2015 Tight Oil's Big Test

There (May) Be Blood

I've been wrong about tight oil production in the US. Or, more accurately, the folks that I think make the most sense on the topic (hence, are much smarter then I) have been wrong about tight oil production in the US. Namely, that the high decline rates of these tight oil wells combined with the 'creaming effect' (that the cream rises to the top so the 'best' areas get drilled up first) would result in a steep decline in production once the production peaked. 

The specific numbers thrown around, guessing the peak level, have been surpassed. But the overall trend described still makes sense to me. What we are seeing now with the collapse in oil prices is certainly going to put this basic notion to the test.

Again, the basic logic: when wells decline quickly (relative to 'traditional' wells) growth in production MUST come from GROWTH in the number of wells being brought on line. That is key, growth comes from an ever increasing INCREASE in wells. Not an increase in over wells in aggregate, since there is a need to replace the rapid run off.

The story described above held that once the best areas of these finite oil plays were drilled up, the production rates of individual wells would fall, requiring either an increase to the increasing increase in wells (think about it) brought on line, or a leveling of production into a steep decline in production (relative to the long slow tailing off of production in traditional oil plays).

So in this story, the price of oil remaining high was assumed. The production decline was motivated by the inability to continually increase growth in new wells (ie. the market for drilling rigs would be at capacity) and/or the decline in production of new wells relative to older wells (the creaming effect).

Now, consider that this story is strictly about physical properties (although the rig capacity might be construed more as a financial property). This doesn't take into account the financial constraints that producing companies are under. For companies that are highly levered, and assuming the financial institutions had based their lending on future cashflows that took status quo production behavior (ie. not considering the creaming effect or the increasing increases effect (I need a name for that)) then if either of these two factors moved in any direction besides positive-positive, we'd likely see forced liquidation into a market that would then be pricing in the new (not positive-positive) understanding of future cashflows.

For anyone to really be an awesome prognosticator they'd have to have seen the 50% drop in oil prices. I don't think anyone has really nailed this. However, this drop in prices exogenously imposes this reduced revenue condition on companies (and their lenders) that would have resulted from a deterioration of the positive-positive scenario.

Forward Guidance: The Saudi's as Oil's Central Bank?

What should we watch for? The biggest wildcard is how long the depressed price of oil should last. Any marketish monetarist (like myself) will tell you that a central bank's best tool in enacting monetary policy is simply stating what you will do in the future. The market reacts to what it thinks is being said, and how credible that is. So the ECB (and the FED to a lesser extend) has constantly undershot the stated 2% inflation target (despite having a dual mandate that should require overshoot in the FED case). So the market basically prices that in. This is why FED statements are so heavily analyzed (we're beyond what they say, but how they say, what mood were the trying to express, etc. etc.). The market is saying: Ok we see what you're doing now, but what are you likely to do in the future. How will that impact the market (This is why a price level of NGDP level target makes the most sense to me, but that's another story for another day).

The interesting choice by the Saudi's to simply say: we're pumping this oil out period. Is that the market gets to weigh: can the physically do it? and, will they actually do it? Well physically, yes, they can produce oil profitably at whatever price the market wants (as far as a best guess goes). They have the cheapest large deposits of oil anywhere. The only corollary to that is in the "budget break even oil price" stat you see trotted out. Ignore that, it doesn't apply here. Will they actually do it? They need the market to think so. They have an example where they didn't do it (in the 70s) where they got screwed over by OPEC (the Saudi's were the only producer to cut).

My guess is they won't do it long term. But from their perspective it makes the most sense to convince the market that they are doing this on a going forward basis. If the market was to price in a Saudi production reduction, or if the Saudi's were to announce a price range they'd like to see oil at, the market would either price that into current prices or, perhaps more importantly for American tight oil, would discount future cashflow accordingly.

And that is the kicker. Now that the market isn't so wildly optimistic about shale, how will this impact drilling. If there is a drop off in drilling, according to the story told above (and the best guesses that I think are the best, best guesses (think about it)) any slowdown in the increasing increase of new wells, will exert strains on future cashflows (the upfront capex savings offsets some portion of the loss in revenue, but again, it depends on the leverage piece).

Are Cracks Starting to Show?

This article from the New York Times (via the Economic Times) identifies a couple cracks starting to show:

The national rig count had remained surprisingly resilient over recent months even as oil prices dropped by more than 50 percent since June, and it still tops the count of a year ago as domestic production continues to surge. 

But an announcement on Wednesday by Helmerich & Payne, the giant contract rig company, that it planned to idle up to 50 rigs over the next month sent shudders through the industry. And that came on top of 11 rigs that it has already mothballed, meaning that in just a few weeks, its shale drilling activity will be reduced by about 20 percent. 

Again, oil producers rely on increasing increases to maintain tight oil projection trajectory. What will happen if the increasing increase of wells drilled/completed stagnates or declines? Well certainly a decrease in production. Since the tight oil of the US (and the Oil Sands of Canada) are likely the greatest contributor to the global supply glut, we'll likely see the markets equilibrate to a higher price level.

