February 7, 2020

February 7, 2020

7th February 2020

Oil Drilling Activity

Onshore US drilling activity decreased by 1 with a total active count of 767 (Y/Y decrease of 262) rigs; those targeting oil up 1, with the total at 676. Across the three major unconventional oil basins, the oilrig count decreased by 2, with Permian down 1, Williston flat and Eagle Ford down 1.

Source: Baker Hughes Rig Count

US domestic crude production was down 100,000 barrels last week; crude production stands at 12.9 million barrels per day, of which ~2.55 million barrels per day is offshore and Alaska production.

US crude flows to Europe are set to increase over the coming month as demand from Asia has plummeted due to the coronavirus outbreak.

US employers ramped up hiring in January and wage gains rebounded, providing new evidence of a durable jobs market that backs the Federal Reserve’s decision to stop cutting interest rates.

Carbon Management – Trees define the long-term value of fossil fuels?

In January of this year, the CEO of Blackrock – the world’s largest asset manager – stated in his annual influential public letter that “climate change has become a defining factor in companies’ long-term prospects” and predicted a significant reallocation of capital based on climate risks “in the near future.”  Blackrock is not alone in this view. More than 600 institutional investors with $37 trillion in assets under management are working through the Investor Agenda to urge governments to phase out thermal coal, price carbon, end fossil subsidies and align public policy with the Paris Accord 2 degree Celsius climate targets.

The tide therefore appears to be turning for fossil fuel companies, which face an increasing imperative to address greenhouse gas emissions in their operations, their supply chains and possibly beyond.  Some companies are starting to take up these challenges with Shell, ENI and Repsol setting emission reduction targets for 2030 or 2050; Repsol is the first oil and gas major to aim for net zero emissions by mid-century.  Other companies are expected to follow suit, including those outside the energy sector.  Microsoft just committed to being “carbon negative” by 2030 then removing all historical emissions since the company’s founding in 1975.  

These companies acknowledge that the energy transition will take decades and require a broad suite of solutions.  Some big themes include operational energy efficiency, investments in renewable energy and sustainable biofuels, shifts to natural gas, electric mobility and CCUS.  Beyond these, many companies are also looking to the potential role of carbon markets and the use of offsets.  Nature-based offsets, in particular, could offer some of the quickest, lowest cost options in the short term. 

Nature-based offsets, or natural climate solutions, are investments in forests, agricultural lands, grasslands and wetlands that create a positive climate benefit.  Projects include restoration of landscapes and soils or avoiding converting forests into non-forest land uses, such as burning Amazonian rainforest to clear land for soy production.  Research shows that one-third of low-cost emission reductions before 2030 could be provided by natural carbon solutions.  Further, the IPCC reports that these more sustainable land use practices are required to meet 2 degree Celsius targets.

Shell and Total have committed $100 million annually to natural climate investments to help achieve their climate commitments, and ENI, BP and others have offset portfolios that include forestry offsets.  These investments – while all voluntary – can be one part of the puzzle in working toward energy transition targets.  In 2018, the voluntary carbon market doubled in volume and value from the previous year to nearly 100 million tonnes of CO2-equivalent worth $300 million.  While still a nascent market, this growth was driven primarily by new investments in natural climate solutions. 

Compliance carbon markets are proliferating as well.  According to the World Bank Group, there are now at least 57 jurisdictions with carbon taxes or regulatory carbon trading in place.  These cover 11 billion tonnes of CO2-equivalent, roughly 20% of global emissions.  Oil and gas operations are increasingly included in these markets, requiring new technological, commercial and strategic options to manage exposures and stay competitive in an increasingly carbon constrained world.

GCA’s expertise in carbon markets provides advice to clients that are seeking to understand, participate or lead in the energy transition.  Services include:

* education on carbon markets and implications for business/product lines
* trusted advisor for voluntary offset procurement or project investment processes
* strategic and commercial analysis of internal options and compliance carbon obligations through supply chains
* competitive analysis of the oil and gas sector landscape related to carbon market investments

Natural Gas – To hedge or not to hedge?

2020 dawned with the global gas sector already facing a series of major challenges, as prices appeared to be failing to respond to the usual colder weather and peak winter season.  We are barely one month into the year, and the picture has become even worse.

With LNG production continuing to surge ahead of demand, spot prices that should be moving up at this time of year have actually been moving down, and not just marginally.  The latest blow to the LNG spot market has been the ongoing Coronavirus epidemic in China, which has reportedly led to lower than expected demand in China, with CNOOC issuing a Force Majeure notice, effectively turning even more LNG cargoes back into an already oversupplied market.

