Crude Oil Price setting mechanisms 101

Oil ProductionCrude Oil

We have recently seen the price of Brent crude oil (the global standard) drop steadily from over 100 dollars per barrel to close to 80 dollars. The reason is a current small “oversupply” of crude at a time of slowing demand for gasoline and other crude-derived fuels. What are the factors at work here? To understand these, we can look at the left graphic from Reality Check as well as the right graphic, which shows the dramatic turnaround in U.S. crude oil production.

First, a comment about the bars that show production costs from various sources and regions. Crude oil prices normally reflect the sum of “finding” costs (exploration and well development) plus “lifting costs” (production from developed wells).  The U.S. Energy Administration in 2009 estimated U.S. total cost of crude oil production to be $31/bbl onshore and $ 51/bbl offshore.  Lifting costs were $12/bbl onshore and $ 10/bbl offshore. The U.S. still has over 5 MM bbls/day that can be produced at close to these relatively low cost, though this is not shown in the left graphic which presumably depicts incremental cost of new crude oil produced from  wells being developed in the different regions. Since almost all new U.S. crude oil comes from “fracking” in Texas and in the Northern U.S., no other U.S. oil prices are shown. Moreover, since fracking-based oil has an incremental production cost of $ 65 per barrel, new crude oil production here will keep rising unless world oil prices drop well below $ 80/bbl.

Looking at the other graphic, it is evident that the rapidly growing U.S. oil production, together with the instability of some OPEC sources (Libya, Iraq) is moving crude oil into an oversupply situation. The Saudis, with the largest production source, could cut back and stabilize the price, but they are apparently unwilling to give up market share to the U.S.

Let’s look at the price-setting mechanisms at work here. Short term, there is likely to be some cutback in production simply because refineries will need less oil to meet worldwide demand. This cutback will come from the more expensive shale oil and oil sands wells, from tertiary recovery, and from producers whose inventory tanks are full. As to demand, low crude oil prices make gasoline prices fall and that means more people will drive more miles, thus raising demand.  At some price, supply and demand must balance. It would be surprising to see oil fall much below, say, $ 70/bbl., short of a major economic slowdown.

Long term, other things come into play. Lower crude oil price forecasts will slow down offshore oil production investment and will cut back on more oil sands and Arctic  investments as well as more expensive fracking sites.

The laws of supply and demand are alive and well!

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Little Progress by Renewables

RENEWPrevious posts have commented on the fact that trying to change the contribution of the different energy sources making up our domestic energy supply is somewhat analogous to changing the direction of an ocean liner. It’s just hard to make significant changes, given the fuels and energy infrastructure and even economics. That’s why the graphic for 2011 is probably not very different from this year’s (2014), though natural gas is making slow inroads into coal and petroleum. Significantly, we still get less than 10% of our energy from “renewables” and a third of that is from hydropower, which  has been a steady contributor all along.

Wind energy still supplies three times as much as solar, though solar is starting to make strides as the cost of PV panels keeps coming down. There has been some disappointment with solar energy as derived from boiling fluids in pipes exposed to thousands of mirrors in sun-drenched California deserts as this technology is now more expensive than PV with the additional problem of bird kills resulting from birds burning up when flying into the zone served by the mirrors concentrating the light on the pipes. Solar is optimistically expected to make more rapid progress, as projected in an ATKearney study for Europe as depicted below.SolarRRRR

The unfortunate fact is that renewables will continue to constitute a pretty small part of our energy supply. As a consequence, carbon dioxide emissions remain stubbornly high, not surprisingly as automotive vehicles and aircraft still run almost exclusively on fossil fuels. With some nuclear capacity scheduled for decommissioning, the situation will get worse before it gets better.

Europe is better placed to increase renewables because both coal and natural gas prices there are quite high, providing great incentive for installing wind or solar.

I don’t think there’s much interesting news in this post, but it’s still useful to understand the statistics. Also, as I’ve pointed out in other posts, there are areas in the U.S. where renewables for short periods of time, supply a surprisingly high percentage of local energy demand. Nevertheless, the overall picture for renewables is bleak, to some extent a collateral effect of low natural gas prices and hydraulic fracturing.