Under this umbrella of assumptions. And all else equal, we would expect these tight oil producers to shut in wells until price rebounds. But all else isn't equal here. If a company is highly leveraged or if they've locked themselves into production quotas (for pipeline/rail space contracts) they may be forced to sell into a depressed market.

Access to finance is typically constrained by cashflow, expected cashflow, and equity. 

Here's Nick Cunningham on Oilprice.com, in this article he outlines all of the bearish downgrades being issued on oil companies. This stripping away of equity, in a cashflow constrained environment is a company killer if they have debt to roll over.

This article from Market Watch looks at the highyield junk bond market. You can see that Energy has been the largest player since around 2005 with a whole wack of high yield debt. The article outlines the precarious nature of high-yield markets;

There’s “no question” that for energy companies with a riskier debt profile the high-yield debt market “is essentially shut down at this stage,” and there are signs that further pain could hit the sector, Heckman said.

For energy companies with weaker credit, debt spreads are around 800 basis points over Treasurys, he said. 

“We are getting to the point that it is becoming very concerning, “ he said. “In the last few days we’ve seen a further selloff in energy names.” 

For the high-yield debt specifically, there’s a threat to liquidity, and the high-yield market is “very, very sensitive to liquidity.” Liquidity for energy issuers in the high-yield market is gone, and it’s very difficult to be a seller, Heckman said. If liquidity dries up further, the high-yield market would extend the selloff, he said. 

Junk-bond expert Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors, argued that energy companies aren’t so much shut out of the high-yield market as they may be unwilling to tap it under current conditions. 

He notes that around 30% of the bonds in a key junk-bond index are trading at “distressed” levels, defined as more than 1,000 basis points above U.S. Treasurys, with some sporting yields of around 20%.

The exposure level in the high yield market from the same article is here:

Conclusion:

At the end of the day, it's going to be an interesting time for light tight oil. It takes money to make money is about as true as a saying gets. With high capex needed in this space to get wells producing, lots of money is needed to make lots of money.

While things aren't uniform (texas has better existing infrastructure for example). The physical properties and resulting production/decline profiles of the wells are similar across LTO and materially different from conventional oil reserves. How these characteristics aggregate to the entire play remain to be seen. Logically, or mathamatically, it looks fairly obvious. The unknown is when the tipping point will occur.

While I had been really curious to see if and when the physical charactersitics of this type of oil production would find the tipping point, this recent price collapse might just accelerate the process exogneously.

Either way, it's going to be interesting to watch and find out what happens.

A Follow Up On Supply Side Destruction

I posted here about how I believe markets will behave. My particular emphasis was on the precarious nature of the status quo. Namely, that it's unstable; because current output levels can not be maintained in this current price environment.

It seems to me that the Saudi's need to convince the market that their strategy is the new status quo. Period. We will produce oil if it's economical, our oil is economical down to $x, so good luck with your oil! Similar to forward guidance in monetary policy, the swing producer can only move markets with words if their actions (or more specifically, their communicated future actions) are deemed credible.

Arguments against the credibility of this new non-price supportive strategy seem to hinge on the 'break-even' fiscal story (which gets mentioned all the time and I largely ignore when it comes to KSA). However, in terms of sheer economics, market share, market power, geo-political and regional balances of power, alternative fuel viability, the KSA seems likely to pursue their market grab. At the very least we need to consider it credible until proven otherwise.

Implications of Lower Prices

Although we hear it discussed more and more, I still believe the heterogenous nature of oil market is underreported. First, defining oil is inherently difficult, what we call 'oil' is crude oil, the EIA summarizes the variety here where oil is classified according two qualitative variables: density (API) and sulfur content (sour/sweet). Sweet oil is good (less refining required to get useable product). Mid density is good (the heavier the oil the more 'energy' is contained in the carbon chain, it's a balance between energy content and difficulty in cracking it in the refining process).

The second differentiator is the price differential. In Canada we know all about this. These differentials are driven by the local quality of the oil, but also the ability of that oil to get to markets that want them. The EIA article above outlines that globally. In this article from Bloomberg describes inter-regional price differentials. Which is where things start to get a bit more interesting. First let me set this up a bit.

This article by Euan Mearns on Seeking Alpha points sketches out where the 'new oil' is coming from. Namely, Canada and the United States:

Figure 2 Global production of conventional crude oil and condensate has not changed since May 2005 despite a prolonged spell of record high oil price. All of the growth has come from expensive LTO and tar sands. The toxic mix of high debt and losses in the LTO industry that are in the making may short circuit the global banking system again.

Here, LTO refers to the Light Tight Oil that is typically referred to as shale oil (not to be confused with oil shale). This is the Bakken, The Eagle Ford, the multi-stage fracks, all that good stuff.

So that's the set up. Why these sources of oil have been prolific is something we'll skip over (how much is ingenuity, how much is the recent steady state of $100+ oil?). But where this gets interesting is when you consider the variation in production costs.