Whether or not the events of the last few days are described as a “price crash” or just a temporary slump, the numbers speak for themselves.  With forward prices in Europe (NBP) now less than $3/MMBtu for the next two months, and deals for Asian LNG closing at similar levels, the financial effects are material. For example, those entities who are having to manage LNG spot price risk and liquefaction tolling commitments are approaching a pricing environment that not only puts any kind of return on capital in doubt (which has been the case for many months now), but also preclude any kind of positive cash flow.  Whether or not we see cargoes being left in the tank, and LNG plants beginning to reduce or even cease production, remains to be seen; but it is a phenomenon that is drawing ever closer.

A further risk to US LNG remains Henry Hub input prices, which are also stubbornly low, which is helping to ease the burden on US exporters.  However, it also means that for many US dry gas producers, substantially reduced profitability is continuing to slow down drilling, and rig counts, especially in basins such as the Marcellus and Utica, are falling.  If the fall off in drilling activity for gas starts to create a recovery in wholesale gas prices, but international LNG prices continue their decline, the prospect of turning back LNG plants becomes even more likely.

In todays sophisticated US and European wholesale gas markets, the options available to gas players to manage price risk are higher than ever. For those companies who have chosen to hedge gas prices and manage exposure, the outlook may not look quite so dismal, or at least will be less volatile from an earnings perspective.  However, for those who have elected to confront the full force of spot LNG prices and Henry Hub based feedstock, the time to act has passed, and improved financial results will depend on some cold weather, and a resumption of demand in China and elsewhere.

Gas market trends in Brazil

We would like to inform you that GCA is hosting a roundtable discussion on gas market trends in Brazil. It will be held in Rio de Janeiro on February 12 from 6 PM onwards. If anyone is interested in attending the event or would like more details, kindly get in touch with us by emailing to GCA.BD.Houston@gaffney-cline.com.

Crude Oil – Shipping rates for crude oil tankers fluctuate

After nearly 10 years of relative price stability, shipping rates for crude oil tankers have fluctuated widely since mid-2018 because of a combination of geopolitical events and changes to maritime fuel specifications.

The shipping rate disruption caused by geopolitical events also coincided with a fleet-wide switch in ship fueling practices. On January 1, 2020, new regulations from the International Maritime Organization (IMO 2020) came into effect that limited the sulfur content in marine fuels used by ocean-going vessels to 0.5% by weight. Although the full impact of the IMO 2020 regulations will not be known for some time, early reports suggest that the standard has had two primary impacts on tanker rates.

First, many ship owners have switched away from high sulfur fuel oil (HSFO) to fuels with lower sulfur content such as low sulfur marine gasoil (LSMGO) and low sulfur fuel oil (LSFO). Although differences in their energy content and performance characteristics complicate direct comparison, both LSMGO and LSFO fuels are more expensive than HSFO. As of January 2020, LSMGO and LSFO were being sold at a premium.

Second, some ship owners have instead chosen to retrofit their vessels with new scrubbers that allow them to continue burning the same fuels while still complying with IMO 2020 regulations. These retrofits do take time, however, and the IMO-induced retrofits might temporarily remove ships equivalent to approximately 2% of the crude oil tanker fleet’s total capacity. Although their effect on tanker rates is almost certainly not as impactful as the geopolitical implications of sanctions and other oil market disruptions, IMO 2020 regulations are still significant and they are more likely to shape long-run charter prices. 

Weekly Recap

Drilling Activity

Total US rig count (including the Gulf of Mexico) stands at 790, flat last week. The horizontal rig count stands at 711, flat. US rig activity continues to show constraint and is 262 rigs below (-25%) last year’s total.

US Crude Oil Supply and Demand

Sources: EIA Weekly Update and GCA analysis

Crude oil inventories increased by 3.4 million barrels from the previous week, compared with expectations for a build of 3.4 million barrels. The crude stored at Cushing (the main price point for WTI) increased 1.1 million barrels; total stored is 36.7 million barrels (~41% utilization). Total US commercial crude stored stands at 435 million barrels (~55% utilization).

US crude oil refinery inputs averaged 16 million barrels per day, with refineries at 87.4% of their operating capacity last week. This was 48,000 barrels per day more than last week’s average.

US gasoline demand over the past four weeks was at 8.7 million barrels, down 3.1% from a year ago. Total commercial petroleum inventories decreased by 0.9 million barrels last week.

US crude net imports averaged 3.2 million barrels per day last week, up by 50,000 barrels per day from the previous week. Over the past four weeks, crude oil net imports averaged 3.1 million barrels per day, 38.2% less than the same four-week period last year.

Authors

February 7, 2020

P. Kevin Galvin

Facilities/Cost Engineer - kevin.galvin@gaffney-cline.com
February 7, 2020

Nick Fulford

Global Head of Gas/LNG - nick.fulford@gaffney-cline.com
February 7, 2020

Nigel Jenvey

Global Head of Carbon Management - nigel.jenvey@gaffney-cline.com

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