PED's Chairman and CEO Frank Ingriselli and Dome Energy CEO Paul Morch rang the NYSE Opening Bell this morning along with other energy company CEOs.
This week's release of the US Energy Information Administration's new Annual Energy Outlook features the key finding that the US is on track to reduce its net energy imports to essentially zero by 2030, if not sooner. That might seem surprising, in light of the recent collapse of oil prices and the resulting significant slowdown in drilling. EIA has covered that base, as well, in a side-case in which oil prices remain under $80 per barrel through 2040, and net imports bottom out at around 5% of total energy demand. Either way, this is as close to true energy independence as I ever expected to see.
It wasn't that many years ago that such an outcome seemed ludicrously unattainable. I recall patiently explaining to various audiences that we simply couldn't drill our way to energy independence. The picture of self-sufficiency that EIA has assembled depends on a lot more than that, but without the development of previously inaccessible oil and gas resources through advanced drilling technology and hydraulic fracturing, a.k.a. "fracking", the US would have remained vulnerably reliant on imports of oil and natural gas as far into the future as those fuels will be used.
Every forecast depends on assumptions, and it's important to understand what would be necessary in order for conditions to turn out as the EIA now expects in its "reference case", or main scenario. This includes a gradual but pronounced oil-price recovery, to average just over $70/bbl next year, $80 within five years, and back to around $100 by the end of the 2020s. That helps support a resumption of oil production growth next year, followed by a plateau just above 10 million bbl/day--surpassing 1971's peak output--for the next decade and a gradual decline thereafter. EIA also expects natural gas prices to head back towards $5 per million BTUs by the end of this decade, in tandem with a further 34% expansion of US gas production by 2040.
However, attainment of zero net imports also depends on the continuation of some important trends, including energy consumption that grows at a rate well below that of population, and a continued decoupling of energy and GDP growth. This is crucial, because through 2040 EIA assumes the US population will grow by another 20% and GDP by 85%, while total energy consumption increases by just 10%. That has important implications for greenhouse gas emissions. Energy-related emissions barely grow at all in this scenario.
Renewable energy output is also expected to continue growing, with US electricity generated from wind surpassing that from hydropower in the late 2030s and solar power in 2040 yielding roughly as many megawatt-hours as wind did in 2008.
Finally, reaching a balance between US energy imports and exports also depends on the continued contribution of nuclear power at roughly current levels. That suggests that new reactors will replace those that are retired, including for economic reasons, precluding a large wave of early nuclear power plant retirements in the next decade.
In Tuesday's rollout presentation at the Center for Strategic & International Studies (CSIS) in Washington, EIA Administrator Sieminski also emphasized what is not included in the Outlook's assumptions, notably the EPA's "Clean Power Plan" that is currently under review. It would be hard to imagine US coal consumption remaining essentially unchanged at 18% of the total energy mix in 2040, if EPA's plan to reduce emissions from the electricity sector by 30% by 2030 were fully implemented. EIA will apparently issue its analysis of the impact of the Clean Power Plan next month.
It's also worth comparing this view of zero net energy imports with popular notions of what energy independence might mean. It certainly does not mean that the US would no longer import any oil, natural gas, or other fuels from other countries. As the US approaches zero net imports, routine imports and exports of various energy streams will remain necessary to address imbalances between regions and fuel types.
Because EIA's forecast is predicated on current laws and regulations, it does not include any significant growth in oil exports. As a result, exports of refined products such as propane, gasoline and diesel fuel would continue to expand, eventually exceeding 6 million bbl/day gross and 4 million net of imports. In its "High Oil and Gas Resource" case the constraint on US oil exports forces an expansion of refined product exports that seems literally incredible when refinery capacity in Asia and the Middle East is also slated for expansion, while refined product demand growth slows globally. Perhaps this is EIA's subtle way of focusing attention on the US's outdated oil export regulations.
Exports of liquefied natural gas (LNG) would also take off, accounting for around 9% of US production by 2040, while imports of pipeline gas from Canada would shrink but not disappear. In the high resource case, US LNG exports would grow dramatically until the late 2030s, reaching 20% of a much bigger supply.
The report provides a few surprises, including one that won't be welcomed by advocates of biofuels and a continuation of the current federal Renewable Fuels Standard, the reform of which has become a topic of lively debate in the US Congress. EIA's figures show total US biofuel consumption growing by less than 1% per year, with ethanol's only real growth coming in the form of a modest increase in sales of E85, a mixture of 85% ethanol and 15% gasoline, to around 3% of gasoline demand in 2040.
