Guest Article


Dragon RisingWhileWest Waivers Written by Hugh Ebbutt, Senior Consultant, CRA Marakon


Welcome to the Year of the Dragon! As its name suggests, the twelve months from Chinese New Year (on 23rd January) are likely to be volatile and unpredictable, with plenty of challenges and risks, and probably some dramatic flare-ups. Already some key energy trends are emerging. As 2012 progresses, imbalances and emerging stresses, events and new ideas will make many things turn out quite otherwise than most now expect.


Uncertain Demand and Risky Supplies


The developed world’s enormous debts – sovereign, bank and private – threaten a second recession. With confidence low and enforced austerity the prescription of choice, credit, investment and consumer spending, and so economic activity all remain stalled. Jobs are being cut. Structural disparities and national political pressures are constraining decisive action, particularly in the Eurozone. The US now looks better, but political initiatives will be all but paralysed for the rest of 2012, by polarised politics and a drawn out election. Despite rising stock markets, the situation seems likely to get worse before better . . .


So energy demand is likely to stay flat or even fall, especially as energy efficiency improves with high fuel prices. Falls in the OECD will offset growth, at slightly lower rates, in developing regions. Refining margins once again look thin – depending critically on location. Renewed or new oil supply, coming from Libya (initially faster than expected), Iraq, Brazil, Canadian oil sands, plus NGLs and increasingly oil from North American shales, and soon GoM, is likely to depress oil prices, and WTI rather more than Brent. This differential - already almost $18 - may rise more as new US and Canadian oil production grows (and can get to key markets). North American energy self-sufficiency may after all be on the cards – perhaps in 8-10 years, if helped by more efficient use.


But, rather sooner, oil may spike if Iran and the West fall out further (as the former has set its sights on going nuclear). This would impact supplies to southern Europe and potentially threaten the 15 mmb a day and key Europe and Asia-bound LNG cargoes from Qatar passing through the Straits of Hormuz. Other geopolitical events from the now partly sprung Arab world to Pakistan, Korea and perhaps Russia, China or Venezuela, and others, are likely to keep risk and volatility high. The Arab spring is turning stormy.


Power Shifting East


While much of the West is preoccupied with its own difficulties, Asian and other developing economies - and their populations - continue to grow, even if a little more slowly. Enormous flows of money continue to move from consumers to producers.With these, goes economic power. After 20 years of booming exports, China is now the world’s second largest economy and still growing at an astonishing rate – over 8% a year. Chinese and other savers, funding others’ debts, may soon find better uses for their hard earned cash – improving life at home. Chinese companies are likely to continue their ‘resource mop-up’, using their low cost capital to buy from those short of funds and credit. Other investors, such as Abu Dhabi or a newly assertive Qatar, enriched by the flood of petrodollars, may too look to buy more high profile western assets, gold or more useful scarce raw materials.


Gas Galore


With gas everywhere, prices in North America are likely to stay low. Under the enormous momentum of US gas shale drilling and production, they hit $2.3/mcf in January – more than seven times cheaper than oil on an energy basis, and probably well below cash costs for many dry gas producers. US gas storage utilization is 20% higher than normal and demand is down, with several months of warmer weather in both the US and Europe (2011 was the second warmest year on record – after 2006). Despite recent signals of cut-backs, over 700 rigs remain active with many E&Ps still committed to drilling natural gas; while 1200 rigs are now committed to oil plays. Rich gas and liquids wells can generate cash, but their associated gas adds to the surplus. This gas glut offers low cost feedstock for US industries. Perhaps we need more power from gas and real incentives for CNG vehicles and gas stations.


In contrast, gas demand in Asia and other growing economies, is still growing strongly. Tight LNG supply in the near term - impacting particularly Japan (as it moves away from nuclear) means high prices look set to stay for now in the Far East (currently near the equivalent of $90/boe).


But more gas in three or four years from the current wave of Australian LNG projects underway is likely to change this. US LNG exports and shale potential in places like China and Argentina, when realised, could have an impact on some of those big LNG projects. China’s ability to throw human and financial resources at industrial challenges has been extraordinary and should not be underestimated.


Drillers and Dealers :::


::: February 2012 Edition


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