Prices and Production Costs

Again, this is an incredibly difficult figure to make sense of. These costs vary with the factors mentioned above. The regulatory and transportation frameworks are also key. But aggregated I think we can fairly make some interesting and relevant inferences.

Decline Rates: By definition, if decline rates increase, the number of new wells that need to be brought online to maintain production levels also increases. This isn't controversial. How quickly wells decline is another difficult thing to be accurate on, however, it isn't controversial to suggest that LTO wells have significantly higher decline rates.

It will be interesting to watch how oil sands and LTO production behave if oil prices continue to hover in this lower range for a significant portion of time. You'll see capex budgets slashed in Alberta, without any real production decline (rather a reduction in growth), but how will LTO production behave?

It will depend on the fiscal health of these companies and the duration of $70ish oil, but since LTO requires drilling activity to maintain production levels, and increased drilling activity to produce the production growth we've seen, any hiccup in capex will have a much larger impact then we'd see in any other oil play.

Costs vs. Prices: Let me butcher Econ 101 here: shut down isn't justified simply when operations are cashflow negative. Rather, you have to make a few considerations. The future behaviour of both costs and price. Costs have both a sunken and operating portion, where the sunken portion are more long run (infrastructure, regulatory, exploratory, etc.) and operating costs refer more to the actual production and transportation of oil to markets.

Again, with high decline rates comes more drilling, comes more regulatory issues, comes more infrastructure (increased production points). And these decisions happen in real time. Oil sands projects have massive upfront costs. They also have high operating costs (relatively speaking). The difference is in how the economics impact production volume.

LTO companies can immediately cut the sunken costs by reducing drilling activity. How long it takes to work through the backlog of well sites ready to go (with significant sunken costs) remains to be seen. But I have to believe that if low prices stretch through this drilling season into next year's drilling season, we're bound to find out.

Oilsands production might stagnate, but remember that massive upfront investment also results in fewer individual decisions.

Duration: Steep decline rates also mean that when a new LTO well is brought into production is more important to the lifecycle economics of the project. Rune Likvern has done alot of interesting work on decline rates and the subsequent economics. While, his overall production predictions have not come to fruition, the underlying logic still remains solid (in my eyes). In this follow up posted on Peak Oil Barrel, Rune makes some interesting points.

Most relevant here is the notion that the leverage that has enabled this massive drillout of the LTO plays in the United States are likely also conditional on the high price of oil. Now we have pressure from both the strict cost and benefit economics of the oil well, but also, the exogenously determined credit conditions. Being in the finance game I know that when some guy in some office some where gets freaked out about a negative trend, the tap can turn on and off pretty quick. Might the tap turn off quick here? It likely depends on the expected duration of these low oil prices.

Remember, LTO producers are firms, they have no access to printing presses. They dividend out their earnings. They are accountable to quarterly reports. They are not national oil producers. This makes for the most efficient model when it comes to exploiting economic plays. But when they become uneconomic? Well... we might just find out.

Conclusion

I believe we will see supply reduction and prices rebound. Over what time frame? No idea. But if the KSA won't take on the entire burden. The first domino to fall will be the US Shale producers. They've had the greatest impact on global oil production. But the nature of the oil production and the debt factor will necessitate blinking first.

Supply Side Destruction

As discussed here, OPEC's latest (last?) decision to not reduce production in order to arrest the recent fall in price, has lead to alot of speculation about what we're likely to see come out of this.

Now, I should start by confessing to being totally wrong on this type of occurance happening. While I'm not quite convinced that I need to scrap my overwall Peak Oil Dynamic world view (explained here), this certainly has caught me by surprise.

One of the key factors of the Peak Oil Dynamic world view was that the conventional cheap oil is shrinking both in aggregate and proportionally to expensive and/or unconventional sources. That logic led me to believe that the offshore oil market would be strong going forward and we'd see oscillating prices around that $100 mark for awhile but likely a steady secular rise in prices until someone figured out renewables.

Obviously, the oscillation didn't happen. Why? This is a supply side phenomenon.

From the IEA

Demand growth may not be as rapid, but it is still growing. And despite what all the hippies are saying, there is no viable replacement on the horizon.

So the collapse in price must be supply side.

Where that supply is coming from is interesting. I'd think about this 'new oil' in two seperate categories: expensive oil and cheap oil. Basically, expensive oil is the oil that was made available due to the $100+ price of oil (and SOME technological improvements, but don't kid yourself it was mostly the price), and the cheap oil is the production that is from conventional legacy sources that for political reasons have not operated at or near full capacity in some time. Think Libya, Iraq, Iran, etc.

Now, price certainly has an impact on cheap, politically sensitive oil production levels. But those effects are typical complex and to entangled in secondary and tertiary political/social/economic effects and so I will leave them be.

The more interesting of these two sub-sections of 'new oil', the expensive stuff, are where things will get interesting and where marginal barrells will be taken off the market if an exogenous supply reduction is not imposed.

In terms of simple Econ 101, suppliers will either make due at the lower price level, or we would expect the marginal producers (those requiring $70-$100+ oil to maintain operations) will drop off.