 

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New, Middle West cracker breaks the mold

images Last week The Joseph Priestley Society of Chemical Heritage Foundation in Philadelphia hosted a luncheon and a speech by Fernando Musa, head of Braskem USA, which is now the largest polypropylene producer in the Americas. The most interesting part of the speech was the description of a new ethylene plant that will shortly be constructed by Braskem near Parkersburg, West Virginia in the heart of the wet” Marcellus Shale gas region. Shell Chemical is also planning an ethylene complex in this region – to be built most likely near Pittsburgh.

Braskem is a Brazilian company that dominates the petrochemical industry in its home country, but also has extensive investments in the U.S. and Europe.  Brazil’s Odebrecht group and Petrobras, Brazil’s national oil and gas producer, own large percentages of the company, which also has public shares.

Some early U.S. crackers  were built in the 1950s in Iowa and Illinois when the first  pipelines were constructed to bring Gulf Coast natural gas to the Middle West. Since this gas had a BTU value much higher than 1000 (i.e.  containing ethane, etc), so-called straddle plants were built to extract ethane and propane from the gas to bring its heating value down to the desired range. The recovered LPG then made a perfect feedstock for producing ethylene. But after that time, essentially all new crackers were built on the Gulf Coast, using either ethane/LPG of naphtha and heavier liquids as feedstocks.

For a long time, the U.S. had a strong competitive advantage in petrochemicals, as described in Michael Porters 1990 book (“The Competitive Advantage of Nations”). Our advantage fit Porter’s model, which was based on Demand Conditions (large domestic market), Related Supporting Industries (A local “cluster of suppliers, universities, contractors, etc), Industry Structure Rivalry (strong competitors constantly improving operations) and Factor Conditions (primarily favorable raw material and energy costs).

By the late 1990s, natural gas prices on the Gulf Coast had risen sharply and naphtha became the worldwide feedstock , with the U.S. losing its competitive advantage. Then, as we all know, it regained the advantage as low cost dry and wet shale gas became abundant a few years ago. With that background, let’s look at Porter again with respect to the prospective new crackers in the Middle West:

Demand conditions: Similar, but slightly better as demand for petrochemical end products is more concentrated in the Middle West than on the Gulf Coast.   Related Supporting Industries: Less favorable. The interconnectedness of petrochemical plants on the Gulf Coast was highly important to non-integrated downstream producers, who could source ethylene or benzene from a number of suppliers using existing pipelines. Also, contractors were quickly available for shutdowns and turnarounds. Barge, rail and container ships were at hand to allow efficient supply chains. Industry Structure Rivalry: No longer important as leading worldwide competitors all use the best technologies. Factor Conditions: Favorable.  Shell will enjoy the full benefits of being back-integrated into the Marcellus shale gas. Braskem will obtain well-priced ethane from local suppliers and, while less competitive than Shell, will still have a worldwide competitive advantage. It may have the opportunity to back-integrate by acquiring a fracking company.

Interestingly and not surprisingly, Musa said that he hopes that Shell will also move ahead with its project. Having two producers in relative proximity, no doubt enhancing the growth of a Midwest petrochemical “cluster” moves in the direction of guru Michael Porter.

 

 

 

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First big carbon capture project moves ahead

imgres My January 8th post illustrated a combination of carbon capture from coal-fired power plants with enhanced oil recovery from depleted oil fields using the recovered carbon dioxide. With a scheme like this, the considerable cost of extracting carbon dioxide from power plant flue gases is justified when the carbon dioxide is pumped to a nearby oil field for additional crude oil recovery(tertiary recovery) as the CO2 pushes out some of the remaining oil left in the ground from conventional drilling plus water flooding (secondary recovery).

C&EN’s September 1st issue details a first-of-its kind project as described above. NRG Energy Corp. and JXNippon Oil & Gas Exploration plan to divert about a third of the flue gases  from NRG’s 610MW coal-fired power plant near Houston, Texas to a carbon dioxide scrubbing and recovery plant using an amine solvent system developed by Mitsubishi Heavy Industries. The carbon capture plant will cost $ 1 billion, financed jointly by the partners and by the Department of Energy, and will capture 1.6 million tons of CO2. This will be piped 80 miles to a relatively depleted oil field, where the current production of 500 barrels per day is expected to increase to 15,000 barrels per day which at $ 100/barrel would generate annual gross revenues of 540 million dollars.

