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Unconventional Gas Developments

Energy, Global Economy, On the cover, Sin categoría

Our team has attended a few seminars on non-conventional gas. I thought it was worth compiling a few thoughts.

US breakeven costs have further to decline (easily 15%) taking breakeven economics to sub $5.0-5.5/mmbtu. Additionally, internationalization of the unconventional gas outside North America will be slow, with the possible exception of China.

1)North American insights:

a. Currently there is an abundance of plays that make sense at sub $6/mmbtu.

b. Technological advances are still ongoing and Take-up of known practices will cut costs by 15%, bringing breakeven costs to sub $5-5.0/mmbtu. The latest example is the deployment of “zipper” frac’ing.

c. These advances are offsetting a general rise in service costs, even though that rise is being accentuated by the withdrawal of some service capacity (early deployment overstretched rig capability, and those rigs are now failing).

d. Canada has potential to be a significant unconventional gas producer, and will keep downwards pressure on US gas prices into the medium-term.

e. Against that, the pace of drilling/development will slow as the majors become more involved.

f. WoodMac forecast US shale gas adding at least 1.5bcf/d per year through to 2020 on current drilling plans.

2) Outside North America:

a. Service companies are gearing up to take unconventional technology outside North America (eg Schlumberger buying Smiths and Baker Hughes).

b. European plays will be slow to develop:
i. Resource basins are relatively small.
ii. Regulatory issues have to be overcome (eg not only has PGNiG the exclusive rights to drill but all crews must speak Polish).
iii. No infrastructure to support rapid development.
iv. Exxon drilling 10 wells in Germany is a bit of a sidetrack – need to drill over 50 wells to get any understanding of the resource.
v. Costs are intrinsically higher – breakeven today is nearer to $10/mmbtu, but with 20% cost reduction/productivity improvement, there are several basins that can produce at $8/mmbtu.

c. China will be big as an unconventional gas play, and sooner than Europe:

i. Chinese policy has failed to hit coal-bed methane targets (but gas price higher now!).
ii. Resource basins have the right characteristics (big and tectonically stable, silicon strata).
iii. Fiscal terms can be supportive.
iv. Labour can be directed into sector.
v. The second East-West gas pipeline could unlock reserves along that route.

Unemployment inflection

Energy, Global Economy, On the cover, Sin categoría,

From one of my colleagues:

As of today, looks like the unemployment rate peak is behind us, and this long disastrous road of job losses that started December 2007 has ended. Job creation and job attrition look about flat. Unemployment would be able to fall naturally in the future without adding jobs because unemployment benefits run out and long-time unemployed people stop filing or reporting data–this is a data quirk, not necessarily a big positive per se.. Further, in the next 3 months, we get the once-a-decade US census hiring, which can be several hundred thousand jobs (though lined out by economists). All eyes are pointing now to expectations in June-Aug employment.

Combined with ISM’s running >50 for 7 months, global GDP coming in strong, and leading indicators running well above average (though maybe already having peaked on the recovery), seems we are in for slightly better economic picture than expected a few months ago.

Gotta be bullish for oil prices, as well as many globalized commodities. Goldman reporting US power demand running slightly above expectation in the US already, that may continue now, but admitedly its rather a shallow recovery (
Interest rates not really reacting to this data, except modestly on the front end. Further risks remain: the double dip on housing activity appears a growing risk, and end of March marks the completion of the Fed MBS purchasing program (read: mortgage rates will move higher). The sheer magnitude of bank write-downs coming on home mortgages is really just getting warmed up (the Fed kicked that can down the road, and we’re near the cul-de-sac). No idea how Fannie/Freddie even function post Fed purchasing program, they can’t warehouse all these mortgages and the banks aren’t holding new ones at all (85% securitization to Fannie/Freddie last year!)

So + industrial activity, slowly moving inflection on employment (but loads of slack to keep wages low for a while), and – on banking sector, lending. Seems that is a net/net positive environment for commodities and equities, neutral for bonds.

A Short Term Outlook For Gas Prices: Russia Calls The Shots (Again)

Energy, Global Economy, On the cover, Sin categoría

Gas prices have held up well, in part on the prolonged cold spell. However, in absence of weather support, by the summer prices will have to be lower in order to take the rise in LNG and Russian gas (161BCM) expected.

It is widely recognized that there’s a big build in LNG supply coming (extra 8bcf/d from the summer, ie three-quarters of UK consumption)) and that Gazprom is planning to increase its sales to Europe (by about 2bcf/d over the year = 20% of UK demand).

So likely that European gas storage will be filled relatively early. Unfortunately, storage levels are still relatively high (equal to almost 3bcf/d of extra supply if returned to normal levels over 3 months). Nevertheless, should storage still close to current levels rather than drop to 25-30% fullness, that would add 9bcf/d to demand over the next 3 months.

Economic recovery may lift demand, and Spain has started 2009 with January consumption up 4.2%. However, the industrial production is still more than 10% below 2008 levels.

The big mover for LNG would be a recovery in Japan, which looks encouraging even when industrial production is still 20% below 2008. South Korea and Taiwan are picking up but together these two countries are only half of Japan’s LNG demand.

Last year, in Europe, Gazprom’s gas buyers sharply reduced volumes early in the year. These are huge numbers – about 14-15bcf/d (ie almost the entire consumption of the UK and Germany combined). This was a”no-brainer” for the gas buyers. Their contracted price is based on oil prices with a 6-9 month lag. So deferring gas take until later in the year meant the gas would be cheaper.

