Natural Gas

A series of articles by Reuters columnists and Chesapeake Energy’s August 2011 Investor Presentation (once the “Ra-Ra” is filtered out) serve to underline the rapid and largely unseen revolution that is going on in the domestic US oil & gas industry. And I don’t mean in shale gas — well, close — this is shale oil. From almost nothing just two years ago, production is ramping up faster than just about every projection expected. Chesapeake alone is expecting some 41 percent of its production to come from oil by 2012, up from just 12 percent in 2009, as this graph shows.

Source: Chesapeake Energy

Where Chesapeake leads others follow, or more accurately, race them neck and neck. Drilling for liquids has taken off with a shift towards shale oil rather than pure shale gas plays. Rig demand is outstripping supply as explorers look to capitalize on high oil prices in preference to subdued natural gas prices.

Source: Chesapeake Energy

But between June and July, the U.S. Energy Information Administration boosted its own forecast for 2012 liquids production by a startling 170,000 barrels per day. Further revisions will no doubt follow. The consultancy Bentek said last week that output at Eagle Ford Shale in Texas had more than doubled in the last two months to 160,000 barrels per day and was on track to grow fivefold by 2015. Likewise, Chesapeake’s Utica Shale — stretching over large areas of Ohio, into Pennsylvania and north into Canada — has been valued by the firm at $20 billion. To put that in perspective, the FT advises that is roughly equivalent to Chesapeake’s current market capitalization.

Not everyone is convinced however, although the often-close occurrence of shale gas and shale oil is proving a boon for explorers as they seek to share cost savings across both resources. Many say shale oil resources suffer from the same challenge as shale gas. That is, initial well fracturing releases significant volumes, but well productivity drops off quickly, requiring operators to keep up the pace of drilling.

To counter this firms are investing significantly in new technology and drilling processes. US firms’ leadership in this area is underlined by the massive inflows of foreign investment in the sector as oil and commodity firms around the world look to both secure a chunk of what they see as a valuable asset and also the technology. Unlike natural gas, for which the US is still largely a closed market with very limited LNG export capability, oil from shale is priced at world oil prices, not domestic US gas prices, which are below world markets. LNG prices abroad are twice the level they are at home, driving a coal-to-gas switch for electricity generation; levels doubled this summer from last.

A sharp correction in oil prices may slow drill rates, but even pessimistic predictions of a fall to $80/barrel should not significantly dent the rate of reserve increases seen so far. If shale oil proves as bountiful as shale gas, it may not be long before the US import bill for Middle Eastern crude begins to fall as a result of greater domestic production.

–Stuart Burns

The natural gas market’s underperformance in the investment world hampers its current role as (at least an investment) alternative to crude oil, effectively making the abundant fuel take a backseat.

The biggest hurdles for gas production and consumption to become as ubiquitous as that of oil or at least as profitable were recently outlined by Mickey Fulp, who calls himself the Mercenary Geologist, which I’ll summarize below:

  • Supplies: Abundant. (And often re-exploited on top of existing wells.)
  • Risk/Reward: Natural gas’ development play requires low risk venture capital.
  • Transportation: Natural gas is difficult to transport, needing dedicated pipelines to the wellhead. This infrastructure is sorely lacking.
  • Storage: Difficult. Must be stored in underground caverns in gaseous form; liquid form is better to store, but proper liquefaction facilities are unavailable/inadequate.
  • Processing Capacity: Insufficient in the US.
  • Power Plant Capacity: Most domestic plants are coal-fired; retooling them to use natural gas is burdensome and expensive. Also, even though natural gas burns far less CO2 than coal, its main component methane is a bigger culprit behind greenhouse gas emissions.
  • Environmental Opposition to Drilling, Transportation, Processing, and Storage: Almost self-explanatory.
  • Land Access: “The federal government owns nearly 30% of the country’s land where an estimated 40 percent of potential natural gas resources exist. Adding in federal offshore waters ups this resource figure to almost 60%.

But as demand of natural gas begins increasing, especially in quickly growing economies such as China’s (which my colleague Stuart wrote about in a July 7 post), the price may follow, and if increased prices indicate any sort of sustainable trend, then that will spur investment to build up production infrastructure.

Indeed, here in the US, the fracking process a primary method of extracting natural gas by injecting water and chemicals into the rock that contains it has been under fire for years; but potential production may soon climb astronomically.

