Donald Trump vs. OPEC

As of last week's price report from the US Energy Information Administration, the average US pump price of regular gasoline has gone up by $0.19 per gallon since the first week of March. That reflects normal seasonal factors but is mainly due to a jump in international crude oil prices of around $8 per barrel in the same period. President Trump's accusation that OPEC is responsible for rising fuel costs shouldn't have surprised anyone:

Last Friday's tweet prompted a quick retort from Saudi Oil Minister al-Falih: "there is no such thing as an artificial price." It doesn't require a deep study of OPEC or economics to conclude that, however phrased, Mr. Trump's remark was closer to the truth than his chosen foil's reply on this issue.

The more interesting question is whether OPEC's very intentional efforts in conjunction with Russia to tighten oil markets are actually harmful to US interests at this point. Could our instinctive reaction to rising oil prices be based on outdated thinking from the long era of perceived scarcity that began with the oil crises of the 1970s and ended, more or less, with this decade's US shale boom?

Let's recall that less than four years ago oil prices fell below $100 per barrel as the rapidly growing output of US shale, or "tight oil" production from wells in North Dakota and South and West Texas created a global oil surplus and rising oil inventories. Oil prices went into free fall around the end of 2014--eventually bottoming out below $30 per barrel--after Saudi Arabia and the rest of OPEC abandoned their output quotas and opened up the taps.

That response to the shale wave began the only period in at least four decades when the oil market could truly be characterized as free, when all producers essentially pumped as much oil as they desired. Some referred to it as OPEC's "war on shale."

However, those conditions proved to be just as hard on OPEC as on US shale producers, and by the end of 2016 OPEC blinked. The output agreement between OPEC's members and a group of non-OPEC producing countries led by Russia has been in place over a year, and it has taken this long to dry up the excess inventories that had accumulated in 2015-16. OPEC's quota compliance--historically mediocre at best--was aided significantly by geopolitical factors affecting several producers, notably the ongoing implosion of Venezuela's economy and the oil industry on which it depends.

Given all this, it's fair to say that OPEC has engineered today's higher oil prices, while its leading members contemplate even higher prices. It's much less obvious that this is bad for the US, which now has a vibrant and diverse energy sector and is finally approaching the energy independence that politicians have touted since the late 1970s.

Prior to the shift in the focus of the shale revolution from natural gas to oil, the US was still a substantial net importer of petroleum and its products. In 2010, we imported over 9 million barrels per day more than we exported. That was around half of our total petroleum supply. Today, these figures are under 4 million barrels per day and 20%, respectively.

That means that when the price of oil rises, this is no longer followed by enormous outflows of dollars leaving the US to enrich Middle East and other producers. Something like 80 cents of every dollar increase in the price of oil stays in the US, and in the short run the effect may be even more beneficial as investment in US production steps up in response.

In other words, when oil prices go up and gasoline and diesel prices follow, the main effect on the US economy is to shift money from one portion of the economy to another, rather than the whole economy springing a large leak. What makes that shift challenging is that consumers come out on the short end, while oil exploration and production companies, and to some extent oil refiners, gain.

A useful way to gauge the impact on consumers is to compare one year's prices to the previous year's. When oil prices were falling a few years ago, year-on-year drops of as much as $1.00 per gallon for gasoline (2014-15) put up to $100 billion a year back into the pockets of consumers. That provided a timely stimulus for an economy still recovering from the financial crisis of the previous decade.

As oil prices started to recover last year, these comparisons turned negative. Currently, the average regular gasoline price is $0.31/gal. higher than last year at this time. If gas prices were to stay that much higher than last year's for the rest of 2018, it would impose a drag of about $45 billion on consumer spending. $2.75/gal. is the highest US average unleaded regular price for April since 2014. Although gas is still nearly $1.00/gal. cheaper than it was then, memories tend to be short.

We may be living in a new era of energy abundance, but I am skeptical that our political instincts have caught up with these altered circumstances. The price of gasoline is still arguably the most visible price in America. When it goes up week after week, consumers notice, even in an economy running at essentially "full employment" and growing at 3% per year.

Most of those consumers are potential voters, and this is another election year with much at stake. In that light, I would not expect President Trump to abandon his attack on "artificial prices" for oil, even if it's arguable that the US economy as a whole may not be worse off with oil over $70 instead of below $60 per barrel.

Is the US Really Energy Independent?

Toward the end of Sunday night's presidential debate I was startled to hear Secretary Clinton reply to an audience question by stating, "We are now for the first time ever energy-independent." If the price of oil were $100, rather than $50, that might have constituted a "Free Poland" moment, recalling President Ford's famous gaffe in a 1976 debate.

This point is likely to get lost in the dueling fact-checking of both candidates' numerous claims, but while the overall US energy deficit has fallen from about a quarter of total consumption (net of exports) in 2008 to just 11% in 2015, we still import 8 million barrels per day of oil from other countries. That includes over 3 million barrels per day from OPEC, a figure that has been growing again as US oil and gas drilling slowed following the collapse of oil prices in late 2104.

Oil has always been at the heart of our notions of energy security and energy independence, because it is our most geopolitically sensitive energy source and the one for which it is hardest to devise large-scale substitutes. So although the US is certainly in a better overall position than it has been in decades, with progress on multiple aspects of energy, it is not yet energy independent, especially where it counts the most.