Going forward, it looks likely that gas prices now are close to the lowest level for the year. Hence, the buyers are likely to want to take the gas now (saving about $2-2.5/mmbtu).

As a result of coal’s decline, gas at higher prices would no longer be the preferred fuel for generating power in the UK (where most of the swing occurs between coal and gas).

• Coal has come down as concern surfaced about the extent of policy tightening in China. The Australian coal price has been hit hardest, but clearly this has been the driver for South Africa (and European) coal over much of the past year.

• Marginal generation costs in the UK now favour coal dispatch.

So, gas prices will have to drop (or coal prices have to rise) in order to stimulate enough demand to take the Russian gas. Coal market fundamentals look positive once the trend of Chinese coal import data post-tightening is evident in 1 month time. So near-term, the market balance is more likely to be brought back into balance by falling gas prices enhancing power station competitiveness (along with Europe maintaining high storage levels over the summer), but more expensive coal and lower Russian gas might balance the equation.

So the x factor to bring gas markets to balance is Russia. Unless Gazprom allows a smaller off take, there could be as much as 10bcf/d trying to find a home in the UK/European power sector over the coming 3-6 months. That’s too much for UK/Europe to absorb; so up to 5bcf/d could end up headed for the US. I struggle to believe Russia will work on volume alone given they have a 6% decline in the base. If they allow a lower off-take, US pricing won’t get dragged down in this environment.

The current forward curve has Henry Hub some $0.5/mmbtu above UK’s NBP, so there is not much scope for UK prices to drop without impacting LNG flows and depressing US prices.

In summary, the picture is not that oversupplied if Gazprom volumes (161BCM) include storage and some level of flexibility. Chinese coal buying might keep gas prices more competitive than coal for power generation, and we are seeing LNG projects delayed (Shtockman, Australia) or sending lower volumes to Europe (Yemen). Looks like the picture of oversupply that the market discounts is too extreme. Not that my view will imply gas price appreciation, but the massive downside predicted by some looks less evident to me.

Can Spain afford to be "green"?

Energy, Global Economy, On the cover, Sin categoría,

(This article was published in Spain’s Cotizalia on February 11th 2010)

What timing. After months preparing for a trip to Madrid, I arrived on Thursday 4th, amid the market and debt debacle. A day after the market crash and four days before the presentation of the Spanish Secretary of State for Economic Affairs here in London. The macroeconomic forecasts “from -0.3% GDP growth in 2010 to +3% in 2012 by doubling the exports” worry me. What country will Spain double its exports to in two years with the Euro at all time highs and competitiveness at historical lows?

I have the luck or misfortune of following the economy of 58 countries. What country in the world is forecasting to increase its imports from Europe between 2010 and 2011? No idea. And above all, how can Spain take away market share from other exporting countries in an environment of aggressive competition?

Amid all this, people wonder why the markets fell and different articles comment on the role of “short speculators”. Too bad no one called us “long speculators” or “saviors of enterprises requiring capital increases” in 2009.

Going back to the Spanish Government presentation… Imagine the CEO of any publicly traded company which had breached the consensus estimates for three years in a row submitted such bullish growth plan and think how much his companies shares would drop. Obvious.

Fortunately, my meetings on Friday left me much calmer. The companies are doing their homework and, as always, it will be the private sector which will rescue the economy. I hear no one expects a quick economic recovery and corporates, which are close to the customer and the export industry are preparing themselves for several years of less than modest growth. I hear excellent plans to cut costs by 30-40%, diversification efforts and, above all, restraint in capex and debt control.

And in this day an issue did pop up constantly. In Spain there is little more that can be done in infrastructure and renewable spending for a few years. The drastic cut of the civil works and infrastructure spending is imminent. Spain has invested in infrastructure like an emerging country, but with the demand of a mature market, and now it has an enormous excess capacity while it needs to digest, and pay, the national debt increased through a stimulus plan that brought debt to GDP to 11% devoted to infrastructure and civil work with no returns, ie spending that generates debt but does not generate GDP.

In this environment, power prices are at historic lows due to overcapacity and lack of demand, and yet the fact that renewables account for 40% of the electricity generated in some days make the premiums for these technologies (especially solar) to generate a tariff deficit of between €1bn and €1.2bn, a bill that is transferred to future generations.

This deficit is generated by the monstrous deception that is to have a government that raises electricity tariffs by a maximum 3-4% annually in one of the countries that pays less for electricity in Europe, while the real energy costs, including renewable premiums, is much higher. And this then becomes debt, owed to the power companies, that must be placed in the market to be securitised… And we have spent many months waiting for the tariff deficit securitization while the figure of debt rises month after month, which is unacceptable and introduces even more uncertainty in the power stocks. This is the national problem of Spain: to fix it all with debt, and now the bubble of debt is almost unbearable. The government has to refinance €60bn, saving banks and autonomous regions €150bn, etc … Let’s see just what kind of spreads will be required to place this paper.

Spain’s GDP is approximately €1.06 trillion, premiums for renewables account for 6 billion euros, 0.6% of GDP, and the accumulated tariff deficit is 11 billion, or about 1% of GDP. Additionally, the tariff deficit expected for the next two years is an additional €4 billion. Spain, at the same time, wants to install about 5,000 additional megawatts of wind generation and other 2,300 megawatts of solar by 2012.

Well, friends, do numbers. Either the government passes the real tariff to the consumer, which is unlikely given there is a 20% unemployment, or the bubble and its financing becomes unsustainable and with it the green economy model. Green energy costs. Let’s face it. Now it’s time to face whether the green energy model is sustainable in a weak economic and high debt environment.