In oil's case, things are complicated by the wide divergence in a number of factors, a few of which are: 1). the sunk cost of different production methods, 2). the decline rates of different production methods, 3). what market the oil is sold into, 4). the firm's fiscal health, 5). the firm's hedging strategy.

Again, mix, oil, politics, and big business, and all you can do is make guesses. Popular opinion seems to be fairly mixed, with a number of folks suggesting that the wheels will fall off the shale boom and other suggesting they've all hedged out any risk.

This piece in the Telegraph has a few interesting items:

US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015. 

Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production. “We can produce down to $50 a barrel,” said Harold Hamm, from Continental Resources. The International Energy Agency said most of North Dakota’s vast Bakken field “remains profitable at or below $42 per barrel. The break-even price in McKenzie County, the most productive county in the state, is only $28 per barrel.”

So those are the headline numbers, but this of course begs the questions: how do you determine the break even cost? Is that break even on existing production? Is that break-even to maintain current production levels? Is that break even to maintain current growth rates in production levels?

And all credit to this article for taking the time to wade into this discussion but I have to disagree with the following quote from Ed Morse at Citigroup:

Mr Morse says the “full cycle” cost for shale production is $70 to $80, but this includes the original land grab and infrastructure. “The remaining capex required to bring on an additional well is far lower, and could be as low as the high-$30s range,” he said. 

Critics of US shale may have misunderstood its economics. There is a fast decline in output from new wells but this is offset by a “long-tail phase” for a growing number of legacy wells. The Bakken field has already reached 1.1m bpd, and this is expected to double again over the next five years.

I don't believe we know too much about how these legacy wells will behave. Also, we need to remember that these growth rates, in the context of fast production decline, are necessarily the result of increased drilling.

Now, to maintain drilling, you need to maintain acerage and the expansion of infrastructure IF prices remain depressed beyond what drill sites have been allocated. Beyond that then the full cycle cost is back in play.

Another items to consider is that the best portions of an oil play typically get drilled up first. Of course, a play isn't known in it's entirety from the get go, but it's not unrealistic to expect that the 'sweet spots' are more likely have played a starring role in the ramp up in production.

Also, remember that when companies are talking about break even costs in the media they also have stock prices to maintain. Any highly leveraged play gets increasing leveraged when stock prices dip. That combined with a reduction in cash flow (even if most of it's hedged) is a dangerous game to play.

So you want to watch for a couple of items: a reduction in drilling activity and a reduction in the per well production rates.

This article in Reuters showed a reduction in drilling permits issued dropped over 40% in November, which is a bit of an eye opener. But to be honest with you, I don't have a clue about the typical fluctuations in permits so I took it with a grain of salt.

The author also cites Allen Gilmer at Drilling Info who suggested that this was mostly due to companies wishing to avoid tapping new sweet spots in this depressed price environment. So the exact opposite of what I said above.

Who the hell knows. But it should be interesting to watch.

Thinking About OPEC's Meeting

OPEC's meeting concluded with a resounding shrug of the shoulders. At the end of the day it was the Saudi's decision. I had suspicions that they'd communicate price support at some level; but in hindsight why would they? At the end of the day, I can't think of any particular self interested reason for them to do so.

The interesting thing about this meeting, and given the complexity of modern finance, I was curious to see how price would react to OPEC's (the Saudi's?) communication; and specifically so. Forward guidance, is pretty well understood to be the dominant tool of central banks.

When credibly made the bulk of a centrals banks adjustment is done by markets inline with their expectations. So, if a central bank continuously targets 2% inflation and continuously undershoots it. The market prices in the undershoot. If a central bank announces the injection of funds on a short term basis, the markets price this in and money neutrally basically holds.

Would the Saudi's be able to achieve price support, simply by communicating a target? Would the world believe them?

We certainly saw markets react to OPEC's shoulder shrug, WTI quickly shot from $74 USD down to about $66, similarly Brent plummeted from about $73 to $70.  And I suppose we'll never really know if it's reaction would have been symmetrical (asymmetrically interesting to me).

Why would the Saudi's enable OPEC?

Had the production cuts been proportionately felt across OPEC members, it might make sense. If Russia had indicated that they would also be willing to curtail production in pre-meeting talks, then it might have made sense. But if the Saudi's have to bear the entire burden, why would they?

Vox's Brad Plummer outlines this point here. The key is probably in this Reuters article linked to in this article describing who would be bearing the brunt of that production decline:

With world markets awash in oil, Saudi Arabia embarked on a strategy of defending prices, which at the time were largely set by exporters rather than the nascent futures market. The kingdom slashed its own output from more than 10 million barrels per day in 1980 to less than 2.5 million bpd in 1985-86. 

Other producers failed to follow suit, however, both within the Organization of the Petroleum Exporting Countries and among new petroleum powers such as Britain and Norway. Prices fell into a years-long slump, leading to 16 years of Saudi budget deficits that left the country deeply in debt.

Plummer also links to this often cited look at government budgetary break even price of oil for OPEC countries. I still see this as apples to oranges.

