Musings: In A World Of Oil Terrorism, Natural Gas Storage Is Crucial
This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.
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.
Source: EIA, PPHB
As often happens when the petroleum industry concentrates on a specific trend, the investment community and commodity traders become overly concerned with how weekly results compared to the forecasts made by analysts. We now have analysts guessing what the weekly gas injection volume will be and following the announcement, natural gas prices move based on whether actual results meet, exceed or fall short of the analysts’ estimate. This phenomenon is displayed in Exhibit 1 (prior page) that tracks the weekly gas price movement following the injection announcement.
As Exhibit 1 shows, in the first couple of weeks of the injection season, actual injection volumes fell below the estimates, and in response, natural gas prices rose. Starting in the fourth week and continuing until the June 12th injection report (week 11) when the reported injection volume was below the estimate, gas injections outperformed estimates causing natural gas prices to fall. As violence in the Middle East escalated and statistics showed a strengthening U.S. economy, natural gas prices started climbing. They jumped higher after injection volumes fell below analysts’ estimates, but then fell after last week’s injection beat forecasts.
Source: EIA, PPHB
We thought it would be helpful to look at what volume the withdrawal season might start with if the remainder of the 2014 injection season follows either the weakest injection season (2000) or the strongest (2003). We also examined how the storage volume might grow if the 2014 injection season merely followed last year’s pattern. To understand where these scenarios might put the 2014 season in relation to the past, we plotted the forecasts against the average of the minimum and maximum storage volumes each week over the past five years and over the past 20 years. It is easy to see that the current industry replenishment rate is doing better when compared with the long-term history versus the more recent short-term history.
While 2000’s injection season started with slightly more than 300 Bcf of gas in storage than this year, the season ended at less than 2,800 Bcf, meaning the industry was only able to inject 1,595 Bcf of gas during the summer. Only 2012 saw less gas injected than in 2000, which was marked by the industry beginning the injection season with 2,472 Bcf of gas in storage, and ending it with 3,929 Bcf, the greatest volume in storage ever since 1994.
In contrast, the 2003 injection season began with storage of about 125 Bcf below this year’s starting volume of 822 Bcf, but wound up the summer with storage at 3,155 Bcf, reflecting a total injection volume of 2,495 Bcf. That was the most gas injected in any year since 1994, slightly exceeding the 2,414 Bcf of gas injected in 2001.
Source: EIA, PPHB
Last year, the industry began the injection season with 1,687 Bcf of gas in storage. After injecting 2,127 Bcf of gas, the injection season ended with a storage volume of 3,814 Bcf. Based on the weekly storage volumes so far this year, the industry is averaging 81.5 Bcf of gas per week being injected, which is well above the low season average of 58 Bcf per week of 2000, but modestly below the high volume of 87 Bcf per week injected during the 2003 season. Last year, the industry averaged 70 Bcf of gas injection weekly. With the industry outperforming the seasonal averages of last year and the weakest injection season, hopes are high that the industry will reach a storage volume that will ease the price spike concerns of gas users.
If the industry injection volumes track those of the three years we modeled, only the weakest historical injection season would leave storage volumes below 3.0 Tcf, but none of these scenarios would put storage volumes within the range of the minimum and maximum volumes of the past five years. When looked at over 1994-2014, all three scenarios put the industry storage volumes within the minimum-maximum range, with the high injection volume (2003) pattern putting it in the upper half of the range. An injection season averaging the same as last year would put the final volume in the bottom third of the historical range. Only the weakest injection season (2000) would put the final volume near the absolute minimum of historical storage volumes.
To appreciate the task in front of the gas industry, Exhibit 5 shows where we started and where we are in rebuilding storage volumes as of June 19. To reach 3.4 Tcf of gas in storage, the industry needs to inject 1,681 Bcf of gas before the end of October. With an 81.5 Bcf per week average storage injection, if that pace is maintained for the rest of the season, the industry would reach a volume slightly above 3.4 Tcf by November 1. We still have several months of hot weather potentially ahead along with possible production disruptions due to hurricanes. Those issues will impact weekly injections, as will other factors such as the performance of nuclear power plants and switching between gas and coal.
Source: EIA, PPHB
In our view, barring some unforeseen production disaster, we would rule out the industry only matching the weakest historical injection season. Therefore, the question becomes whether the industry can match the best injection season ever, or only exceed the performance of last year. It may still be too early to make that call, but we are confident the industry will wind up averaging more than last year but less than the historical best year. Thus, we are now thinking that the industry will wind up with storage reaching 3.2 Tcf, with the outside possibility that it will reach 3.3 Tcf. We don’t believe the industry will reach 3.4 Tcf as we sense there are too many variables that could work against gas during the balance of the injection season. If the industry hits our estimate, or those of other gas storage optimists, we would expect natural gas prices to remain in the $4.50-$4.75 per thousand cubic feet range. You can expect us to revisit this forecast several times before the start of the withdrawal season because gas prices will be an important influencing factor on the domestic economy’s outlook and the future of oilfield activity and the petroleum industry’s performance.
WHAT DO YOU THINK?
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