Moreover, the policies that Mrs. Clinton has proposed would, at least initially, be likely to expand that gap by imposing additional restrictions on hydraulic fracturing, or "fracking." Mr. Trump, for his part, seemed to devote much of his response to Mr. Bone's debate question  talking about coal, which while still a significant player in electricity production has become largely irrelevant to the topic of energy independence, because its use is being displaced by other domestic energy sources, mainly natural gas and renewables like wind and solar power.

In fact, of the various contributors to the energy independence gains the US has made from 2008-15 (shown in blue in the above chart) the largest depend on fracking. Oil still makes up most of our remaining energy deficit, after help from a million barrels per day of ethanol--50% of the energy content of which comes from domestic natural gas. Electric vehicles also help, but the roughly 400,000 on the road in the US today displace the equivalent of only about 12,000 barrels per day of oil products, too small to be visible on the scale of this graph. As a result, continued fracking of shale and tight oil resources must be the linchpin of any realistic strategy to close the remaining US energy deficit within the next decade or so.

I understand that Secretary Clinton's proposed energy policies put a higher priority on addressing climate change. However, she raised the issue of energy independence in the second debate, even though her proposals are unlikely to deliver it in the foreseeable future--or preserve our present, hard-won reduced dependence on foreign energy sources. Anyone who doubts that this is a pocketbook issue should recall where oil and gasoline prices were just three years ago, before US shale added over 4 million barrels per day to global oil supplies.

An Ill-conceived Tax Idea

Yesterday we learned that President Obama's final budget proposal includes a plan to raise money for transportation projects and other uses by imposing a per-barrel tax on US oil companies. Here are a few quick thoughts on this ill-conceived idea:

• As I understand it, the tax would be imposed on oil companies, exempting only those volumes exported from the US. The US oil industry is currently in its deepest slump since at least the 1980s. Having broken OPEC's control of prices and delivered massive savings to US consumers and businesses, it is now enduring OPEC's response: a global price war that has driven the price of oil below replacement cost levels. This is evidenced by the recent full-year losses posted by the "upstream" oil-production units of even the largest oil companies: ExxonMobil, Chevron, Shell, BP and ConocoPhillips, particularly in their US operations. The President has wanted to tax oil companies since his first day in office, but his timing here would only exacerbate these losses, putting what had been one of the healthiest parts of the US labor market under even more pressure.
• This tax would also increase OPEC's market leverage, providing a double hit on the cost of fuel for American consumers: We would pay more immediately, when the tax was imposed and companies passed on as much of it as they could, and then even more later when OPEC raised prices as competing US production became uneconomical.
• Focusing the tax on the raw material, crude oil, rather than on the products that actually go into transportation, as the current gasoline and diesel taxes do, is guaranteed to produce distortions and unintended consequences. For starters, exempting exports--a sop to global competitiveness?--would give producers a perverse incentive to send US oil overseas instead of refining it in the US. It would also shift consumption toward more expensive fuels like corn ethanol, which provides no net emissions benefits but has been shown to affect global food prices.
• Singling out oil, which is not the highest-emitting fossil fuel and for which we still lack scalable alternatives, will put all parts of the US economy that rely on oil as an input at a competitive disadvantage, globally, and undermine what had become a significant US edge in global markets. Petrochemicals, in particular, would be adversely affected. The President's staff is well aware that the distribution of lifecycle emissions from oil, and the structure of the industry and markets, make policies focused on consumption far more effective than those aimed at production. This is why his administration's first act in implementing the expanded interpretation of the Clean Air Act to greenhouse gases was to tighten vehicle fuel economy standards. Taxing the upstream industry does nothing for global emissions but makes US producers less competitive, ensuring a return to rising oil imports and deteriorating energy security.

As widely reported, the Congress will not enact a budget containing this provision. It is hard to gauge whether this proposal represents a serious attempt to inject new thinking into the debate on funding transportation upgrades, or is simply one last shot across the bow of the administration's least favorite industry before leaving office in 349 days. It's not unusual for the wheels to come off as a presidency winds down, and this particularly flaky and futile idea might just be an indicator of that.

Disclosure: My portfolio includes investments in one or more of the companies mentioned above.

Cheapest Gasoline Ever?

Last week the Energy Information Administration  (EIA) reported that the $2.43 per gallon average US retail price for regular gasoline in 2015 was the lowest since 2009. A quick look at the EIA's handy page for comparing nominal and real fuel prices over time shows that last year's average, when adjusted for inflation, was actually the cheapest since 2004. A recent article suggested that current prices are lower than those in the mid-1960s, in the heyday of the American love affair with driving. I've lost the link, but that factoid checks out, too. However, even this understates the bargain currently on offer at the gas pump.

The price of gasoline is still one of the most visible prices in the US, prominently displayed on gas station signage and roadside billboards across the country. However, it only captures one aspect of how much motorists really pay, just as measuring fuel economy in miles per gallon misses the economic impact of driving. A few years ago I ran across a metric that combines these factors into a simple gauge of driving cost: miles per dollar, or mp$.

The chart below incorporates EIA data on inflation-adjusted fuel cost and data from the National Highway Transportation Safety Agency (NHTSA) on actual fleet corporate average fuel economy (CAFE) performance for each model year of passenger cars--not SUVs or light trucks--to display average mp$ for the last four decades.