No only do I believe that the Saudi's along with the rest of the gulf states likely set budgets according to revenue more then they raise revenue according to their budget. But the ruling regime does not hold the tenuous position, politically or economically then the other major exporters (of course including Russia which is not in OPEC).

With both Russian and Mexican officials meeting with Venezuela and Saudi Arabia pre-OPEC this probably presented a crucial test of price support viability. Between Russia and the Saudi's a joint strategy, would have significant market power due to not just their high level of production (Russia at 10.5 mm/bopd and KSA at 11.6 mm/bopd) but also their relatively low consumption levels (Russia at 3.3 mm/bopd and KSA at 2.9 mm/bopd) in contrast with the USA who, despite a huge upswing in production remains a massive importer on global markets.  It's these net available exports that are the interesting barrels to me on the market place.

Russia's Part in all of This.

But it's hard to imagine Russia artificially reducing production (as opposed to some new projects becoming uneconomic at low price levels) with the sanction package biting down on the economy. This article estimates that effect of oil and sanctions at $90-100B and $40B respectively.

This could make for an interesting winter. As far as I can tell, besides an escalation of the war, Putin's only real leverage would be physically delivery (mutually destructive) and a huge stockpile of nuclear material and know how. That or Putin backs down physically and rhetorically.

Market Share... At Who's Expense?

With no price support OPEC (KSA) made a clear statement that it would let markets dictate things going forward. It was always a fractious bunch and with the only partner, with both the production levels and political leeway to do anything but maximize oil revenue (the Gulf Emeritus would have the ability, but not the gross quantities), unwilling to cut production. OPEC basically isn't.

As for the Saudi's motivation, it may be a fight for market share by way of undercutting the more expensive marginal barrels on the market. From OPEC's official release:

"world oil demand is forecast to increase during the year 2015, this will, yet again, be offset by the projected increase of 1.36 mb/d in non-OPEC supply.  The increase in oil and product stock levels in OECD countries, where days of forward cover are comfortably above the five-year average, coupled with the on-going rise in non-OECD inventories, are indications of an extremely well-supplied market."

If the Saudi's are going for market share the obvious play to target is the rapid build up in tight oil production in the US. Not only is it fairly expensive (estimates oscillate in aggregation, to say nothing of the wide variation in per well/per location costs) but it's also typified by relatively steep decline rates.

How This Might Impact The US

You have to remember that once the investment in discovery, drilling, and establishing the production infrastructure, not in maintaining existing infrastructure and production. With increasing decline rates on each well any interruption in those initial capital outlays result in a much steeper drop in oil production.

Tyler Cowen links to this article by William Watts on Marketwatch that makes an interesting point:

At the same time, analysts have also noted that for many shale producers, a large chunk of production costs - acquiring acreage, contracting wells, etc. - have already been spent. As a result, the more important figure might be "half-cycle" production costs which analysts at Citi last week pegged at between $37 to $45 a barrel"

Eric Lee who is one of the Citi analysts on the report in Platts:

a “full capex cycle” shale project might have a per barrel cost of $70/b or more, but one that is a “half cycle” project, where a lot of the costs are already sunk, could be down into the high 30’s. Overall his conclusion is that a $70 basis WTI price could slow the roughly 1-million b/d growth rate in shale by 25%. “It looks like you would need about a reduction in rigs of 40% to 50% to really flatten production growth, and to do that you’d need about $50 oil,” he said. Overall then, the impact of the price fall on US production growth will be “soft.” (Morse noted that Citi has not changed its robust projections for higher US output.) 

I couldn't find the Citi report. It would be interesting to see how they got to these numbers. But we'll have to settle with for the author's synopsis. I'd be pretty curious to see the timeframe the author is speaking of. Certainly that full capex cycle number increases in importance as time rolls.

Bottom Line

I effectively read this as OPEC being no more. If there was a deal to be made, it would have been made between Russia and the KSA. There's an alliance to watch for. Maybe not until sanctions end. Maybe if sanctions intensify. Maybe never.

The things I'll be watching beyond the price of oil: Russia/Euro sanction negotiations, Russia in the Middle East (and Iran), Chinese oil consumption.

Cold Shouldering Putin and Opec's Big Meeting

 

A couple of interesting developments over the weekend at the G20's in Brisbane with Putin bailing out early got me thinking about end goals and strategic thinking. Naturally, with thinking about Russia comes thinking about oil. With thinking about Oil comes thinking about the Saudi's and the up coming OPEC meeting.

G-20 

The interesting thing about all of this is trying to parse out the end goals of key players. So we'll start with the G-20 and work our way back. While everyone has basically condemned Russia's behaviour in Crimea and eastern Ukraine, Cameron, Abbot and my own Canada's Stephen Harper lined up to get their very public digs in. My question is why? Ok, maybe 'why' is the wrong question. These statements are meant to play to their domestic audience, to make everyone feel like they are doing their part, standing up to the bully, etc. etc.. I get that. But perhaps questioning what these types of statements might actually accomplish is appropriate.

