21st February 2020
Oil Drilling Activity
Onshore US drilling activity increased by 2 with a total active count of 768 (Y/Y decrease of 258) rigs; those targeting oil up 1, with the total at 679. Across the three major unconventional oil basins, the oilrig count increased by 1, with Permian up 1, Williston and Eagle Ford flat.
US domestic crude production was unchanged last week; crude production stands at 13 million barrels per day, of which ~2.55 million barrels per day is offshore and Alaskan production.
Oil prices firmed as worries eased about demand declining because of the spread of coronavirus cases in China, while supplies tightened as the US moved to cut off Venezuelan crude from the market. Linkages between oil price and rig activity levels in the short term is complicated by operators with WTI hedge positions higher than the current market, offset by swap dealers who held short positions for 32% of the open interest WTI futures as of late January 2020, close to the all-time high of 33% in 2018. A delicate balancing act is underway, with scope for volatile movements either way.
Associated gas production from Permian oil operations is still rising, offsetting declines in most other shale gas basins, and giving almost no net gas supply growth for the last three months.
Carbon Management – IRS’s guidance for CCUS projects, action required
On Wednesday this week, nearly two years after extensions and reforms of the US 45Q tax credit for Carbon Capture, Use and Storage (CCUS) projects were passed in the Bipartisan Budget Act of 2018, the IRS finally issued guidance covering some, but not all, of the required clarifications for developers and investors to proceed with projects. So what does the partial guidance cover?
Firstly, commencement of construction for a project needed to start before 2024, but project developers needed definition of what this needed to include. Would it be simply land clearance, or did equipment need to be purchased, and if so how much? The IRS guidance uses a similar approach to tax credits for wind and solar energy projects by clarifying that beginning of construction can be when ‘physical work’ has officially begun, such as manufacture of turbines, pumps, towers, piping, and start of onsite installation work, or when 5% or more of the total cost of the project has been spent. Both require continuous work, so a project cannot start construction and then delay further progress. However, given CCUS projects are more capital cost intensive than most renewable energy projects, the IRS made a provision to extend the period for construction from four to six years from start of construction.
Secondly, many projects potentially did not have sufficient tax liability to monetize the value of the 45Q tax credits, so project developers needed definition of whether they could form tax equity partnerships with parties that can, which is commonplace in wind projects. Would this be allowed, and if so what would and would not constitute a partnership for tax purposes? The IRS guidance again uses a similar approach to renewable energy tax credits by ensuring the parties act in good faith with an intended business purpose, rather than solely formed to take advantage of the tax benefits. To ensure this, investors will have to maintain 20% or more of certain capital investments to gain access to the tax credit or a cash equivalent. Still this is a thorny issue for some CCUS projects where the only economic return is from tax credits.
So what is still left to be clarified? Issues remaining include what constitutes ‘secure geological storage,’ what the clauses are for tax credit ‘recapture’ should the CO2 be released, and how CO2 utilization options should be assessed for their lifecycle CO2e emissions. The IRS said that it “anticipates issuing further guidance in the near future” on these issues. Until then, projects need to continue to wait to get certainty.
Will the 45Q tax credit then be effective? Beyond the remit of the IRS, the National Petroleum Council CCUS Study recommends that amendments to 45Q are needed by Congress to further extend the deadline for beginning of construction to 2030, lengthen the duration the credit is applicable for to at least 20 years, lower project size thresholds to accommodate smaller projects, and increase the value of the credit for saline aquifer storage. These actions will make the 45Q tax credit much more effective for CCUS deployment.
Natural Gas – Tank Topping
We have highlighted the glut in LNG supplies globally in many previous Monitors, but even for seasoned gas people, the current collapse in spot prices is surprising and unprecedented.
We appear to be reaching the point where LNG is becoming physically hard to place in re-gas terminals around the world, and at this stage even if weather conditions turn colder in coming weeks, the entire heating season has been a “bust” for gas suppliers, and of course particularly those who are unhedged.
The number of LNG carriers at sea without specific unloading destinations is reaching record levels, although some of this is because of storms Ciara and Dennis affecting deliveries to Europe. However, the diversion of cargoes from China continues amidst the Coronavirus measures and drop in Chinese industrial activity that has ensued.
The one feature that LNG liquefaction plant operators try to avoid at all costs is shutting down with all the technical and operational issues that go with a restart. However, what plant operators call “tank topping,” when the there is no longer a viable outlet for LNG, seems to be on the horizon unless competing pipeline supplies in Europe and Asia start to respond to the low prices currently being realized.
Either way, it appears that US gas producers’ hopes of international gas prices creating demand-pull on Henry Hub have been ill founded. Instead, low Henry Hub has pushed downward price pressure on the rest of the world.... It remains unknown when there is an end to the pain that all gas producers globally are now sharing.
Crude Oil – A short-lived drop in consumption
Epidemics have a severe but relatively short-lived impact on economic activity, with the impact on manufacturing and consumption measured in weeks or at worst a few months.
China's coronavirus outbreak should conform to this pattern of a severe downturn followed by swift recovery, provided it does not initiate a broader cyclical slowdown in the already-fragile global economy.
In most cases, the main impact on the economy has come from public health measures, such as quarantines, isolation and business closures, intended to control the spread of disease, rather than from the disease itself.
As a result, policymakers face a difficult trade-off between stringent public health measures to contain the epidemic and the need to resume normal business and social activities as soon as possible.
Over time, policymakers, business owners and employees face increasing pressure to resume near-normal operations, while taking practical steps to reduce if not eliminate transmission risk. If the past is any guide, economic activity and oil consumption should return to normal over the next 3-6 months, which is why Brent prices have been progressively strengthening over the last 10 days.
The main remaining risk is that the short-term economic shock from coronavirus could push the global economy, which was only just recovering from the trade war of 2018/19, into a full-blown cyclical downturn.
Oil markets are anticipating a deep but short-lived drop in consumption, with the impact concentrated in the first three months of the year and gradually fading in the second and third quarters.
Total US rig count (including the Gulf of Mexico) stands at 790, flat last week. The horizontal rig count stands at 713, up 2. US rig activity continues to show constraint and is 263 rigs below (-25%) last year’s total.
US Crude Oil Supply and Demand
Crude oil inventories increased by 0.4 million barrels from the previous week, compared with expectations for a build of 3.3 million barrels. The crude stored at Cushing (the main price point for WTI) decreased 0.2 million barrels; total stored is 38.2 million barrels (~42% utilization). Total US commercial crude stored stands at 442.9 million barrels (~56% utilization).
US crude oil refinery inputs averaged 16.2 million barrels per day, with refineries at 89.4% of their operating capacity last week. This was 190,000 barrels per day more than last week’s average.
US gasoline demand over the past four weeks was at 8.8 million barrels, down 2% from a year ago. Total commercial petroleum inventories decreased by 1.0 million barrels last week.
US crude net imports averaged 3.0 million barrels per day last week, down by 1,025,000 barrels per day from the previous week. Over the past four weeks, crude oil net imports averaged 3.34 million barrels per day, 22.3% less than the same four-week period last year.
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