Taking last week's average price of $2.03 for unleaded regular and using 36.4 mpg for the 2013 model year (the latest on NHTSA's site), today's fuel cost of driving is cheaper than at any time since 1978--and maybe ever. The 18 miles per dollar I calculated just beats the previous peak of mp$ in the late 1990s, when fuel economy was around 28 mpg and gas prices averaged barely over $1, due to the effects of the Asian Economic Crisis. By comparison, the $0.31 per gallon that motorists paid in 1965 was downright expensive, after adjusting for inflation and factoring in the low-to-mid-teens fuel economy of cars of the day.

Miles per dollar is also handy for comparing driving cost on gasoline to the cost of operating vehicles that use other fuels or electricity. When I first looked at miles per dollar in 2008, electric vehicles were significantly cheaper, per mile driven, than cars running on gasoline or diesel, even hybrid cars like the Prius. That gap still exists, but it has narrowed. At an US average residential electricity price of $0.126/kilowatt-hour last year, a Nissan Leaf or Chevrolet Volt would get around 26 mp$. However, in New England and other parts of the country with significantly higher-than-average electricity prices, the miles of driving that an EV can deliver per dollar of energy used could be less than that for gasoline in some locations.

A few caveats are in order. Based on data from the Transportation Research Institute at the University of Michigan, new-car fuel economy has slipped 0.8 mpg since oil prices started falling in the summer of 2014. And in any case, new cars are typically more efficient than the entire US car fleet, which includes older vehicles and substantial numbers of SUVs and light trucks. The Consumer Price Index is also an imperfect tool for comparing prices over long periods of time, because the Bureau of Labor Statistics periodically changes the components of the "basket" of goods and services that go into calculating the CPI.

None of those issues seems big enough to alter the basic conclusion that the gasoline cost of driving is exceptionally, perhaps historically cheap at the moment. If oil prices stay "lower for longer", as some experts expect,  changing the make-up--and thus the emissions--of the US car fleet is likely to be an uphill battle.

Where Is the Stimulus from Cheap Oil?

• Those expecting a boost to the US economy from lower oil prices--the opposite effect of past oil price spikes--have been disappointed by the anemic response so far.
• In GDP terms cheaper net oil imports have been offset by cuts in oil & gas investment. However, consumers now have billions saved at the gas pump to spend elsewhere.

For the last couple of months media coverage has reflected skepticism about the benefits of lower oil prices, and especially cheaper gasoline, for the US economy. This is somewhat puzzling, since the US is still a net importer of crude oil, and as such has enjoyed significant savings on our collective oil import bill during this period. And while the fallout for US oil producers whose rising output helped to trigger last fall's oil price collapse might negate some of the upside of that decline for the nation as a whole, the benefits for consumers ought to be more obvious.  

 

Start with some basic figures. From January to September of last year, West Texas Intermediate crude oil, the main benchmark for US petroleum, averaged $100 per barrel (bbl), in line with the average of the previous three years. From October through mid-May of this year, WTI has averaged just over $60/bbl, near where it trades today. The data for what US refineries paid to acquire imported oil through April reflect a similar drop, implying national savings of around $60 billion since the price of oil fell below the previous year's lows last October, on the basis of 7 million bbl/day of net crude oil imports. That equates to $94 billion on an annualized basis.

 

However, as I've noted before, the US has become a significant net exporter of refined petroleum products like gasoline and diesel fuel. If the revenue from those sales has fallen in parallel with oil prices, that would shrink the benefit for overall US petroleum trade by about a third.

 

At that level, the GDP gains from cheaper imported oil appear to be more than offset by cuts of over $90 billion in capital expenses as US oil producers seek to reduce their costs and manage their cash flow in a low-price environment.  Those cuts, along with reduced operating expenses, ripple through oil companies and their supply chains, resulting in job losses and suppliers that have less, in turn, to invest in new equipment.  

 

Of course the flip side of that is that with US net petroleum imports below 5 million bbl/day, out of total consumption of just over 19 million bbl/day, the country would suffer much less than previously from a sudden increase in oil prices due to some geopolitical event or a further change in OPEC's strategy.

 

Nor does this alter the fact that US consumers whose jobs are not tied to the oil industry have more left to spend or save every month, thanks to lower prices at the gas pump. Since the beginning of last October, US retail gasoline prices have averaged $0.84 per gallon less than at the same point a year earlier, peaking at a $1.25 year-on-year discount in mid-April. Current prices for all grades average $0.92/gal. less than in early June of 2014, following the Memorial Day weekend. As a result, consumers have gained around $90 billion in gasoline savings through May, equivalent to $137 billion per year.

 

If they're not yet spending the difference on other goods and services, they have reacted in other ways more directly related to cheaper gasoline: They appear to be driving more. The US Department of Transportation's gauge of vehicle miles traveled is up sharply, at or near a new high. API's oil statistics for the first quarter of 2015 show total US gasoline consumption ahead by 2.9%, compared to the first quarter of 2014. As cold and snowy as the past winter was, that's surprising.  If this trend persists, it could indicate a reversal of the generally downward trend in US gasoline demand since the financial crisis.

 

Consumers also appear to be purchasing larger, somewhat less fuel-efficient new cars. The Transportation Research Institute at the University of Michigan reported that average US new-car fuel economy of new cars sold in April was 0.6 mpg lower than at its peak last August, though still up by 5.1 mpg since October 2007.  Consistent with the figures on fuel economy, sales of hybrid cars fell by 16% in the first quarter, compared to last year, and now make up just over 2% of US new cars. Plug-in hybrids fell by nearly a third. Only battery-electric EVs bucked this trend, driven largely by Tesla's growth in sales.