Is Putin going to say: "oh I didn't realize Stephen Harper doesn't want me in the Ukraine... shit, get me a phone and we'll pull funding/troops/tanks/whatever out... my bad". Or do you think he's more likely to dig in? Putin remains popular, ibut that popularity is dropping according to numbers cited from Leada in this article which also shows that the average rating out of 10 given to Putin by Russians was 7.33 (this in a time of capital flight, economic sanctions, tanking crude prices, and invasion of a non-threatening neighbour). Might backing him in a corner, help him drum up domestic support the old fashioned nationalistic (ie. they are bullying Russia... and so we bomb) way? I don't know. And Putin probably doesn't either. But I wouldn't bet that he'd opt for a passive reaction to blustery headline grabbing. When his constituents are convinced his current path is a positive one.

Also remember, that although many of the big multi-natinoal companies have dollar denominated debt that sanctions will prevent being rolled over; they and Russia in totality itself aren't too bad on this front. Also remember that since the Ruble has tanked, and oil is priced in USD this acts as a slight mitigant to price declines domestically. 

This article from the telegraph gives us a great summary of events in this post (found after I started).

I think they overstate the case that the global economy needs Russia more then Russia needs the global economy. But there is truth in it. Especially as fall turns to winter and the importance of energy supplies grow. I think the EU is feeling a bit more confident in their position as Brent trades near 5 year lows. Is that sustainable?

A potentially interesting bit in this article is the discussion on how prepared Russia is to hunker down. Alluding to the national sacrifice historical narrative, it does seem like Putin has a better chance of talking his Russian electorate into a winter of sanctions then Merkel would have talking her's into a self imposed winter of intermittent supply or inflated prices on their natural gas. Should Putin decide to retaliate in this manner (notice that Merkel didn't work as hard as the leaders mentioned above to grab headlines while still maintaining a critical position).

Despite letting the Ruble float (and subsequently tank), Russia has significant reserves (over $400B USD) and was wise to not stand it's ground so early. It won't be a couple weeks or likely even a couple of months until economic pressure is so significant that Putin is forced into backing down. It may turn into a battle of popular political will between a sanctioning euro population and a sanctioned Russian population. Here's hoping it doesn't come to that.

OPEC

The 27th could be a watershed moment. Hopefully we get some clarity on the strategic vision of the organization, or more specifically, the Kingdom of Saudi Arabia going forward. While this article does a great job of outlining the challenges faced by each of the major oil exporting countries. I think it doesn't fairly capture KSA's position. This graph that it cites from the Economist is a nice visual summary:



Like Russia, KSA has significant reserves ($745B in Sept.) so a downturn can be weathered. But articles like these assume all budgets are made independent of revenue. That doesn't seem likely in all cases (particularly KSA), where it seems more likely that they say: "hey look at all this money we're going to have, lets spend a bunch of it".

One of Manifa's 27 Man Made Islands

At any rate, the Saudi's  legacy oil production is some of the cheapest in the world. The billion dollar question of course is what the composition of Saudi production is now, and will be going forward. By the end of this year Manifa is supposed to be producing 900,000 bopd. That's not nothing. The scale of the project, and subsequent cost might (must) impact cashflow considerations. If their production remains the cheapest in the world, they might just go for market share.

Conspiracy theories abound about the motivation behind the OPEC's willingness to crater the price of oil. It's certainly helping economies around the world, particularly a country like China where through their structural reform the addition of nearly (5.7 million bopd this October x $100 vs. $80) $100 million dollars daily has been great. From another angle, the western bloc of countries imposing sanctions on Russia couldn't have had the oil markets help them much more.

Regardless of whether they will enforce or lower the production quota, hopefully we get some direction. I suspect that markets will be on the move shortly after the Nov. 27th meeting. Similar to FED announcements I suspect forward guidance on price support would have a huge impact immediately. Perhaps there will be an asymmetrical move with the opposite announcement, but I also suspect the market is pricing in continued low prices.

We'll just have to wait and see.

The return of the Mackenzie Pipeline.

The truly northern northern pipeline route gained some publicity this week as a report from Canatec Associates (an arctic petroleum consultant) that was commissioned by the Albertan government last year and has just been released  (I believe found here).

I had wondered about this possibility back in December (here) after Bill C-15, which grants more control over these types of decisions to the NWT, passed. My belief was that with a strong resource development supporter at the helm, NWT would be much more likely to get pipelines through then BC; all else being equal. Of course, all else isn't equal, and that hasn't changed.

Here is the Financial Post story: Arctic Route for Alberta oil could trump stalled B.C. pipeline projects.

The board is appointed by the federal minister for Northern Affairs. The result is a far more streamlined approvals system that could well usher a new pipeline through in record time.
Following the release of the report, Northwest Territories Premier Bob McLeod said he was “heartened,” and that he’ll be meeting with his counterparts in Alberta to figure out the next steps.  

“We’ve always said that there are significant resources that have been stranded for 40 years and we’re not going to leave them stranded for another 40,” Mr. McLeod told the Financial Post.