Will Natural Gas Prices Grow¦or Not?

Penn State University professors recently released a report stating that production from Pennsylvania’s Marcellus Shale home to the largest gas reserves in the US will yield 3.5 billion cubic feet of gas per day in by the end of 2011. This would be double 2010’s yield.

In 2012, production should reach 6.7 billion cubic feet per day and in 2020, up to 17.5 billion, according to the Penn State report. This year, some 2,300 wells will be drilled (up from 1,405 in 2010), and the professors forecast some 2,500 per year to be drilled by the time 2020 rolls around.

The big win for the industry is New York State’s recent reversal of the ban on the practice. According to Pennsylvania’s Department of Environmental Protection, 24 of the 25 highest-producing wells are in the counties that border New York.

With the US leading the world in natural gas production (nearly 23 billion cubic feet in 2009), these predicted production amounts from the Marcellus not to mention other expanding reserves would considerably add to the global supply. Although the gas price is expected to remain stagnant for the next 25 years (at 0.5 percent annual growth, according to Fulp), if China ups its appetite for the stuff, US natural gas could become a much more crucial global commodity in the decades to come.

With power plants and metal producers both relying on natural gas more and more, it may not be cheap for long.

–Taras Berezowsky

An interesting article in the New York Times last week looked at Chinese plans to release details this month of its new five-year plan for energy conservation. The issue facing the authorities is more than pollution or the balance of payments, cost of coal, or oil and natural gas imports, as severe as those issues are for the world’s biggest consumer of energy and largest emitter of greenhouse gases. China’s greatest worry is one of national security. China is a net importer of coal, oil and natural gas, making it vulnerable (in Beijing’s eyes) to foreign pressure or disruption of supply. China is Saudi Arabia’s biggest customer for oil and gas, but as the paper points out, all that oil flows through waters controlled by India and the US. Nor is Saudi Arabia (or Iran, the next largest supplier) seen as politically stable today as it was three months ago. Social unrest in the Arab world has made the whole Middle East a riskier supply source than was previously assumed.

In spite of becoming the world’s biggest — and lowest-cost — manufacturer of wind turbines and solar panels, the country is still heavily reliant on imported coal, failing to produce enough domestically to meet its relentlessly rising electricity demand. The trend for rising coal imports is almost certain to continue; even with China’s best efforts at reorganizing the domestic coal industry, they cannot meet rising demand from domestic sources. Russia has been earmarked as a major new source of natural gas and oil just as Europe makes strenuous efforts to reduce its near total reliance on the country for gas supplies. But a major new pipeline from Russia just completed this winter can only meet 3 percent of China’s oil needs, highlighting what a massive investment in infrastructure would be required to even get into double digit percentages. To this must be added natural gas demand, currently meeting just 4 percent of energy needs (the plan is likely to call for this to be doubled by 2015). Again, Russia is the natural supplier, but infrastructure barely exists and multiple pipelines will again be required.

By far the biggest energy source, particularly for electricity generation, is and will remain coal. China consumes some 3.2 billion tons per year and a target of no more than 4 billion tons by 2015 is widely expected to be part of the new plan. That represents just 4.24 percent growth per year for a country that is growing GDP by over 10 percent per year. Even with the growth of renewables and nuclear, that is a tall order and the fear is demand will have to be constrained by allocating electricity to cities and industries. But who decides, with no free market to set prices on the basis of supply and demand? The impact that could have for resource-hungry activities like steel, aluminum and zinc smelting could be profound in the first half of this decade. China may decide it would rather import metals than import energy, reversing the trend of the last decade. Having temporarily idled some of the 20+ million tons of aluminum capacity, could the Chinese really close a significant portion of it permanently?

The world is not short of aluminum. Best-guess figures suggest there could be up to 10 million tons in both visible and invisible stocks; in reality, only China is likely to be able to make inroads into that kind of position, and only then if large parts of the country’s own capacity were closed down. Likewise steel, where China has significant over-capacity and whose demand has been the driver of global iron ore and coking coal prices. If the country became a net importer, global demand for these commodities would not necessarily drop, but the point of consumption would shift and with it the dynamics of the market. There will be a lot more than oil producers looking for the details of China’s new five-year energy plan when they are released, and we may all be feeling the effects for years to come.