 

Despite these shifts, I don't believe the return--for however long--of fuel prices that start with a "2" instead of a "3" or "4" will turn the US back into a nation of gas guzzlers. Consumers are only spending a fraction of their savings at the pump buying more fuel, and the preference of many for cars larger than those they were buying when gas prices reached $4 per gallon seasonally in much of the country doesn't alter the fact that even light trucks are becoming steadily more efficient.

 

Wherever the rest of that $100-plus billion a year from cheaper gasoline is going today, Americans would be wise not to assume it will carry into the future indefinitely. Oil prices remain volatile and uncertain. Although OPEC might be correct in projecting that we will not see $100 per barrel again soon, current prices may not prove sustainable, either. 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

 

A Lesson in Oil Pricing

• The recent oil-price collapse confirms what we should have learned in 2007-8 about the influence of the last increments of supply and demand on price.
• This also means that future oil prices should be largely independent of the size of the oil market, even in a decarbonizing world.

In 2008, near the peak of a historic oil-price spike, the US Energy Information Administration (EIA) published a study projecting that opening the Arctic National Wildlife Refuge (ANWR) for drilling would reduce oil prices by no more than $1.44 per barrel, compared to their forecast without ANWR. Adding up to 1.5 million barrels per day to US production by 2028 would thus save motorists less than 4¢ per gallon. That result appeared during a Presidential election campaign that featured the slogan, "Drill, baby, drill!" and received significant attention.  I hope the authors of that study have been watching the current oil price collapse, because it provides some useful lessons in how oil prices are determined.

Oil traders and most economists understand that oil prices are ultimately set by the last few million barrels per day of supply and demand in the market, and resulting changes in inventory. The oil price spike of 2007-8 provided firm evidence for this phenomenon, as rapidly growing demand and production problems eroded global spare production capacity to a level of around 2 million barrels per day (MBD) compared to more than 5 MBD in late 2002, prior to the Venezuelan oil strike and the start of the Iraq War. This may have been obscured by the rise of the widely publicized Peak Oil meme, which provided a more viscerally appealing explanation for high oil prices until it ran out of steam recently.

A chart from one of the International Energy Agency's recent Oil Market Reports provides a neat illustration of the main factors leading to the recent price collapse. (See below.) Here, the emergence of a sustained surplus of 1-1.5 MBD starting in early 2014--less than 2% of the global oil market of around 93 MBD--was instrumental in depressing oil prices by more than half. Another factor was that, contrary to a key assumption of the 2008 EIA study, OPEC elected not to "neutralize any potential price impact of (additional US) oil production by reducing its oil exports." While shale technology has expanded US oil output by a multiple of what the EIA expected ANWR might add, the benefit for consumers isn't just pennies per gallon, but more than a dollar, at least for now.

Since the price of oil is set at the margin, it is also essentially independent of the total size of the oil market. That has important implications for how we envision the future of the oil market, especially in a world that is increasingly concerned about greenhouse gas emissions and transitioning to cleaner sources of energy. Even if future oil production were to be increasingly constrained by energy efficiency improvements and environmental policies, it doesn't necessarily follow that future oil prices must be low. That would only be the case if producers mistakenly invested in more production capacity than the market actually ended up needing.

As things stand today, there is a significant risk that the industry will not invest enough in future capacity, and that prices will again rise sharply before electric vehicles and other alternatives could scale up sufficiently to fill the gap, particularly if low oil prices also deter their growth. That's because without large investments in new oil output, current production will eventually decline from today's levels. Field-level decline rates range from just a few percent to 65% per year, depending on whether we're looking at the conventional oil reservoirs that make up over 90% of global supply, or at US shale production, which accounts for less than 5% of world oil.

Perhaps the bottom-line lesson is that we should never become complacent about the potential price volatility of what is still, at this point, an indispensable commodity. The shale revolution and OPEC's current behavior don't guarantee that oil prices must remain depressed, any more than previous concerns about Peak Oil meant they would remain high indefinitely.





 

What Will Fuel Today's Advanced Vehicles?

Last month 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 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. 

BMW i8 plug-in hybrid

Toyota Mirai fuel-cell car

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 a definite emphasis on vehicle electrification and much less on biofuels than in past years.

Another announcement at last month'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 more conventional models with which each EV competes. While a Tesla Model S surely lures buyers away from 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 per year 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 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 emissions or oil use for many years.

 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

How Much Will Low Oil Prices Stimulate Demand?

• Since weak oil demand growth is a major ingredient in the current oil price crash, higher demand stimulated by low prices could be a moderating factor.
• While US demand has risen since prices fell, there are several reasons why the global response may be slower to appear and less dramatic.

One of the main factors that will determine the depth and duration of the current slump in oil prices is the extent and timing of a resulting rebound in demand. It is likely to occur first in countries like the US, where fuel taxes are low and consumers see the results of lower oil prices at the  gas pump relatively quickly--a $1.65 per gallon drop already, since June. However, other factors besides taxes could impede faster demand growth elsewhere. 

From 2007 to 2009 the combination of high oil prices and a weak economy reduced US petroleum demand by almost 2 million barrels (bbl) per day, compared to its 2006 peak. The first volumes backed out of the market were imported refined products, which had grown rapidly from the mid-1990s until 2005. Low domestic demand and expanding US oil production then led US oil refiners to seek new markets, particularly in Latin America. US petroleum product exports have increased by around 1.7 million bbl/day since the recession began.

