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US natural gas is set to continue rising but fundamentals keep it capped at $6.5/MMBTU mid-term. The conclusion is that US gas is likely to be in a tight range of plus/minus 15% of the marginal cost of production (downside to $3.5/MMBTU and upside to a c$6/MMBTU short-term) as the contango flattens.
I would highlight three data points:
- Current 55-60% decrease in gas directed drilling activity in the US has not been sufficient to balance 2009 supply and demand. These rigs will gladly come back any time gas reaches $5-$5.5/MMBTU. Additionally, onshore rigs are being moved to Russia and West Africa, where there are stronger conomics. On the support side, coal-to-gas switching tends to kick off at $4/MMBTU
- Estimated base decline with current drilling activity (33%) can be misleading as production will still be c54BCF/day in the US in a worst case scenario and there is plenty of resources (if demand stays weak as predicted) in unconventional gas plus ample new reserves in the US (Marcellus, Barnett) .
- I do however believe the LNG “threat” is less than what market anticipates (although I am happy to assume 2-2.5BCF/d LNG into the US in 2010). Case in point is that all of consensus expects Chevron-Exxon’s Gorgon and BG’s Queenland Curtis to supply at sub-target ROCE levels (DB expects them to make 13% versus a target of 20%). This (in my view) is unlikely to happen as these are companies that ruthlessly monitor and manage ROCE, and have proven, to everyone’s surprise, that delays in LNG happen. The LNG overcapacity disappears in 2012 (no more LNG projects commissioned post 2011) so waiting and monitoring is not an issue.