–Stuart Burns

Scenes of rioters in Cairo’s Tahrir Square have followed hot on the heels of similar events in Tunisia that resulted in the president fleeing the country. While we should be cheering from the sidelines as the rule of dictators across the Middle East is brought to an end and (hopefully) democratic government takes its place, most of us probably have not seen these developments as trade-related. In the case of Tunisia the demonstrations were relatively short-lived and peace has thankfully resumed.

Tunisia is not a major metals producer and its energy exports in the form of oil and gas are modest by Middle Eastern standards. Arguably, the same could be said of Egypt, although Egypt is industrially more developed; being a major regional steel producer it is still a net importer of steel products, according to Wikipedia. But the country is an exporter of gold and aluminum — both in primary and semi-finished forms — and of natural gas with both LNG facilities and pipelines stretching into Israel, Jordan and Syria. Although disruptive to the regional economy, a collapse in exports from Egypt would not have a major impact on the world’s metals or energy markets although both cotton and oil futures have been panicked by recent events. Egypt’s significance to world trade is more because of its greatest man-made asset (its greatest natural asset unquestionably being the Nile): the Suez Canal. This 120-mile stretch of waterway (in small part thanks to my great-grandfather, who oversaw the dredging of the canal in the early part of the last century) carries some 8 percent of global seaborne trade including 14 percent of the world’s LNG traffic and 4.5 percent of global oil supplies, but more crucially, a significant proportion of the Asia-to-Europe container traffic. According to GlobalPost, about 2 million barrels of oil traverse the canal each day — roughly 5 percent of the global amount in transit while another 2.3 million bpd go through Egypt’s Sumed pipeline.

So far the canal has not been severely impacted by the events in Cairo, Suez or Alexandria. Traffic is still moving through the canal, but several shipping companies have ordered their vessels not to change crews in the port of Suez to avoid the risk of becoming involved. According to a NY Times article, there are already signs of slowing cargo operations at the Alexandria and Damietta Ports, which handle container and bulk shipments of grains and other goods. Employees must leave their posts early to comply with the government curfew that begins at 4 pm and a Dow Jones article notes that Maersk Line, Safmarine and Damco offices are closed. APM Terminals’ Suez Canal Container Terminal (SCCT) in Port Said is not operating and only a skeleton crew is manning the reefer containers and IT systems.

A FT article explains how the Suez Canal’s significance to the global oil trade has declined over the last decade or so, but how its significance to container traffic has increased. In recent years, according to Erik Nikolai Stavseth, an analyst at Oslo-based Arctic Securities, oil tankers have accounted for only 15-20 percent of canal traffic. About 50 percent of transits now consist of container ships taking Asian manufactured goods to Europe and return sailings.

So far disruption has been minimal and no one is saying its closure would cut off trade between Asia and Europe; vessels would have to take the much longer Cape of Good Hope route around the southern tip of Africa adding up to two weeks to the voyage. Maybe of more significance is that this vulnerability of world trade to the free movement of goods through the canal is a wake-up call for the consequences of further unrest in other parts of the Middle East. Riots have already resulted in a change of government ministers in Jordan and other countries are looking on with trepidation. The Gulf states can probably afford to buy off their populations, as can Saudi Arabia, but Syria, Pakistan and Iran are all at risk of a population deciding they have had enough of authoritarian rule. Watch this space.

–Stuart Burns

MetalMiner and its sister site, Spend Matters, along with Nucor, will host a live simulcast, International Trade Breaking Point on March 1, 2011. If your company sources products from overseas, you will not want to miss this half-day event:

Register for the live simulcast today!


The financial pages have been awash with analysis of BP’s latest study of the energy market through 2030. It certainly makes interesting reading, but the Telegraph’s focus on the changing role of the oil majors is not our topic of interest here, although the reasons for it are. Is that a little opaque? Let me explain.

As a Financial Times article covering the BP report explains, oil’s share of global energy markets will continue its long-term decline over the next 20 years as the overall fuel mix will gradually shift. While fossil fuels contributed 83 percent of the growth in energy from 1990-2010, over the next 20 years they will contribute just 64 percent of the growth, the BP Energy Outlook study says. The contribution of renewables will grow across all sectors, but particularly biofuels. Crucially for the oil majors, OPEC’s importance is expected to grow, with its share of global production expected to rise from 40 percent in 2010 to 46 percent by 2030, a level not reached since 1977, as fields are developed in Saudi Arabia, Iraq and Angola, among others. A separate analysis in a Telegraph article lists out some of the expected trends.