These refiners might reasonably expect their domestic and foreign markets to grow faster with oil prices dramatically lower. So far, it's hard to see more than hints of this in the lagged data from the US government or API, which reported December gasoline demand at a 7-year high. It's also hard to discern how much can be attributed to oil prices, rather than to US economic growth and a falling unemployment rate. The October update of vehicle miles traveled from the US Department of Transportation was still well below its 2008 peak but showed a modest upward trend, although that seems to have begun before oil prices fell.

Other indicators are also mixed. By the end of last year sales-weighted fuel economy of new vehicles sold in the US had declined by 0.7 miles per gallon from its August 2014 peak. That reflected US consumers buying larger vehicles, including more SUVs, fewer hybrids and only slightly more plug-in electric cars than in the prior year. Despite this retreat, full-year-average fuel economy tracked by the University of Michigan still showed a more than 5 mpg gain since 2007, equating to 20% better fuel efficiency. So the roughly 45 million cars and light trucks sold in the US in the last three years--nearly a fifth of today's light-duty fleet--will use less gasoline than the ones they replaced, even in the most robust response to low gas prices imaginable.

Globally, growth prospects seem equally mixed. Since last July the International Energy Agency has reduced its forecast of 2015 petroleum demand growth by a cumulative 500,000 bbl/day, to +0.9 million bbl/day, as the global economy weakened.  These conditions could combine with currency-related effects to dampen, or at least delay, a potential surge in global oil demand due to low prices. 

Because oil is traded in US dollars, the dollar's recent strength shrinks the oil savings experienced by other importing countries. While all of these countries are paying less for oil than they did last summer, exchange rates have eroded 10-30% of that benefit. The chart above displays this effect for the Euro and Japanese Yen. Closer to home, currencies like the Mexican and Colombian Pesos have depreciated by 12% and 29% since June, respectively.  That could prove significant, since Mexico's refined product imports from the US averaged over 500,000 bbl/day in 2014 (through October), along with over a million bbl/day to the rest of Latin America.

Since petroleum products are sold in local currency, after tax at the pump, consumers in many countries have seen a smaller drop to which they might respond, compared to US consumers. The average German gasoline price has fallen by just 19% since June and the average UK price by 20%, compared to 42% in the US. Meanwhile state-controlled gasoline prices in Brazil and Mexico have  gone up. That's unlikely to induce more driving.

So far the weekly figures  for US refinery throughput are up compared to last year, implying higher expected product sales. However, US inventories of gasoline and diesel fuel have also been growing for the last several months. If rising demand doesn't erode inventory gains soon, refiners may need to reduce processing rates, and that would feed back to oil prices. The next few months of energy statistics should tell a very interesting story.

 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

2014 in Review: Shale Energy's First Price Cycle

2014 was an extraordinary year in energy, vividly illustrating both sides of the Chinese proverb about interesting times. Oil market volatility was the big story for much of the year, with the dominance of geopolitical risks finally yielding to surging supplies. Of the two energy revolutions underway, shale wields the bigger stick for now, while the growth of renewables gathers momentum. All of this has implications for 2015 and beyond.

The US remained the epicenter of the shale revolution this year, with development elsewhere still subject to uncertainties about economic production potential, infrastructure, and the rules of the road. A comparison of oil-equivalent additions to US energy supplies from oil, gas and non-hydro renewables for the first nine months of the year highlights both the significance of shale and the differences in relative scale that impede a rapid shift to renewables.

US shale drilling added over a million barrels per day of "light tight oil" (LTO) production, compared to 2013, based on US Energy Information Administration data for the first nine months of the year. That brings cumulative gains since 2011 to nearly 3 million bbl/day. This hasn't just upended the global oil market; it has also revolutionized the way oil moves across North America. Over a million bbl/day now moves by rail, a figure recently projected to peak at 1.5 million by 2016. Nor is that entirely the result of delays to pipeline projects like Keystone XL. One proposed pipeline for Bakken LTO was reportedly canceled due to a lack of interest from shippers. Rail is expensive but provides producers and refiners with greater flexibility in both volume and destinations than fixed pipelines.

The collapse of oil prices has prompted many producers to reassess drilling plans, although it has been a boon for refiners and consumers.  Refining margins look relatively healthy, at least based on the proxy of "crack spreads", the difference between the wholesale prices of gasoline and diesel and the oil from which they are made. Some refiners also anticipate that low prices will spur demand growth, as described in a fascinating Wall St. Journal interview with Tom O'Malley, who has turned a succession of castoff refineries into profitable businesses. 

We may already be seeing the demand response to lower prices. November US volumes were at a 7-year high, according to API. This is unlikely to be replicated quickly elsewhere, however, for the same reasons that global oil demand was slow to moderate when prices rose over the last several years: In many countries the influence of oil prices on consumer behavior is overwhelmed by fuel taxes or subsidies. With prices now falling, some developing countries are capitalizing on the opportunity to unwind billions of dollars in consumption subsidies, offsetting market drops. That could have important implications for future oil demand and greenhouse gas emissions.

Meanwhile US consumers have watched retail gasoline prices fall by $1.39 per gallon since July and by over a dollar compared to a year ago. If sustained, the effective stimulus could exceed $100 billion annually, ignoring the effect of lower prices for jet fuel, diesel and other products. It's not surprising that half of respondents in last month's Wall St. Journal/NBC poll indicated this was important for their families.