The scrubbing technology was piloted by Mitsubishi at a pilot-scaled plant adjacent to a large coal-fired power plant near Mobile, Alabama.

Adding a carbon capture system (there are different kinds) to a coal-fired power plant is economically costly due to the so-called parasitic load of the capture system, which substantially decreases the efficiency of the power plant when the electricity generated is used to operate the capture system. In the case of the NRG/Nippon Oil plant, a separate 75MW natural gas-fired power plant will be built to run the capture system rather than decreasing the net electricity output of the coal-fired plant.

Since the economics of the proposed installation appear to make sense, we should see several other installations of this kind moving ahead. While some of the CO2 from tertiary recovery does escape to the atmosphere, this does not greatly detract from the fact that such combined systems can greatly decrease CO2 emissions, a stated goal of the Obama administration.

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Shale gas-based ethylene boom: Future planning is essential

images[9] The availability of cheap ethane (best ethylene feedstock) from shale gas and from new, light crude oils has resulted in boom times for the U.S. petrochemical industry. From a position of relative lack of competitiveness, U.S. olefin plants are now the low cost world producer with similar economics to Middle East plants that, however, must ship products to distant markets. Both U.S. and foreign companies are investing huge amounts of money  in new plants here, with eventually far more capacity than can be absorbed by the U.S. market. But in the meantime, profits are incredibly high as domestic producers sell into a world market where prices are set by marginal producers in Europe, China and elsewhere. So, where do we go from here?

Accenture has just released an interesting report entitled “Exploiting Big Bang Disruption in the Chemical Industry”, partly based on a book by Larry Down and Paul Nunes on their “big bang disruption for industries” theory.  For people familiar with the history of the ethylene/petrochemical industry the concept makes sense, though we favored a simpler model that roughly went (1) demand growth, (2) supply constraints/high profitability), (3) overinvestment and (4) unprofitable period (Example (1981-1986) (1987-1989) (1988-1991)(1991-1994). This type of cyclical behavior was the norm.

Accenture says that U.S. petrochemicals are now in the high profitability/overinvestment mode (see chart taken from Accenture’s article) and face a “bust” whose consequences can be mitigated with good forward planning and unusual customer relationship management. But, in addition to overinvestment, there will also be another factor, namely increasing availability of cheap shale gas and ethane in different parts of the world (e.g. Europe, Mexico, China) exacerbating the inevitable U.S. overcapacity situation, as ethylene producers in those countries match our economics.  SharkfinSo, what should domestic companies do when the “sharkfin” bonanza is seen to end a few years hence? Accenture’s recommendations make a lot of sense. Firstly, with huge capacities( about 1.6 times the demand in the domestic market), companies must now focus much more on exports rather than traditionally seeing exports as incremental sales. They should form alliances with shipping companies and foreign customers to develop strong, permanent relationships while foreign competitors are still not a problem. This should go beyond normal sales agreements, and should, for example, include technical assistance, including application development with high value customers who will then depend on their U.S. supplier for more than product offtake. Permanent or semi-permanent linkages should be sought,

The “crunch” time for pricing collapse may come around 2020, so its a longer cycle than before. This should give the more forward-looking domestic firms time for some realistic long range planning.

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Unusual forms of carbon: Growing Commercial Uses

Scan Richard Smalley’s team’s discovery of Buckyballs( Fullerene) at Rice University in 1985 was a breakthrough in the knowledge of so-called allotropic forms of carbon. Thirty years have now gone by, but commercial applications of these interesting shapes of carbon are still hard to find. Not so for carbon nanotubes, a cylindrical form of fullerenes and for graphene, arguably the most important form of allotropic carbon other than diamonds.