Overall, I'm struck by several things. First, the value of the EIA's forecasts comes mainly from identifying the implications of current trends and policies, rather than accurately predicting the future. Mr. Sieminski seemed appropriately humble about the latter task in his remarks at CSIS. Yet the reference case this time suggests an eventual reversion to pre-oil-crash conditions, ending in 2040 at the same oil price in 2013 dollars as last year's forecast--a level that would exceed the 2008 peak by a sizeable margin. That seems inconsistent with a world of expanding energy options, improved drilling efficiency, at least for shale, and a growing focus on the decarbonization of energy.
There also appears to be a disconnect between the forecast's rising real price of natural gas, with implications for the cost of electricity generation, and its virtual flatlining of solar power's expansion after the scheduled expiration of the current solar tax credit in 2016. This looks like a bet against further solar cost reductions and technology improvements, along with structural changes that are already occurring in some electricity markets.
Despite these reservations, I wouldn't dispute the headline finding of steady progress toward a version of US energy independence that includes large volumes of energy trade with both North America and the rest of the world. The combination of resource growth and steady energy efficiency improvements looks like a recipe for putting the US on an energy footing that politicians of both major parties have only dreamed of for the last 40 years.
Media coverage of energy has focused heavily on oil prices, lately, for understandable reasons. Oil's dramatic plunge and subsequent volatility would be newsworthy, even if petroleum weren't still our leading source of energy, especially for transportation. In this context, the dog that hasn't barked is natural gas, although oil and gas are still linked by common drilling hardware and often produced from the same wells. With oil drilling being curtailed in response to low oil prices, should we be concerned about natural gas supplies in the months and years ahead?
At first glance the answer ought to be a straightforward "no." As most people now know, US drillers figured out how to tap the country's vast shale gas resources economically. US gas production is at record levels, after rising steadily since 2006 and surpassing former top producer Russia around 2009. US natural gas inventories were severely depleted following last year's "Polar Vortex" winter, but output grew fast enough to keep the benchmark price of gas below $4 per million BTUs this winter, despite below-average temperatures east of the Mississippi.
However, in assessing gas supply under low oil prices we must factor in the industry's response to the natural gas price collapse in 2008. The prices of oil and gas both dropped precipitously during the financial crisis, but gas didn't recover to the same extent as oil. In 2007 the average spot price of natural gas on an energy equivalent basis was just over half that of West Texas Intermediate crude (WTI). By 2010 gas was worth only a third as much as oil, and by 2012 just 17%--the equivalent of $16 per barrel in a world of $100 oil. Drillers responded accordingly.
As the Energy Information Administration (EIA) chart on the right depicts, drilling for gas fell sharply from 2009-12, while "oil-directed drilling" rose just as sharply. In fact, these were mainly the same rigs, redeployed to pursue different targets--sometimes in the same shale basin--as gas grew cheaper.
So shouldn't natural gas production have fallen in tandem with the decline in rigs drilling for gas? The extremely useful charts in the EIA's latest Drilling Productivity Report help to explain why gas output continued to climb. First, just as the increasing productivity of shale oil drilling has confounded expectations about how soon US shale oil production would begin to decline after prices fell below $50 per barrel, shale gas drilling productivity improved rapidly following the gas price collapse.
For example, between 2009 and 2012 average gas production per rig--not per well--in the mainly gas-yielding Marcellus Shale more than tripled. From 2012 -14 it doubled again. Those gains reflect the combination of improvements in drilling efficiency (more wells or more feet drilled per month), improvements in hydraulic fracturing effectiveness, and companies targeting more productive well sites as knowledge of the basin's geology increased.
A key development following the gas price collapse was the growth of gas production from rigs targeting shale oil. The best example is the Eagle Ford Shale. While oil production there grew from virtually nothing to over 1.7 million bbl/day, the region's gas output nearly quadrupled, to 7.5 billion cubic feet (BCF) per day, or 10% of total US gas production.
Now we've entered a new chapter, due to a global oil surplus. As of the latest drilling rig count from Baker Hughes, oil-directed rigs employed in the US have fallen by 45% since November 2014, and gas-directed rigs are down by 25%. A few companies may have shifted from oil back to gas, but the overall rig trend is still down for both.
The net result is that the EIA expects oil production from the major US shale basins to remain essentially flat from March to April, while gas production should still grow by about 0.3%. How much farther would US shale oil and gas drilling have to contract before lower rig counts swamped productivity improvements for gas? Comparing those figures to the growth rates in previous months, perhaps not very much.
Of course the US represents only about a fifth of the global gas market. Elsewhere, especially in Europe and Asia, many gas sales contracts are pegged to oil prices, while supply is dominated not by flexible shale, but by large conventional gas fields and the trade in liquefied natural gas (LNG). So outside the US, lower oil prices may do more to stimulate gas demand than to shrink supply. Cheaper gas imports into China are apparently already having an impact on coal consumption.