While oil has been making headlines, shale gas without much fanfare added the equivalent of another half-million bbl/day to US production. That explains why despite enormous drawdowns of gas during last winter's "Polar Vortex", gas inventories began this winter much closer to normal levels than was widely expected in the  spring. Gas has lost a little ground in electricity generation to coal in the last two years, but few reading the EPA's proposed Clean Power Plan regulation would expect that trend to continue.

Shale gas remains controversial in some areas due to perceived environmental and community impacts. New York state is apparently making its temporary ban on hydraulic fracturing ("fracking") permanent, preferring to rely on shale gas supplies from neighboring Pennsylvania. Yet while shale drilling in North Dakota has led to an increase in gas flaring--burning off gas that can't economically reach a market--the latest findings from the University of Texas and Environmental Defense Fund measured methane leakage from gas wells at an average of 0.43%. That shrinks gas's emissions footprint and enhances its potential role in climate change mitigation.

Turning to renewables, wind energy now provides a little over 4% of US electricity. However, its growth has slowed due to uncertainty about continued federal subsidies. The wind production tax credit, or PTC, had previously been extended through 2013 in a way that allowed projects brought online later to benefit from the extension. It was just extended again through the end of 2014, along with a broad package of other expiring tax benefits. This late revival might be a gift to a few projects already under construction, but it seems unlikely to spur additional projects without further legislative action in the new Congress.

Solar power has also made great strides, with costs falling rapidly and US additions in 2014 expected to reach 6,500 MW, likely outpacing wind additions. This is happening despite the ongoing trade dispute between the US and China over imported solar modules. Utilities are already experiencing solar's impact on their traditional business model. Yet as important as wind and solar power are likely to be in the future energy mix, their impact in 2014, at least in the US, was still dwarfed by the growth of shale resources. Drilling is already slowing down, however, so renewables could take the lead in 2015 as shale is expected to post smaller gains.

Looking ahead, the global focus on greenhouse gas emissions will increase in the run-up to the Paris climate conference in December.  It remains to be seen whether enough progress was made in the recently completed talks in Lima, Peru, to resolve the significant remaining obstacles to a new global climate agreement. And while oil supply gains trumped geopolitics in 2014, a list of risk hot-spots from the Council on Foreign Relations includes several scenarios with major implications for oil and/or natural gas prices. Meanwhile we can expect the new Congress to take up Keystone XL, oil exports, EPA regulations, and other energy-related issues. I'd bet on another lively year.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

The Impact of the Global "Sweet" Crude Bulge

• The recent slide in global oil prices has been compounded by the pressure that rising US shale oil production is putting on the price of sweet crude benchmarks like Brent.
• OPEC's producers may suffer as much as those in the US, while consumers benefit from significantly lower fuel prices than last year.

When the US went to war in Iraq in 2003, the price of oil embarked on a trend that took it from around $30 per barrel to nearly $150 before collapsing in the recession in 2008. This time, as a new US-led coalition takes on ISIS with a bombing campaign in Iraq and Syria, the price of oil is falling, down 20% in the last two months. It's not just that global economic growth has weakened recently, or that soaring shale oil output in the US has averted another oil crisis. Oil's current downturn also reflects the fact that new production from the Bakken, Eagle Ford and other shale deposits is particularly well-suited to undermine oil's global benchmark prices, for Brent and West Texas Intermediate, both of which are made up of light sweet crude oil streams.

The numbers for US shale, or "light tight oil" (LTO) as it's often called, are impressive, especially to those accustomed to watching the gradual ebb and flow of different oil sources over long periods. In the 12 months ending in June 2014, US oil production grew by 1.3 million barrels per day (MBD), not far short of Libya's pre-revolution exports. Since January 2011, the US added 3 MBD, or about what the UK produced at its peak in 1999. In fact, since 2010 incremental US LTO production has exceeded the net decline of the entire North Sea (Denmark, Norway and UK) by around 2 MBD, contributing to a significant expansion of Atlantic Basin light sweet crude supply.

The New York Mercantile Exchange defines light sweet crude as having sulfur content below 0.42% and an API gravity between 37 and 42 degrees. That's less dense than light olive oil. The specification for Brent is similar. Much of the LTO produced from US shale formations fits those specifications, and what doesn't is typically even lighter and lower in sulfur.

The current "contango" in Brent pricing, in which contracts for later delivery sell for more than those for delivery in the next month or two, is another sign of a market that is physically over-supplied: more oil than refineries want to process, with the excess going into storage. However we also see indications that the historical premium assigned to lighter, sweeter crude versus heavier, higher-sulfur crude is under pressure.

One example of this is the gap or "differential" between Louisiana Light Sweet, which wasn't caught up in the delivery problems that plagued West Texas Intermediate for the last several years, and Mars blend, a sour crude mix from platforms in the Gulf of Mexico. From 2007-13 LLS averaged around $4.50 per barrel higher than Mars, while for the first half of this year it was only $2.75 higher and today stands at around $3.40 over Mars.

And while OPEC's reported Reference Basket price has been falling in tandem with Brent, its discount to Brent had also narrowed by about $1 per barrel, prior to the price plunge of the last couple of weeks, compared with the average for 2007-13. Considering that OPEC's basket includes light sweet crudes from Algeria, Libya and Nigeria that sell into some of the same Atlantic Basin markets as Brent, that looks significant.

By itself a narrowing of the sweet/sour "spread" of only a dollar or so per barrel isn't earth-shattering. However, because the surge of US oil production is effectively focused on the oil market segment represented by the price of Brent, it compounds the pressure on OPEC, many of whose members link the price of their output to Brent. This might help explain why the response of OPEC's leading producer, Saudi Arabia, has been to cut prices rather than output, in an apparent effort to maintain market share rather than price level.