I really believe the viability of the NWT assets, particularly the canol shale potential in the Central Mackenzie Valley will be the key to getting Alberta oil to Tuktoyaktuk. No one wants to simply be a transit point. Then again, without the Canol Shale development, the NWT will be in need of revenue.

And there hasn't really been alot of news on the Canol Shale this year. MGM which had explored the north in general and the Canol more specifically, was subsumed by parent company Paramount Resources after alot of money was sunk into the region with no production to show.

Outlined here, MGM president Henry Sykes talks about the region:

“Our experience has not been a positive one. Obviously we’ve spent hundreds of millions of dollars, drilled 11 wells and have nothing really to show for it today in terms of any cash flow-generating ability,” said Sykes, who predicted similar outcomes for other companies. 

“Until there’s infrastructure in the North, until people can see a clear path to investment and return on investment, I think you’re going to find activity is going to be delayed, if not eliminated altogether,” he said.

Sykes go on to state that they were sitting on billions of barrel of oil (I'm assuming that's the play at large and not MGM's holdings). The scale of which would be pretty solid motivation. However, having helmed a failed venture Sykes might be a bit bias on the potential (if only there was access to markets MGM would be kicking ass!).

At the end of the day it's good to get another viable pipeline option. The added length and variability in operating a year round facility that far north will add significantly to cost. However, one might argue that a more favorable political climate may offset that. Hopefully, the Canol will prove viable economically.

The Oil Kings: How the U.S., Iran, and Saudi Arabia Changed the Balance of Power in the Middle East

Russian Sanctions: Until China is onboard what's the point?

Just killing some time on a layover in Seattle (enroute to the Philippines for some vacation time) and this article on Bloomberg caught my eye.

It brings up a point that needs to be reconciled in order to effectively sanction Russia. Namely, the Chinese response.

The article makes a few key points that don't appear to be fully considered in the wider discussion.

Regarding the push to authorize export crude oil from the US in order to put pressure on Putin:

The U.S., even after the shale boom, must import 40 percent of its crude oil, 10.6 million barrels a day that leaves the country vulnerable to global markets.

Regarding China's past flurry of oil deals with Russia:

China already has agreed to buy more than $350 billion of Russian crude in coming years from the government of President Vladimir Putin. The ties are likely to deepen as the U.S. and Europe levy sanctions against Russia as punishment for the invasion of Ukraine.

Quoting Nicholas Redman from IISS:

“For Russia, there was an idea that Europe was something close by and it worked and it was desirable to emulate,” Redman said. “Over the years, on multiple fronts the attractions of the European model fell. It’s almost a civilizational choice the Russians have made to turn away from Europe, to stress their Eurasian rather than their European identity.”

So the obvious points: What oil is the US going to export (ie. why would Putin concern himself with the exports of the largest (more or less) importer int he world)? How steep of a discount would Putin have to entice a significant Asian demand shift? Would China risk their current rash of deals (and future supply) to enforce western sanctions? Can Putin sell the politics of a short term price discount for export diversity in the long run?

To me these questions seem to put Putin back in the driver seat. I always considered Germany and China as the two key participants to give sanctions any chance. While it seems like Merkel and the Germans are at least vocally supportive (I'm skeptical on their willingness to actually go through with them) the Chinese are noticeably staying out of this.

Another element to consider is if the west proceeds with sanctions against Russia with the knowledge that China will not back them, how this impacts future sanction participation by China and similarly developing countries.

I assume Iran is watching this round of sanction talk closely. If China balks here, will India participate in the next round of Iranian sanctions should they renege on whatever nuclear agreement gets put fourth? You have to assume the liklihood is significantly reduced. Of course if India balks on those sanctions, what do you think the reaction from China will be?

I might be looking at that all wrong. And perhaps all of this is getting hashed out behind closed doors. But significant economic sanctions still seem like a bluff to me.

That being said, Putin putting boots on the ground and actually occupying Crimea throughout this ordeal was also a surprise. So what the hell do I know?

Ukraine: Likelihood of Effective Russian Sanctions

Photograph: Sean Gallup/Getty Images

I'll go ahead an predict that we'll see a deescalation militarily in Ukraine in an empty rhetoric filled new cycle about the 'strength' and/or 'weakness' of various countries and various presidents.

2014 Top 5 POD Stories to Watch. Number 1: Oil Transportation

In this five part post I'll take a look at the five story lines that I expect will be the most interesting for me to follow in 2014.

Previously:
Number 5: New Old Sources of Oil
Number 4: US Tight Oil
Number 3: Monetary Policy
Number 2: China

Number 1: Oil Transportation

Here's my Alberta bias. But around these parts 2014 could well shape up to be the year of the pipeline. While we probably won't get into any construction in this calender year, we might get some clarity on the Keystone XL, but also on Kinder Morgan's TransMountain expansion and Enbridge's Northern Gateway.

2014 Top 5 POD Stories to Watch. Number 2: China

In this five part post I'll take a look at the five story lines that I expect will be the most interesting for me to follow in 2014.

