The energy world is focused on the growing violence in Iraq and what it might mean for global oil prices, but for producers, rebuilding US natural gas storage volumes is critical.
This opinion piece presents the opinions of the author.
The past few weeks have changed the dynamics driving the global crude oil market. For most of the past couple of years, a principle reason why global oil prices have been elevated is that oil production disruptions, primarily in the Middle East and Africa, have kept a significant volume of supply off the market, putting undo stress on the remainder of the oil producing community to lift its output to meet the shortage. Whether it was Nigeria, Libya or Iran, the lost oil output was offset by increased production from Saudi Arabia, Iraq and, surprisingly, the United States. How much more production can come from these suppliers, or are we condemned to facing an energy future dictated by the level of global conflict that disrupts oil output?
In the past few weeks, the ongoing civil violence in Iraq has exploded into an all-out civil war, as a faction of al-Qaida, the Islamic State of Iraq and al-Sham (ISIS), has moved to overthrow the elected Iraqi government in Baghdad in order to establish a new caliphate covering territory encompassing parts of Syria and Iraq where Sunnis dominate the population. This new caliphate has already engulfed a few of Iraq’s producing oil fields, but the heightened civil war has increased the fear that the caliphate will overrun the remainder of the country including its primary oil producing region in the south, except for the northern Kurdistan region. The Kurds are working to break away from Iraq in order to establish a separate nation, and to boost their oil output and exports to the west. As the terrorists have advanced from the north to the south of Iraq, they are threatening the continued production of Iraq’s over 2.5 million barrels a day of crude oil output in the south. Potentially of greater concern for global oil markets, is the possible long-term disruption of Iraq’s plan to boost its oil output to nine million barrels a day. The escalation of the civil war has forced western oil companies and service contractors working in Iraq to move their workers out of the country. Until peace is re-established and the sanctity of the oil company contracts can be assured, the industry will be reluctant to return to Iraq to resume activity, eliminating any hope of the country’s oil output rising. In fact, without production maintenance activities, output is likely to drop.
The prospect of less oil in the future, even though the reality and timing of any increase has always been in question, means the world oil supply/demand balance will remain tight for the foreseeable future, which will sustain high oil prices, or even drive them higher. Under that scenario, oil prices are going to be meaningfully higher for a longer time period than were ever anticipated by the low oil price optimists. Energy analysts suggest that due to the Iraqi turmoil, global crude oil prices are likely headed higher by anywhere from $20 to $85 dollars per barrel, which would put Brent in the $135 to $200 per barrel range. The low end of that potential increase could probably be absorbed by global economies with only a modest loss of annual growth. On the other hand, the top end of the price-rise range probably signals a global recession, potentially as severe as we experienced in 2008-2009. For the oil business the last recession was devastating.
A global recession caused by a spike in world oil prices would hurt all economies, but some would fare better than others. The issue would become just how high the spike in oil prices would go, how long it might last, in addition to how quickly the better-positioned countries are able to adjust to the higher prices. The answer to the first two questions depends on whether the ISIS group seizes the key oil producing fields in southern Iraq and removes them from the world market. This could quickly become a repeat of the 1978 Iranian revolution that took four million barrels of oil off the market and caused global oil prices to double. The answer to the third question depends on whether oil use can be replaced with other fuels. For the United States, our diversified energy supply mix, with natural gas playing an important and growing role should mitigate the economic pain from sharply higher oil prices. The challenge for America is that natural gas and coal, our main fuel alternatives, have limited use in the transportation sector – at least in the short-term. Natural gas marginally could play a role in reducing our transportation-related needs as Flex-fuel-equipped vehicles could shift to using liquefied natural gas (LNG). Likewise, more vehicles powered by compressed natural gas (CNG) could be built. Certainly, vehicles and machinery could be built to be powered by electricity that could be produced from coal and natural gas or even run directly by some form of natural gas.
While it may not appear that the Iraq civil war and spiking global oil prices are linked to rebuilding domestic natural gas storage volumes, our view is that the inability of the petroleum industry to rebuild storage this summer would create fear among consumers about winter gas price spikes and could push our politicians to meddle in the industry’s operations out of concern that energy companies were incapable of solving the nation’s energy dilemma. Demonstrating its competence by rebuilding gas storage volumes would, in our view, go a long way to helping the petroleum industry regain some of the stature it has lost in recent years. What is the potential that the industry can rebuild gas storage this summer and regain some of that lost respect? Understand that this will not make people love the industry – we are well beyond that point.
In the last issue of the Musings, we discussed our view that because the industry has finally gotten its weekly gas injection rate up above last year’s performance, prospects for our estimate had been enhanced. That forecast had the industry injecting at least 2.2 billion cubic feet (Bcf) of gas into storage, bringing total available storage volumes at the start of the withdrawal season on November 1st to 3.0 trillion cubic feet (Tcf) – a level that should be sufficient to ease the concerns of gas users. We also said that some analysts were beginning to think the industry is capable of reaching 3.2 Tcf or even possibly 3.4 Tcf of gas in storage by the end of the injection season. With the Atlantic hurricane season underway and the Energy Information Administration (EIA) now predicting that based on the hurricane forecast of the National Oceanic and Atmospheric Administration (NOAA), the petroleum industry is likely to experience more storm days than last year that could limit production. This concern could be mitigated if a stronger El Niño develops in the South Pacific Ocean this summer that has the power to generate atmospheric conditions that limit development of Atlantic basin hurricanes and weaken any storms that actually do form.
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G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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