Primary energy use is expected to grow by some 40 percent over the next 20 years almost solely due to emerging market demand, met initially by rising coal consumption, but with natural gas making the fastest inroads, such that by 2030 coal, oil and natural gas will each meet roughly 27 percent of energy needs. The balance will be met by rising renewables such as nuclear, hydro, wind, solar and geothermal which will grow from 5 percent to 18 percent of primary energy needs.

Oil consumption in OECD markets peaked in 2005 and is expected to be roughly back to where it was in 1990 by 2030, but will continue to rise in emerging markets. Global liquids as a whole will rise from 85.5 million tons per day to an estimated 102.4 million tons by 2030, while biofuels will make up about 9 percent of transport fuels and will contribute 125 percent of non-OPEC liquid fuel supply growth over the period meaning oil production will decrease from non-OECD markets as biofuels rise.

These are of course BP’s projections and they are subject to considerable degrees of error depending on prices, new discoveries, political developments, economic growth and so on in between. Clearly BP sees the rise of largely Middle Eastern and West African supply sources as a key part of the next two decades’ growth, and that will see a massive transfer of emerging market wealth into the region. Specifically BP sees increased oil supplies to come from Saudi Arabia, which should be able to add another 3 million barrels; Iraq increasing its output from 2.5 million to 5.5 million barrels per day; and an additional 2 million barrels of production should come from Canada’s oil sands. No mention is made in the news coverage of rising crude oil supply from Russia, even though BP has just completed a $5 billion share swap with Rosneft in the expectation that the joint venture will lead to new reserves being opened up in the Arctic; nor of Brazil which has major offshore finds (although considerable challenges ahead of it in terms of exploitation.)

Depressingly, BP does not think the world will achieve its carbon dioxide targets of 24 billion tons by 2030, saying in their estimation the world will over-produce by 27 percent to the tune of an additional 9 billion tons. If that is the case, pressure for carbon taxes will mount dramatically, and the ramifications for energy use and trade can only be guessed at. No doubt BP have factored their estimations into the report, but action on climate change alone adds such a level of uncertainty that BP’s projections could prove to be a Ëœbest case’ scenario.

To see the original BP Energy Outlook 2030 report click here.

–Stuart Burns

MetalMiner and its sister site, Spend Matters, along with Nucor, will host a live simulcast, International Trade Breaking Point on March 1, 2011. If your company sources products from overseas, you will not want to miss this half-day event:

Register for the live simulcast today!


Two reports in the Financial Times could almost be described as illustrative of the glass being half full or half empty. Both articles cover the energy markets of the Middle East but the first bemoans the perilous state of energy supply in many Middle East markets. Decades of extremely low energy prices have embedded a culture of waste and inefficiency that makes energy use per head of population some of the highest in the world. In addition the area has actively developed energy intensive industries such as aluminum smelting on the back of what was considered low cost limitless power supplies. Finally population growth has been relentless. The region’s largest economy, Saudi Arabia, is growing at 2.38% per year according to middle-east-online and 60% of the population is under 40, seeking jobs and demanding industrial development.

Like the rest of the region, Saudi Arabia is rapidly consuming more and more of its own production of oil and gas just to feed rising domestic demand. Khalid al-Falih, the chief executive of Saudi Aramco, the state oil company, recently warned that unless Saudi Arabia tackles inefficiencies in the way it uses energy, the kingdom’s availability of crude for export risks falling by as much as 3m barrels by 2028 to 7m barrels a day. He said that Saudi Arabia’s domestic demand is expected to rise from about 3.4m b/d of oil equivalent in 2009 to approximately 8.3m by 2028. The company is pouring money into exploration of new natural gas fields even though it has the region’s fourth largest reserves; drilling has started in the Red Sea and in the remote Empty Quarter. Although no finds have been made yet, Aramco expects to ramp up current natural gas production at existing fields from 10bn cubic feet a day to 15.5bn cu ft a day in 2015.

