitudes toward EVs, AVs and ride-hailing services. An MIT economist involved in that institution’s transportation mobility research suggests none of these beliefs is true. January was good for crude oil and bad for natural gas prices. Will the “January effect,” associated with the remainder of the year’s stock market performance have any parallel impact in commodity markets?

A new survey of auto execs claims they overwhelming believe battery electric vehicles will fail commercially. They believe hybrid and fuel cell technologies are the paths to a cleaner transportation market. Their comments about different issues with EVs and AVs offer sobering thoughts about the conventional view. California’s governor dreams “big” about the future of zero emission vehicles in his state. His goal of five million ZEVs by 2030 implies a 40% ZEV sales rate in 12 years, up from 5% now. Another big budget expenditure for the state’s residents to fund. Canada’s oil and gas industry is in the middle of another political brawl between British Columbia and Alberta, with the Canadian federal government playing a role, too. Its outcome will shape the industry’s future, and interestingly, government revenues for the future.

Investor returns from owning energy shares have lagged the performance of the overall stock market for a long time, even though energy was the top performing sector in 2016. The extended period of poor performance reflected investors’ realization that energy company profitability was a risk well before the 2014 peak in oil prices and subsequent crash. Producers outspending their cash flow was acceptable to investors prior to 2011, but since then not so much. Could Andy Hall and Boone Pickens shutting their respective oil trading and energy hedge funds down in the past six months have signaled the bottom for oil prices and energy share prices? The bitter cold temperatures in New England earlier this month showcased the dramatic impact weather can have on energy prices, especially in a region that is capacity constrained for cheap natural gas. New England environmentalists blocking new and expanded natural gas pipelines to supply the region are condemning residents in the region to increased energy poverty.

The recent consumer and auto shows highlighted autonomous vehicle technology, while ignoring electric vehicles. Is that because one technology is new and sexy, while the other is now mainstream? Importantly, the future for EVs now is more in the control of regulators than consumers. Predicting that future cannot be done without contemplating how shifts underway in the global transportation market will reshape it. Germany’s green revolution is showing signs of structural problems as the increasing volume of renewable energy is driving residential power costs up sharply. Moreover, utility company embrace of more renewable power is working to the detriment of German’s carbon emissions goal and potentially its leadership role within the EU.

Any good industry newsletter is obligated to present an outlook for the upcoming year, even if you are unsure. We offer commentary on the key trends we believe will shape the trajectory for oil prices in 2018 and beyond. Bottom line, we see higher oil prices (mid-$50s to $70 a barrel) this year with an improved psychology within and about the industry shaping activity and share prices. In our view, the bias is for oil prices to go higher, rather than lower, than people’s expectations. Prices might not go as high as the true bulls anticipate, but, they could stay elevated (the high end of our range) longer than expected due to the damage done to the long-term oil supply outlook by the cutbacks in capital spending and drilling over the last three years. Higher prices and increased government intervention in energy markets will impact demand trends, which is the other side of the equation for determining future oil prices. For example, France just banned oil exploration in its country and throughout its worldwide territories. The action will have minimal impact on the county’s supply and demand, but it cements France’s leadership in the environmental parade against fossil fuels. Another example is NY Gov. Cuomo who wants to push forward on developing extremely expensive offshore wind power. He needs the federal government’s help, but even the most optimistic timetable leaves him short of replacing the 25% of NYC and surrounding counties’ power that results from the Indian Point nuclear plant shutdown scheduled for 2020-2021. Will this position help him in his re-election and presidential ambitions?

Autonomous vehicle development is moving ahead rapidly, but one hurdle yet to be overcome is whether they can operate in snow storms. Until they prove it, their market attraction will be limited to “fair weather” states. Will they be able to demonstrate success? Probably, but the bigger question is: Will the public feel safe in these cars? How well does Bluetooth work connecting your cell phone in your car? Increased capital discipline and a lack of oil discoveries will shape the oil market in 2018. This could leave the industry staring at $70 a barrel oil prices. If prices stay there for long, look for “animal spirits” to begin driving the actions of E&P execs. While the bomb cyclone storm drove the natural gas market crazy, traders aren’t buying a sustained recovery as they see continued production growth and limited demand increases. LNG exports remain the wildcard in this market.