That could create new opportunities for companies developing LNG facilities to export US gas, at the same time that the economics of such exports become more challenging. In markets like Asia, the effect of lower oil prices has cut the gap between landed LNG prices and US pipeline gas--and hence the motivation for exports--by more than half.
Even after oil's collapse, US natural gas at the Henry Hub trades today at less than 40% of the price of WTI. The contraction of drilling in response to low oil prices may tighten supplies and nudge the price of both commodities higher, reminding us that gas isn't entirely immune to oil's influence. However, with US gas inventories ample, the market doesn't seem to anticipate either a spike in gas prices this summer, or a narrowing of gas's discount vs. oil any time soon.
When the International Energy Agency issued its most recent long-term energy forecast last November 12th, Brent crude oil traded just above $80 per barrel. It had fallen only half as far as it would by January 2015, compared to its June 2014 high of $115. As a result, the IEA's assessment of the price drop in its 2015 World Energy Outlook was incomplete, to say the least. The agency's Medium-Term Oil Market Report, issued last week, provides a necessary update and some interesting insights about how--and how far--they envision the oil market recovering.
Anyone expecting the IEA to provide a detailed oil-price forecast for the next five years will be disappointed. The current report reproduces recent oil futures price curves and generally endorses the current consensus that prices won't rise as high as the level from which they have just fallen, at least by the end of the decade. At the same time, in the Executive Summary they remind their audience, "The futures market's record as price forecaster is of course notoriously mixed." Six months ago West Texas Intermediate Crude for delivery in March 2015 was selling for more than $90/bbl; yesterday it closed under $52. So much for the predictive power of futures markets, as most participants are aware.
The report's analysis of the factors influencing the oil supply and demand balance over the next five years is more useful. First and foremost, it recognizes that the factors contributing to this price correction bear little resemblance to the price drops of 1998 and 2008, and share only a few common threads with the big correction of 1986, chiefly involving OPEC's behavior. The biggest differences involve the nature of the North American shale sector, which drove strong non-OPEC supply growth for the last several years, and the economic and policy factors--slowing growth in China, subsidy phaseouts, and currency depreciation-- likely to dampen the global demand response to cheaper oil.
With regard to shale, the IEA suggests that the current pressures on the US oil industry will prove temporary. They expect the growth of unconventional production from both shale and oil sands to slow but remain the largest source of non-OPEC supply increases through 2020, outstripping increases in OPEC's capacity and offsetting declines elsewhere. Those declines include a 500,000 bbl/day drop in Russian production, mainly due to sanctions.
The agency even suggests that North American shale could emerge from this experience stronger, because of its inherent resiliency. The same factors that should see shale output slow sooner than that from big conventional projects that took years to develop would allow it to ramp up faster, once the current global oil surplus has been consumed. Meanwhile, with larger projects delayed or canceled, conventional production would take longer to return to net growth above normal decline rates.
That could become the factor that dispels the current skepticism concerning shale oil opportunities outside North America, as apparently exemplified in BP's latest long-term outlook. Companies looking for growth opportunities in a few years might regard developing the shale resources of China, Argentina and Russia--assuming sanctions end--as lower-cost, lower-risk investments than some deepwater or other big-ticket projects.
As for OPEC, its production growth through 2020 seems to come down to a single country. The report assesses the current situation in Iraq and concludes that despite the threat from the Islamic State and the country's ongoing internal frictions, output should continue to grow by another million bbl/day or so. That strikes me as optimistic, particularly considering the proximity of ISIS forces to Kirkuk, which formerly accounted for around 10% of Iraqi production. Postwar development has focused on the big fields in southern Iraq, which have so far proved to be beyond the reach of ISIS, but a further deterioration of security in the Kurdish north could jeopardize future expansion plans.
The wild card on the supply side is Iran, which under international sanctions has seen its oil exports cut by roughly half. The Medium-Term Oil Market Report explicitly assumes that sanctions will continue. However, if current nuclear talks reached an agreement, sales could ramp up by a million bbl/day over the next year, if buyers could be found. That would alter the IEA's supply/demand calculations substantially.
And that leads us to demand, which at this point is still a key uncertainty. I concur with the report's general assessment that the world has changed since previous oil price drops and rebounds in ways that make a sharp rise in oil use less likely. US demand is up, but as I described in a recent post large groups of consumers around the world have seen little or no relief at the gas pump that might stimulate more consumption.
When I wrote about the IEA's World Energy Outlook last November, I focused on its themes of stress and the potential for a false sense of security. In the short time since then the oil and gas industry has experienced a large dose of stress, but I've seen few signs of complacency on the part of consumers beyond a recovery in the US sales of SUVs and light trucks. That may change if low oil prices persist for a few years.
