Traditional Pillars of Gas Demand Fading Rapidly

Traditional Pillars of Gas Demand Fading Rapidly

20th January 2017

The onshore rig count reversed and swelled 36 this week, the largest weekly increase since mid-2011. This brings the total to 670, sixty three (~10%) above the 607 a year ago. US shale drilling is coming back; production has increased 460,000 barrels per day, 5.4%, in the last six months after falling 600,000 barrels per day in the first half of last year.  

Over the last few weeks, the potential global excess LNG capacity, compared to demand, has been highlighted, the primary driver being the anticipated ramp up in LNG exports from the US and the completion of additional LNG trains in Australia.

The other thread that runs through the gas commentary is the importance of emerging markets such as Africa, Latin America, South Asia, India and China.  The rationale for that is twofold, with the fairly obvious conclusion that the majority of new gas demand will come from those markets, particularly for power generation.  However, the feature that is often overlooked is that gas demand in established markets such as Europe and parts of Asia is not only static, but has the potential to diminish, and of course a few percentage points of demand in Japan, for example, can move the gas demand needle significantly. 

In fact, figures from the Institute of Energy Economics in Japan indicate a drop in demand of about 2 million tonnes of LNG last year, with a further drop of more than 4 million tonnes in 2017 – equivalent to a typical entire LNG train (or around half a bcfd of feed gas), and 2015 saw a similar drop in demand in Korea, according to EIA data.  Europe doesn’t fare much better with around 5 bcfd of gas demand disappearing between 2009 and 2015 with a painfully slow return to growth last year, though overall growth expectations reduced from 2.5% pa to just 1.5% pa (IEA).  With the continued reduction in energy intensity in OECD countries, better energy efficiency measures and tightening standards, those looking for new demand for natural gas are having to look further afield. Of course, from a US standpoint, with demand continuing to grow on the back of low cost natural gas, its easy to forget the challenges in these other major markets

With these traditional pillars of gas demand rapidly fading into the rearview mirror, the deal flow is certainly following activity in the developing economies.  To illustrate this, it is only necessary to look at what's making the gas headlines.  Just this week, another floating storage unit being used as a fast-track LNG-to-power project arrived at the Pagbilao LNG terminal in the Philippines.  This followed hot on the heels of Hoegh’s newest FSRU, installed in Columbia just a few weeks ago.  With that ship now fixed, and two recent new FSRU contracts agreed, one for Ghana the other for Pakistan, another new build contract was let this week with Hyundai Heavy Industries for a further 170,000 cubic meter vessel, with 1 bcfd re-gas capacity.   Is this the shape of future gas demand?  The gas team at GCA is willing to make that bet.

What Could Come Next…..Potential Crude Scenarios

Oil price gains will trigger a significant increase in US shale output as OPEC and other producers rein in supply. At US$55 a barrel or more, core oil shale plays in the US would continue to add rigs and increase US crude production. With higher prices, the outlook for US production has become more optimistic. 

Oil prices have risen about 20% since the Organization of Petroleum Exporting Countries (OPEC) reached a deal to curtail supply last year. The November 30, 2016 agreement prompted a resurgent in activity in the US -- not an OPEC member, but driven by returns on investment -- where oil and gas producers increased drilling the most since April 2014.

The oil industry is becoming more cost-efficient, and a large resource of global output is now profitable at US$50 to $55 a barrel; Brazil and Mexico are countries that will also boost production and compete for market share. There could be significant supply in late 2017 or early 2018 added that would keep downward price pressure on the market.

This will make it more difficult for OPEC and Non-OPEC producers to achieve its goal of restoring the balance on the oil market by means of production cuts. In the first week of January, US crude production rose to 8.95 million barrels a day, the highest level since April 2016. Oil rig use expanded to 529, a 67% increase from the 2016 low of 316.

There has already been a significant increase in drilling activity.  US oil production will certainly continue to increase, which could influence OPEC’s next move.

If US oil shale response is large and fast and can substitute for the OPEC output cut, OPEC is most likely to shift back to increasing production and fight for market share.

However, if US oil shale response is moderate and does not substitute for the OPEC output cut, then most likely OPEC will extend their current output agreement. This may provide a floor on the oil price, accelerate withdrawal of crude stocks - the key objective of the current OPEC agreement - and shift the forward price curve into backwardation.

If the market tightens due to a significant supply disruption, would OPEC producers attempt to increase production and put a cap on the oil price or simply let crude stocks draw faster? OPEC’s decision to cut output in 2016 resolves key market uncertainties concerning production shocks hitting the market and helps set future market expectations in an uncertain world. OPEC oil policy is constantly changing due to economic and political agendas. As new information becomes available concerning US oil shale production, look for OPEC oil policy adjustments.

Weekly Recaps

Oil Drilling Activity

The total number of active onshore rigs increased to 670.  When compared to a November 2014 figure of 1,876 active rigs, the current level is 64% below the 2014 high.

Across the three major unconventional oil basins, the oil rig total increased to 359 (up 18 last week), with Permian up 13, Eagle Ford up 2 and Williston up 3.

Total US rig count (including the Gulf of Mexico) stands at 694, up 35 last week, with rigs targeting oil up 29. The horizontal rig count increased to 559, up 22 last week.

Oil Price

Brent, the global benchmark for oil, was down $0.11 to US$55.45 a barrel, reflecting a loss of 0.20% on the week.

WTI crude rose $0.07 to US$52.57 a barrel, up 0.13% on the week.

US Supply and Demand

Sources: EIA Weekly Update and GCA analysis

US crude oil refinery inputs averaged 16.5 million barrels per day, with refineries at 90.7% of their operating capacity last week. This is 639,000 barrels per day less than the previous week’s average.

US gasoline demand over past four weeks was at 8.96million, down 2.4% from a year ago. Total commercial petroleum inventories decreased by 2.0 million barrels last week.

On the supply side, EIA data indicated that total domestic crude production decreased 2,000 barrels to 8.944 million barrels a day. The Lower 48 crude production now stands at 8.431 million barrels per day, flat last week.

US. crude imports averaged about 8.4 million barrels per day last week, a decrease of 0.674 million barrels per day from the previous week. Over the last four weeks, crude oil imports averaged 8.2 million barrels per day, 4.5% above the same four-week period last year.

Crude oil inventories increased 2.3 million barrels from the previous week and remain at historically high levels. The crude stored at Cushing (the main price point for WTI) was down 1.2 million barrels; total storage is 65.7 million barrels (~73% utilization).

Authors

Traditional Pillars of Gas Demand Fading Rapidly

Nick Fulford

Global Head of Gas and LNG - nick.fulford@gaffney-cline.com
Traditional Pillars of Gas Demand Fading Rapidly

P Kevin Galvin

Principal Advisor, Field Development Planning - kevin.galvin@gaffney-cline.com
Traditional Pillars of Gas Demand Fading Rapidly

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