Carbon nanotubes are cylinders of one or more layers of graphene. This is an extreme thin transparent sheet of carbon which is 100 times stronger than steel and an excellent conductor of heat and electricity, first produced in 2004. Graphene is a honeycomb lattice of carbon atoms. images Because of its atomic structure, graphene is the most reactive form of carbon.  It generally needs to be bonded to another material (nickel, copper, iridium) to make it usable. Graphene is a superb conductor of electricity, supporting current densities 1,000,000 times that of copper.  Graphene’s large surface area and other properties make it an ideal candidate for manufacture of medical devices, electronics, ultrafiltration, structural materials, battery energy systems and photovoltaics (displays). Batteries, in particular, could benefit hugely if certain problems can be overcome: Graphene-based batteries could be charged much faster than current lithium ion batteries (minutes instead of hours) and with greater storage capacities.While the current market for graphene uses is only around $9 million, estimates of billions of dollars have been forecast if graphene’s promise for electronics and batteries is realized (!).

Carbon nanotubes, which have been exploited for some time now, are used as electrically conductive fillers in plastics, for various painting applications in automobiles, in composite wind turbine blades, in inks, as a filtering medium (e.g. for desalination plants), in anti-fouling paints for boats, as transparent conductors and in anti-ballistic vests. With similar but enhanced properties as carbon fiber, carbon nanotubes are now used in composites for bicycle bodies and tennis rackets.Current world capacity for carbon nanotube applications reached five thousand tons in 2011. But graphene is considered a much greater technological breakthrough, in part based on the much larger number of graphene patents issued.

Graphene-based storage of electricity could be the “holy grail”. Previous posts on this blog have discussed the growing need and use of different types of electricity storage to smooth out the intermittent production of power by wind and solar energy. Could graphene provide a useful answer?

 

 

 

 

 

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NAFTA can work both ways: Mexico starts to privatize energy

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The North American Free Trade Agreement, now over twenty years old,  has been very good for Canada and, even more, for Mexico with both countries’ enjoying highly favorable balances of trade with the U.S.  Mexico is increasingly replacing China as a source of our imports, since the cost of Chinese labor keeps increasing and the proximity of Mexico provides the advantage of lower freight costs and quicker delivery. But a very recent development in Mexico will now become a boon to U.S. energy and related companies, which are already transporting and selling huge amounts of natural gas to our neighbor South of the border. This may help to quiet some of the people here who have been opposed to NAFTA from the start.

After almost eighty years of inept management of Mexico’s vast hydrocarbon resources, the country’s senate last month voted to allow outside companies to participate in the exploration and production of natural gas and crude oil. Readers may know that President Cardenas in 1938 expropriated Standard Oil and other U.S. oil companies’ assets and denied outside oil companies the right to operate in Mexico. Petroleos Mexicanos (Pemex), the country’s national oil company, at that time received the monopoly to explore for, produce, refine and distribute hydrocarbons. A combination of lack of expertise and corruption has seen Mexico’s output of oil and natural gas fall sharply, with oil output decreasing almost a third over the last ten years and refining capacity unable to meet refined fuel demand, causing Mexico to import gasoline.

A particularly dire situation on natural gas may have speeded the process of liberalization. While doubling its spending to $ 20 billion on trying to increase crude oil production, Pemex chose to neglect investment to enhance production of natural gas from the world’s sixth largest natural gas reserve (545 Tcf).  With its economy booming, in part due to steadily increasing exports to the U.S. and elsewhere, natural gas demand rose rapidly, leading to huge imports of gas from the United States. When these flows of gas reached the limit of pipeline capacities, Pemex started buying LNG at $ 19.45 per million Btu (!)

The new privatization directives  Pemex will partner with private foreign companies, with profit-sharing agreements, production sharing agreements and licenses. Ownership of the resources will stay with Pemex. The reform will also liberalize production of electricity in Mexico. Both Pemex and Mexico’s Federal Electricity Commission will be transformed into “productive state companies” with control over their budgets.  This will allow them to act more like corporations and become more competitive. The private sector will now also be allowed to build, operate and finance electrical transmission and distribution facilities.

With Mexico now anxious to greatly increase its oil and gas production, U.S, companies i9nvolved in exploration, drilling, production and transmission will soon start to export various kinds of equipment to Mexico, creating jobs on both sides of the border.

 

 

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