The Saudis know better than anyone how that movie could end. The Kingdom's1986 decision to implement "netback pricing", linking the price of its oil to the value of its customers' refined petroleum products, helped precipitate a price collapse so deep that it took oil prices 18 years to reach $30/bbl again, by which time the dollar had lost a third of its value.

Whether aimed at US shale producers or as a reminder to the rest of OPEC, which appears to be unprepared to make the output cuts necessary to defend higher oil prices, the Saudi action increases the chances that oil prices will over-correct to the downside, rather than rebounding quickly. If so, the impact of the sweet crude bulge in the Atlantic Basin--only a little more than 3% of global oil supplies--could play a disproportionate role in prolonging the pain producers will experience until oil markets eventually reach a new equilibrium.

In the meantime, US consumers are benefiting from gasoline prices that are already $0.15 per gallon lower than this week last year. Today's wholesale gasoline futures price for November equates to an average retail price well below $3.00 per gallon, after factoring in fuel taxes and dealer margins, compared to last year's average retail price for November of $3.24. After factoring in lower diesel and heating oil prices, the fall in oil prices could put an extra $10 billion in shoppers' pockets for this year's holiday season.

A substantially different version of this post was previously published on the website of Pacific Energy Development Corporation

The Missing Oil Crisis of 2014

• While the full impact of the surge in US "tight oil" may be masked by problems elsewhere, it is on the same scale--but opposite direction--as key factors that led to the 2007-8 oil price spike.
• In that light it does not seem like hyperbole to credit the recent revival of US oil output with averting another global oil crisis.

Several speakers at last month's annual EIA Energy Conference in Washington, DC reminded the audience that energy security extends beyond oil, starting with Maria van der Hoeven, Executive Director of the International Energy Agency (IEA). In her keynote remarks Monday morning she was quick to point out that it also encompasses electricity, sustainability, and energy's effects on the climate and vice versa. Still, the comment that got my wheels turning came from Dan Yergin, author and Vice Chairman of IHS. During his lunch keynote he suggested that without US tight oil production, this year's conference would have been dominated by another oil crisis.

Although shale energy development certainly deserves to be called revolutionary, crediting it with averting an oil crisis calls for a bit of "show me." Yet with problems in Libya, Nigeria and Iraq, while Iranian oil remains under sanctions and oil demand picks up again, even at first glance Mr. Yergin's assertion looks like more than a casual, lunch-speech sound-bite.

Start with current US tight oil (LTO) production of over 3 million barrels per day (MBD) and estimates of future LTO production rising to as much as 8 MBD--also the subject of much discussion at the conference. As recently as 2008 total US crude oil output had fallen to just 5 MBD and was only expected to recover to around 6 MBD by 2014, with minimal contribution from unconventional oil. Instead, the US is on track to beat 2013's 22-year record of 7.4 MBD, perhaps by as much as another million bbl/day.

With conventional production in Alaska and California declining or at best flat, and with Gulf of Mexico output just starting to recover from the post-Deepwater Horizon drilling moratorium and subsequent "permitorium", the net increase in US crude production attributable to LTO today is in the range of 2.5-3.5 MBD and growing, thanks to soaring output in North Dakota, Texas and other states.

That might not sound like much in a global oil market of over 90 MBD, but it brackets the IEA's latest estimate of OPEC's effective unused production capacity of 3.3 MBD. Spare capacity and changes in inventory are key measures of how much slack the oil market has at any time. When OPEC spare capacity fell below 2 MBD in 2007-8, oil prices rose sharply from around $70 per barrel to their all-time nominal high of $145 per barrel. It took a global recession and financial crisis to extinguish that price spike, and high oil prices were likely a major contributor to the recession.

Global oil inventories are now a little below their seasonal average for this time of the year. Compensating for the absence of over 3 MBD of US tight oil would require higher production elsewhere, lower demand, or a drain on those inventories that would by itself push prices steadily higher.

Concerning production, if the US tight oil boom hadn't happened, more investment might have flowed to other exploration and production opportunities. However, for non-LTO production to have grown by an extra 3 MBD, companies would have had to invest--starting in the middle of the last decade--in the projects necessary to deliver that oil now. Were that many deepwater and conventional onshore projects deferred or canceled because companies anticipated today's level of LTO production more than 5 years ago? And would Iraq, Libya and Nigeria be more reliable suppliers today if US companies hadn't been drilling thousands of wells in shale formations for the last several years? Both propositions seem doubtful.

As for adjustments in demand, US petroleum consumption is  already over 8% less than in 2007. And as we learned in the run-up to 2008, much of the oil demand in the developing world, where it has grown fastest, is less sensitive to changes in oil prices than demand in developed countries, due to high levels of consumer petroleum subsidies in the former. Petroleum product prices in the latter must increase significantly in order to get consumers there to cut their usage by enough to balance tight global supplies. That dynamic played an important role in oil prices coming very close to $150 per barrel six years ago, when average retail unleaded regular in the US peaked at $4.11 per gallon, equivalent to nearly $4.50 per gallon today.

