Feb 24th, 2012
MLP Market Post
Natural Gas is Old News, NGL Price Decline in Focus, is Oil Next?
The talk for the last few months has been natural gas price declines, drilling curtailments, adjusting to a newer normal of natural gas prices below $3.00 on a sustained basis, after having only recently adjusted to the new normal of natural gas below $4.00. The focus has shifted to NGL prices this quarter. Earnings calls Q&A’s were chock full of NGL and ethane questions, and with good reason. Ethane prices peaked on October 21, and have dropped since around 47% through last Friday, and overall NGL prices are down 18% over the same time period. Its not just the decline, but the decline as a percentage of crude oil prices that is significant. Ethane is down to around 20% 0f crude oil price, compared with a typical range of 40% to 55%, according to the chart below from Raymond James.
Ethane consumption decreased 3.5% from December (a record high month) to January. That decline in demand has been rationalized away by the people that know more about NGLs than everyone else as mostly related to planned plant turnarounds and downtime, and most expect NGL prices to firm up in the second half of 2012.
Since 2009, MLPs with well-located processing and fractionation assets have been the primary beneficiaries of high NGL prices. Names like OKS, NGLS, and EPD have posted great numbers in their NGL businesses. NGL-focused MLPs have been able to identify very attractive processing and fractionation projects to develop recently and have been holding up the MLP space (along with crude-focused MLPs). If the NGL party were to end, the MLP sector would face some serious headwinds.
To be clear, the party doesn’t end at today’s prices, which are still historically high. As EPD’s Jim Teague said on EPD’s earnings call: “we talk about softness [in ethane prices], we’ve gone from phenomenal margins to just great margins. We’ve had quite a few turnarounds. We’ve lost probably 50,000 barrels a day; that’s to be expected. We’re still pretty excited [about ethane prices].”
So questions have been raised on NGLs, and skepticism is developing as to the ability of petro-chemical demand to keep pace with NGL production from liquids-rich natural gas wells. If NGLs were to break and become so oversupplied that NGL prices collapse in the manner that natural gas has over the last few years, would the rigs just move onward and upward to focus on crude oil? How long after that before questions started to emerge about oversupply of crude oil? Raymond James’ research team came out with a report this week that lowered their long term oil price target to $90 from $105, even as oil hits new nine month highs. Is this a sign of things to come if the geopolitical situation in Iran calms down and the speculation in crude dissipates? I think its possible.
Extrapolating Production Trends?
Speaking of oil production, there has been chatter from research analysts and journalists on the subject of American energy independence. Citigroup released a report early this month that touted the potential for shale oil as the lever that will help America finally achieve Energy Independence (at least those from the Middle East, Canada is ok). Even the EIA is sending muted signals of the possibility of liquids imports going away:
U.S. dependence on imported oil has dramatically declined since peaking in 2005. This trend is the result of a variety of factors including a decline in consumption and shifts in supply patterns. The economic downturn after the financial crisis of 2008, improvements in efficiency, changes in consumer behavior and patterns of economic growth, all contributed to the decline in petroleum consumption. At the same time, increased use of domestic biofuels (ethanol and biodiesel), and strong gains in domestic production of crude oil and natural gas plant liquids expanded domestic supplies and reduced the need for imports. (EIA, June 2011)
Domestic oil production highest in 8 years. The proportion of demand met from domestic sources over last 6 years to 81% according to department of energy. But as shown in the chart below, crude imports are still double current production. Not exactly drowning in oil…
Clearly we have a long way to go to achieve independence on crude oil, but factoring in growing exports of coal and natural gas, declining demand for gasoline from vehicle efficiency, and production increases it may be possible to have the overall energy balance swing to a national net export situation.
Can we Drill our Way to Financial Independence?
Energy independence is clearly a buzzword that gets used by research analysts to generate buzz. Its pretty far-fetched to think that we may at some point be totally energy independent as a country. Regardless of its likelihood, the conversation / debate is happening. Just do a google news search for “Energy Independence”, and you get articles on both sides, such as:
- The Myth of Energy Independence: Why We Can’t Drill Our Way to Oil Autonomy (the Atlantic)
- Energy Independence Gives Opening for Renewables (Bloomberg)
- Energy Independence, impending oil shocks (Smart Planet)
- America Will be Energy Independent by 2030 (Daily Finance)
What I read in the above article by Smart Planet is that initial production rates for Bakken wells are not that impressive, with large decline curves. At a current cost per well of $7 million, it would appear that the amount of capital and wells drilled (16,000 by the author’s estimation) to continue to achieve substantial growth in production out of Bakken is not feasible. That ignores the potential for U.S. producers to advance up the learning curve, master the process of drilling thousands of wells per year and eventually lower the cost of each individual well.
Also, arguments that focus on oil production growth domestically not impacting global prices because of the massive expected demand growth out of China and India ignore the potential for our technology and mastery of shale development to be exported to other countries. They ignore the potential for some other country to follow our lead and grow their own oil production from previously discarded reserves.
The debate should not be focused on whether or not it is possible for shale oil to solve our energy problem, because the truth is no one knows. The discussion should be around the fact that the U.S. is growing oil production substantially for the first time in decades, and what that could mean. Even if we don’t become energy independent, can this new oil production change our current economic outlook, or potentially change the world’s view of the U.S. dollar? Will this new production allow us to hold on a bit longer to our status as the world’s reserve currency? Can we hold on long enough to re-emerge as the dominant global economic force? Is the production impact large enough to create an economic windfall from cheaper energy and create jobs to save us from a public balance stagflation crisis akin to Japan for the next few decades? In short, can this new oil save the country?
Or, a different line of questioning: could this potential glut of oil destroy all hope of innovating cheap alternative energy sources? Will our thirst for domestic production destroy the environment? If the entire world goes shale crazy, how fast will the oil reserves be depleted. Or will there be innovation that allows us to use some alternative to water in the fracking fluid?
Sorry that this post had far more questions than answers, but I hope I’m asking some of the right questions. If you have the answers, please feel free to comment below or send me an email.