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Countdown to $50 Oil

by HiD Fri Jun 16th, 2006 at 07:18:06 AM EST

Before you flame me

  1.  I fully believe the era of cheap energy is mostly over (I think $3/mogas is pretty cheap on a historical basis).
  2.  Barring the invention of a magic bullet, energy prices will be significantly higher in 10 years than today

Then why the diary?

I offer the following just so people understand that there will not be a straight line path from here to there and why the "market" may not agree with "peak oiler" visions.  We all need to stay nimble as orthodoxy of any sort can prove to be expensive.  Prices could well be much lower or much higher this time next year.

Natural Gas

US Natural Gas was $15/MMSCF ($90/bbl equivalent) this fall/winter past.  The late summer hurricanes shredded production capability as we all know.  Typical speculation/panic buying drove prices of both oil and gas to very high levels.  Predictions of gas piercing the $100 oil equivalent price were common.

We got lucky with a mild winter, aggressive restoration of supply and price led demand reduction.  As a result, nat gas prices have collapsed back to $6.5/MMSCF ($39/bbl equivalent) even while crude prices remain near the highs.  The key difference is nat gas is much more a local mkt insulated from international political problems.

A WAPO article outlines the current nat gas situation:

At the end of last week, natural gas in storage amounted to 2.4 trillion cubic feet, up 23 percent from a year earlier and 38 percent higher than the five-year average,

that's huge.  As Jerome has shown, natgas production curves decline more steeply than oil fields so drilling rates are a key indicator of near term supply.  The EIA has a data series showing proven reserves and another showing Prices.

The data show a real drop off in proven reserves from the early/mid 80's when prices were relatively high to the 1990's when prices were much lower.  From 2000, when electricity markets really began to lean heavily on natgas and prices responded, reserves have been growing.  Lots of holes are being poked.

By OGJ editors
HOUSTON, June 9 -- US drilling activity continued its slow growth with 1,661 rotary rigs working this week, 4 more than the previous week and up from 1,339 during the same period last year, said Baker Hughes Inc.

The bulk of the increase was in land operations, up by 9 rigs to 1,539 working. Activity in inland waters gained 1 rig to 25 drilling. Offshore drilling declined by 6 rigs to 97 in US waters, including the decrease of 4 to 92 in the Gulf of Mexico

[Source]

Rig data from Baker Hughes (large PDF!)

This data shows just how much rig activity can vary.  When prices were this high in 1981, the USA had almost 4000 rigs in action 5000+ worldwide.  Today we have about 1650 (3000+ worldwide) and in 1998 when OPEC were fighting over price we were down around 800 (1800).

these rig counts are oil and gas combined, but gas is generally affected by both as about 1/4 of nat gas production is a byproduct of oil production.

The lesson here is like most commodity markets, gas is volatile.  And while the oil industry is slow to react, they do react eventually and usually over-react damaging their profitablity (back handed proof that if they collude, they don't do it very well).

Will gas spike this fall?  If the hurricane season spares the USG facilities, we could see the opposite.  Storage capacity could hit max, leaving producers nowhere to put the gas until winter comes.  After that, it's just weather.

Crude

Last fall's Katrina price spike has not really abated.  We're still sitting at $70/bbl.  But there are other reasons we're not seeing any relief.

  1.  Venezuela lost 1 mmbd production when Chavez broke PDVSA's resistance to his rule.  They've never gotten back up to their prior production peak.
  2.  Nigeria has roughly 800 MMBD off line due to internal unrest.  The locals are pissed that all the money is sent to Lagos (and then Switzerland) instead of staying in the production area.  They're killing folks to keep the production levels down.
  3. Iraq is still bumping along well below their pre-war capacity.  Mr. Wolfowitz's 5 MMBD production levels turned out to be just an opium dream.
  4. General world paranoia that the worst president ever will invade Iran and risk the entire PG production due to military action at the Straits of Hormuz.  ($150/bbl in a heartbeat)
  5.  Hedge funds are actively investing money in longer dated futures shifting the price band upward.  It's a market.  More buyers, higher prices.

US crude stocks in commercial hands are about 342 million bbls.  That's high relative to the 5 yr average.  But when you look longer term, we've got less in tank than in the early 80's.  Moreover, when you consider days cover we've got 342/16 = 21 days of crude runs.  Back in 1982 we had roughly 350 MM bbls with just 12 mmbd crude runs or more like 30 days cover.

Why?  Oilcos got tired of tying up so much working capital in crude oil.  Especially as that capital was tied up in the refining end of the biz which was making little to no profit.  Consolidation of refiners and just-in-time inventory control both came to pass.  The number of refineries was reduced, tankage was bulldozed to keep line personnel from using it etc.