So to summarize, if the US tight oil boom hadn't happened, it's unlikely that other non-OPEC production would have increased by a similar amount in the meantime, or that OPEC would have the capability or inclination to make up the resulting shortfall versus current demand out of its spare capacity. Demand would have had to adjust lower, and that only happens when oil and product prices rise significantly. With oil already at $100 per barrel, it's not hard to imagine such a scenario adding at least $40 to oil prices--just over half the 2007-8 spike. Combined with higher net oil imports, that would have expanded this year's US trade deficit by around $230 billion. US gasoline prices today would average near $4.60 per gallon, instead of $3.54, taking an extra $140 billion a year out of consumers' pockets.

We can never be certain about what would have happened without the current surge in US tight oil, but for a reminder of how a similar situation was characterized just a few years ago, please Google "2008 oil crisis".  If we found ourselves in similar circumstances today, then the heated Congressional hearings and angry consumers to which Mr. Yergin alluded in his remarks would almost certainly have been major topics at EIA's 2014 conference, instead of the realistic prospect of legalized US oil exports.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Condensate Pries Open the Oil Export Lid

•  A US ruling to allow limited exports of condensate, a light hydrocarbon mix similar to light crude oil, has implications for both producers and refiners, though not consumers.

• Whether or not it leads to wider US exports of condensate and crude, it signals just how much the US energy situation has changed since the oil export ban was first imposed.

Last month we learned that the US Commerce Department gave two US companies permission to export condensate that would otherwise be trapped here under a 1970s-vintage ban on US oil exports. This validates the view, as described in a white paper from the office of Senator Lisa Murkowski (R-AK) earlier this year, that the administration has the statutory authority necessary to allow such exports. An entire session at this week's annual EIA Energy Conference was devoted to the details of this ruling, and whether it paves the way for broader exports of a growing US surplus of condensate and light sweet crude oil.

Over the past several decades US refineries invested an estimated $100 billion to enable them to process the increasingly heavy and sour crude oil types available for import. As a result, most US refineries, particularly on the Gulf and west coasts, are no longer equipped to run large volumes of the extremely light condensates and oils now coming from onshore shale deposits. Allowing producers to achieve world-market prices for their output should boost the economy and raise tax receipts, yet is unlikely to harm consumers.

Condensates are a class of hydrocarbons distinct from crude oil, though they share enough oil-like characteristics frequently to be lumped in with the latter, as in US export regulations. The technical definition of condensates encompasses both the “natural gasoline” extracted during the processing of natural gas produced from oil fields (“associated gas”,) as well as the heaviest liquids separated from “non-associated” gas, i.e. from gas fields, rather than oil fields.

The condensate being exported in this case comes mainly from liquids-rich shale deposits like the Eagle Ford in Texas, which produces varying proportions of dry gas, “wet” gas containing NGLs and condensate, and crude oil, depending on well location. Condensate apparently accounts for around 20-40% of Eagle Ford “tight oil” output.

Condensate mainly consists of natural gas liquids like ethane, propane and butane, along with substantial quantities of naphtha, a low-octane mix of hydrocarbons that boils in the gasoline range, plus much smaller proportions of diesel and heavier “gas oils” than would be typical of crude oil. The naphtha in condensate can sometimes be blended into gasoline, depending on its specific qualities, or processed in a refinery to yield higher-quality gasoline components.

Subsequent to the phase-out of tetraethyl lead, most gasoline from US refineries has been a blend of higher-octane naphtha produced by catalytic cracking units and the “reformate” from catalytic reforming units, with provision for further blending during distribution with up to 10% ethanol. Last month US refineries set an all-time record for gasoline production, at over 10 million barrels per day. They are unlikely to miss the naphtha exported in condensate.

Historically, the global market for condensate has had important distinctions from the broader crude oil market, based on the inherent characteristics of these liquids and the end-users seeking them. Refiners running mainly heavy oils sometimes buy condensate for blending, to lighten their average inputs and fill gaps in their processing capacities.

With the Gulf Coast now drowning in light “tight oil” from shale, this is becoming too much of a good thing, as refiners increasingly have more light material in their feedstock than their facilities can easily handle. One presenter at the EIA conference described the situation as building toward a "day of reckoning", when the discounts required to induce US refiners to process excess light crude instead of imported heavier crude would reach the level at which producers must throttle back oil production. Another expert with whom I spoke was adamant that that day of reckoning has already arrived. One result is investment in new facilities to provide minimal processing–really just distillation–for condensate.

By contrast, petrochemical producers, particularly in Asia, are expected to import growing volumes of condensate for use in the production of olefins like ethylene and propylene, and aromatics like toluene and benzene, from which to make plastics, solvents and other petrochemicals. In that market, US condensate will compete with condensate from other gas producing nations, and with exports of refinery naphtha from Europe and elsewhere. This looks like a good opportunity for US producers.

Some advocates of lifting the ban on crude oil exports see the Commerce Department’s ruling as a precedent for allowing exports of all types of oil, or at least a good first step. However, other reports have focused on this ruling as an end-run around the export rules by redefining minimally processed condensates as a petroleum product, and thus exempt from the ban. In that view, the resulting precedent from condensates for exports of true crude oil may be weaker than that from ongoing, permitted oil exports to Canada.

Either way, allowing condensate exports is a smart move that, if continued, should ease crude congestion on the Gulf Coast and reduce the discounts that could make domestic oil less economical to produce, to the benefit of foreign suppliers. It might even push the problem beyond the current election year and enable Congress to consider normalizing all oil exports without the inhibiting effect of populist pressures at the polls. In the meantime, you can bet these condensate exports will be closely scrutinized for any noticeable effects, good or bad.

A different version of this posting was previously published on Energy Trends Insider.