Previously:
Number 5: New Old Sources of Oil
Number 4: US Tight Oil
Number 3: Monetary Policy

Number 2: China

2013 saw China overtake the US as the largest importer of oil. It saw China show yoy fall in consumption for November. It saw China stave off a hard fall. Whether the performance is positive or negative China's economic performance will always be in my list of top POD stories.

2014 Top 5 POD Stories to Watch. Number 3: Monetary Policy

Been awhile... Life happens.

Back to the five part post looking at the five story lines that I expect to will be interesting to follow in 2014.

Previously:
Number 5: New Old Sources of Oil
Number 4: US Tight Oil

Number 3: Monetary Policy

With Ben Bernanke stepping down as FED Chairman, monetary policy will likely keep itself in the headlines this year. Monetary policy is best left for the backpages, and when things are going well it often is. However, the financial crisis and subsequent 'great recession' has illuminated how divergent mainstream economic views on monetary policy have become.

The Monetary Policy Debate

For the purpose of this post I'll constrain my description of the current monetary policy debates to an extremely simplified summary.

2014 Top 5 POD Stories to Watch. Number 4: US Tight Oil

In this five part post I'll take a look at the five story lines that I expect will be the most interesting for me to follow in 2014.

Previously:

Number 5: New Old Sources of Oil

Number 4: US Tight Oil

There is no questioning the production numbers of the US. And there's no question where that resurgence has come from. The shale plays in North Dakota and Texas.

2014 Top 5 POD Stories to Watch. Number 5: New Old Sources of Oil

The next 5 posts will be of the most interest to me going into 2014 in the realm of the Peak Oil Dynamic.

Number 5: New Old Sources of Oil

This post is, to a large extent, inspired by the events that transpired in Mexico and Iran during 2013. The title of the post reflects the potential of gaining 'knowable' oil. Forget about the unknown type of 'finds' in Coober Pedy, or the unquantifiable shale plays of Eastern Siberia. This production is different.

Book Review: The China Development Bank: Debt, Oil and Influence

The China Development Bank (CDB), in 2010 held $687 Billion in loans. Over twice as much as the World Bank. And I knew almost anything about it prior to reading this book by Henry Sanderson and Michael Forsythe:

China's Superbank: Debt, Oil and Influence - How China Development Bank is Rewriting the Rules of Finance

My main interest was loan-for-oil financing. This is a topic I've been following over the last few months. Info is hard to come by, but as this post outlined, China has been securing oil supply as repayment for debt. Sometimes via the NOC's, but sometimes it's the Export-Import Bank (EXIM) and other times it's the CDB. But these deals are everywhere.

IEA's 2013 World Energy Outlook Summary

The IEA has published their 2013 World Energy Outlook and in it they raise some interesting issues going forward. Unfortunately, I don't have access to the full report (paywalled here). However, the Executive Summary does sketch out the main points.

All in all, the message is pretty similar to the world view encapsulated in the definition of the Peak Oil Dynamic (as I've described it) where the supply side (and falling demand in the developed world) faces significant challenges to maintain pace with the developing world's growing appetite for oil.

The centre of gravity of energy demand is switching decisively to the emerging economies, particularly China, India and the Middle East, which drive global energy use one-third higher.

Chinese Control of Global Oil Assets

China's thirst for oil has been a point of interest on this blog. The incredibly low levels of per capita consumption, the incredibly poor but growing populace, and the sheer magnitude of the market create a situation where any convergence to global norms would have huge implications.

Hattip to Rockman over at Peakoil.com, and The Oil Drum previously, for emphasizing the potential impact of Chinese E&P and Refinery joint ventures, and loans for oil deals that would give 'China' the right of first refusal on oil from the ground and/or finished product.

Peak oil DEMAND!

Peak oil DEMAND theory is the counter point to 'peak oil theory' which generally describes a supply side phenomenon. Peak demand, in a literal sense, purports that the level of demand has or is near it's peak level and will soon decline. More nuanced versions might suggest, similar to (but the opposite) of my definition of the Peak Oil Dynamic, that the demand side will be the driving force of the oil market going forward.

A couple of news stories that caught my eye...

Russia - China Import/Export Math (WSJ):

Last week China and Russia announced a JV deal between CNPC and Rosneft to expand E&P in Eastern Siberia. But the volume of supply deals is outlined here:

The two countries have signed agreements that would increase the amount of oil flowing from Russia to China by around 700,000 barrels a day from 300,000 barrels a day currently, prompting oil watchers to ask where the additional supply will come from.

Most of the oil fields in Russia’s biggest production center, Western Siberia, which accounts for around two-thirds of its output, are more than three decades old and in decline.

And the prognosis isn’t promising. Mr. Khaziev noted that no new giant fields have been discovered in Russia since the 1980s, and unless there are such discoveries, “it will be very difficult to replace the declines in production.” The country’s crude-oil output will peak in 2018-2019, by his estimate.

Another option is to reallocate. According to the IEA, Russia exported around 4.8 million barrels a day of crude oil in 2011, with nearly four-fifths destined for Europe and around one-sixth for Asia.