Last week I attended the annual "policy day" at the Washington Auto Show, which typically emphasizes green cars and related technology. This year it included several high-profile awards and announcements, along with a keynote address by US Secretary of Energy Ernest Moniz. Yet while the environmental benefits of EVs and other advanced vehicles are a major factor in their proliferation, I didn't hear much about how the energy for these new car types would be produced.
The green car definition used by the DC car show encompasses hybrids, plug-in electric vehicles (EVs), fuel cell cars, and advanced internal-combustion cars including clean diesels. One trend that struck me after missing last year's show was that most of the green cars on display this year have become harder to distinguish visually from conventional models. For Volkswagen's eGolf EV, which shared North American Car of the Year honors in Detroit with its gas and diesel siblings, and Ford's Fusion energi plug-in hybrid the differences are mainly under the hood, rather than in the sheet-metal.
Of course some new models looked every bit as exotic as you might expect. That included BMW's i8 plug-in hybrid, which beat Tesla's updated 2015 Model S as Green Car Journal's "Green Luxury Car of the Year", and Toyota's Mirai fuel-cell car. The Mirai is expected to go on sale this fall in California, still the nation's leading green car market due to its longstanding Zero-Emission Vehicle mandate focused on tailpipe emissions.
Many of these cars have electric drivetrains, increasingly seen as the long-term alternative to petroleum-fueled cars. Although Secretary Moniz pointed out that the US government isn't attempting to pick a vehicle technology winner, there seemed to be more emphasis on vehicle electrification and much less on biofuels than in past years.
Another announcement at last Thursday's session addressed where such vehicles might connect to the grid. BMW and VW have partnered with Chargepoint, an EV infrastructure company, to install high-voltage fast-chargers in corridors along the US east and west coasts to facilitate longer-range travel by EV. In making the announcement BMW's representative indicated that EVs will need fast recharging in order to compete with low gasoline prices. With the relative cost advantage of electricity having become a lot less compelling than when gasoline was near $4 per gallon, EV manufacturers need to mitigate the convenience concerns raised by cars with typical ranges of 100 miles or less.
Getting energy to these cars more conveniently still leaves open the basic question of the ultimate source of that energy. Perhaps one reason this isn't discussed much is that unlike for gasoline or diesel-powered cars, there's no simple answer. The source of US grid electricity varies much more than for petroleum fuels: by location, by season, and by time of day. However, even in California, which on average now gets 30% of its electricity from renewable sources and has set its sights on 50% from renewables by 2030, the marginal kilowatt-hour (kWh) of demand is likely met by power plants burning natural gas, due to their flexibility. That's especially true if many of these cars will be recharged near peak-usage times, instead of overnight as the EV industry expects.
Based on data from the EPA's fuel economy website, most of the plug-in cars I saw at the Washington Auto Show use around 35 kWh per 100 miles of combined driving. That reflects notionally equivalent miles-per-gallon figures ranging from 76 for the BMW i8 to 116 mpg for the eGolf. On that basis an EV driven 12,000 miles a year would increase natural gas demand at nearby power plants by around 30 thousand cubic feet (MCF) per year. That equates to 40% of the annual natural gas consumption of a US household in 2009.
To put that in perspective, if we attained the President's goal of one million EVs on the road this year--a figure that may not be achieved until the end of the decade--they would consume about 30 billion cubic feet (BCF) of gas annually, or a little over 0.1% of US natural gas production. With plug-in EVs making up just 0.7% of US new-car sales in 2014, they are unlikely to strain US energy supplies anytime soon.
It's also worth assessing how much gasoline these EVs will displace. That requires careful consideration of the conventional models with which each EV competes. While a Tesla Model S surely competes with luxury-sport models like the BMW 6-series, thus saving around 500 gallons per year, an e-Golf likely replaces either a diesel Golf or a Prius-type hybrid, saving 250-300 gallons per year. A million EVs saving an average of 350 gallons each would reduce US gasoline demand by 22,000 barrels per day, or 0.25%.
At this point the glass for electric vehicles seems both half-full and half-empty. The number of attractive plug-in models that average consumers would consider real cars expands every year, as does the public recharging infrastructure to serve them. However, they still depend on generous tax credits and must now compete with gasoline near $2 per gallon. More importantly, at current levels their US sales are too low to have much impact on total emissions or oil use for many years.
Our writers' profile
Geoff Styles - Managing Director of GSW Strategy Group, an energy and environmental strategy consulting firm
V.P. of Geoscicences, STXRA, a strategic partner in PED's technical and drilling operations
PEDEVCO Corp., d/b/a Pacific Energy Development (NYSE MKT: PED) is a publicly-traded energy company engaged in the acquisition and development of strategic, high growth energy projects, including shale oil and gas assets, in the United States. The Company's principal asset, the D-J Basin Asset, is located in Weld and Morgan Counties in Colorado.
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