With the exception of Qatar, which is coming to the end of a 20 year investment program and now has the capability to move 77 mm tons of LNG per year, much of the rest of the Middle East is scrambling to develop existing reserves or identify new ones. Unfortunately new undeveloped fields are mostly sour gas like Abu Dhabi’s Shah filled that ConocoPhillips has just pulled out of as the gas price has collapsed at the same time as the US$10bn development costs have been identified.

The second article tackles the issue of gas supply in the gulf from more of a short-term perspective. In addition, the impact of the low gas prices in the region is exacerbated by the massive rise in reserves in the US following the success of shale gas development. The price of natural gas has fallen from a high of $13.70 per million British thermal units (mBtu) in July 2008 to lows of $2.75 per mBtu in September 2009, followed by a slight recovery to today’s price of about $4 per mBtu. In addition, demand in the US for imports of Qatar’s LNG have all but dried up and in the UK previously Qatar’s second largest market demand has dropped as a result of the recession. As a result, Qatar has developed sales to China but the issue is that low gas prices are likely to prevail for the next couple of years depressing investment interest in developing new fields particularly if they are technically challenging such as sour gas or in more remote locations.

What the two articles do show is that the energy market in the Middle East, long home to the principal suppliers of the world, is changing rapidly. Finite reserves are coming up against rising domestic demand and more challenging new field development both technically and financially, which will change the landscape this decade. Although cheap at the moment, natural gas’ lower carbon emission profile will make it the fuel of choice in the decade to come and will put a strain on energy supplies in the Middle East.   Middle Eastern states may come to regret the massive investments they have made in energy intensive industries such as aluminum smelting if their domestic market has to start importing natural gas from elsewhere to make up the shortfall.

–Stuart Burns

The market is looking up for onshore oil and gas operators both in North America and Europe. In the US, the pace of recovery has caught many insiders by surprise. Over the last four months the U.S. land rig count has increased more rapidly on an absolute basis than in any other four-month period over the past decade according to the latest RigZone Review. Furthermore, the rig count has only posted weekly decreases four times in the 37 weeks since bottoming as this chart illustrates:

The rig count rise is impressive and the recovery is developing in a V-shaped pattern. Since the bottom, the industry has added an average of 13 rigs per week, and the best one-week gain came in late-December when 38 rigs went back to work. According to data quoted by RigZone, there were 1,313 land rigs working in the U.S. as of late-February, which is 60% above the June 2009 bottom but still 32% below the August 2008 peak.

The rig construction market is expected to continue to increase as contractors shift towards use of more sophisticated rigs capable of drilling horizontally into shale gas beds. In fact it isn’t just shale gas that is prompting this migration to high spec rigs, according to a  Mineweb article, the industry is moving towards multipurpose rigs that can meet a variety of roles, such as geo-technical and subsurface investigation, geothermal and wire-line coring in addition to the most sophisticated fracking drill techniques needed for gas shale. Rig operators with multipurpose rigs find they have a higher capacity utilization rate because they can be turned to any one of a growing range of drill work required.

Meanwhile rig builders and operators are turning their eyes to Europe where oil and gas companies have invested heavily in American drill firms such as BP, Statoil and Total who each struck deals with Chesapeake Energy to acquire the technology and skills to successfully drill gas shale deposits. Europe has extensive onshore gas shale deposits and energy companies are keen to develop opportunities in a market overly dependent on Russian natural gas. According to a FT article, the International Energy Agency estimates unconventional gas resources at 32,511 trillion cubic feet, with half comprising shale gas and the other half made up of gas stuck in tight sandstone formations and in coal beds.

But Europe has two major challenges. The first is environmental. In the US, the land owner directly benefits from resource extraction programs making locals more willing to put up with the trucks, noise and disruption of ongoing drilling operations. But in Europe, mineral rights reside with the state so most benefits pass landowners by. The other challenge at least in the short term are drill rigs. Equipment shortages represent a real headache. The US has up to 2,000 onshore drilling rigs, although not all are operating at any one time. Even so, they dwarf the 50 or so that usually operate in Europe. This big discrepancy could prove crucial as shale needs continuous drilling to maintain production flows because each individual well tends to start with a gush and then loses 70 to 90% of its volume within one to two years.

Europe’s preoccupation with environmental issues will undoubtedly slow the roll out of shale gas projects there but even so the opportunities for manufacturers of piping and for rig constructors are clear. If the last decade was good in the States this decade is going to be about Europe.

–Stuart Burns

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