As you might expect, refiners are much more nervous about covering their needs and are forced to pay up for crude even with decent stock levels.  Prices do show that there is no prompt shortage as front month futures are below outers (contango)

See: NYMEX data (may have to go to the main page and click thru accepting the NYMEX's data delivery terms)

6/16 close:
July  $69.5
Aug  $69.93
Dec  $71.83

Where are we going on price?  Ask Bush.  If his broker tells you he's buying calls, watch out Iranians.  If he's flat, call the hurricane prediction centers.

One very contrary opinion comes from BP.  It's one we should all consider as they actually have thinking management unlike the rest of the majors. They're calling for a decent chance that we head back to $40 in the medium term.

Refining Capacity

Capacity continues to grow.  US capacity damaged last year is basically back up and running with mogas production back at last year's highs.

Still the spread (or crack) between mogas and crude is wide at $16/bbl.  People are still worried that we cannot cover demand which is not dropping off much despite the price increases.  Stocks are building back into the 5 year average range, but we've no great cushion forming.

Better slightly down than up, year on year, but so far the demand reduction I expected hasn't been seen.  The US consumer still has enough money in pocket to buy gas even though we all whine about it.

Longer term, there have been a bunch of new refinery projects announced.  The Saudis alone have announced 2 new 400 MBD refineries.

Each week the OGJ reports on the talk in the trade. In the latest:

Interesting that the Venezuela are considering 3 new ones at a total of 700 MBD.  If all these projects go, we'll repeat 1979-82.  Massive expansion followed by margin collapse due to overcapacity.

Conclusion -- who actually read this far?  I've no great insight other than the energy markets are far more complex than meets the eye.  Don't make any sucker bets.


Display:
Good information as always, HiD. Thanks for the diary.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Jun 16th, 2006 at 09:03:14 AM EST
Jerome could please make a comment/deconstruction about the interview by the CEO of BP as he is telling us that lot of big oil fields are still beeing discovered.

it is quite contradictory with the datas you provided in your interesting diaries and Enegize america.

thansk a lot

by fredouil (fredouil@gmailgmailgmail.com) on Sat Jun 17th, 2006 at 09:25:27 AM EST
[ Parent ]
It will remain in the 60-80$ until the end of the year...

I also indeed hope so... I think an steady rise in oil prices above inflation is indeed very good.

And I also hope that the refinery capacity stays flat..this means a peak in oil delivery before the real peak oil.. giving the world economy some badly needed years to adapt.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Sat Jun 17th, 2006 at 07:22:12 AM EST
refinery capacity won't stay flat.  There are a ton of projects on the books to take advantage of $16 mogas cracks.  That's about triple what they were in the early to mid 90's.  Diesel crack is also very, very wide.  Refiners see a lot of money to be made in new projects.

If you look in that OGJ link, you'll see a project where Saras is installing a bit more desulph for their gasoline.  It's a pretty cheap fix I suspect.  That puts a big refiner that was historically a major exporter to the USA back in the mkt.  (when we lowered sulfur levels in our gas, many of the European export refiners held off on investment until they could see where things were going to settle out).  

One of my old friends at Chevy told me a year ago they are looking to re arrange the units we put in in 1980-2  + some new ones to allow an additional 100 MBD crude runs.  The $1 billion invested in 80-82 really had miserable payout for 10-15 years as too many people did the same sort of project at the same time.  I suspect all the refiners are doing the same again (herd mentality runs strong).

Capacity creep is a given. With these margins, creep will become a rush until the margins collapse again.

by HiD on Sun Jun 18th, 2006 at 05:17:00 PM EST
[ Parent ]
Good diary, but I eliminated "naked links" as they blew up the page.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sat Jun 17th, 2006 at 07:45:17 AM EST
thanks,  I'm about 20 yrs out of date on anything to do with programming  (Fortran for cavemen was my last course)
by HiD on Sun Jun 18th, 2006 at 05:05:51 PM EST
[ Parent ]
I really like the energy diaries- as a biological scientist, I never really noticed the energy sector, but I have become convinced since reading yours, Jerome's and bonddad's diaries that it is one of the most important topics.

thanks

by Spatz (sonya.faberATizi.fraunhofer.de) on Sun Jun 18th, 2006 at 10:01:41 AM EST
As one trained as a physicist, both ecology and economy are ultimately about thermodynamic flows, and I think economics has a lot to learn from concepts of biology.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Sun Jun 18th, 2006 at 11:55:49 AM EST
[ Parent ]
"economics has a lot to learn from concepts of biology.
"

not sure, biology is a science, economy, i am still not convinced ;-).

by fredouil (fredouil@gmailgmailgmail.com) on Sun Jun 18th, 2006 at 02:34:40 PM EST
[ Parent ]


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