Musings From the Oil Patch December 30th 2014
Comment of the Day

December 30 2014

Commentary by Eoin Treacy

Musings From the Oil Patch December 30th 2014

Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section

The EIA later makes the following point about its scenario in which there is even greater closures of coal-fired power plants, which was authored prior to the EPA’s introduction of its new carbon emission restriction plans for existing power plants. “If additional existing coal-fired and nuclear generating capacity were retired, natural gas-fired generation could grow more quickly to fill the void. In recent years, the number of coal and nuclear plant retirements has increased, in part due to a decline in profitability as low natural gas prices have influenced the relative economics of those facilities. The Accelerated Coal Retirements case assumes that both coal prices and coal plant operating costs are higher than in the Reference case, leading to additional coal plant retirements. In this case, natural gas-fired generation overtakes coal-fired generation in 2019, and by 2040 the natural gas share of total generation reaches 43%. In the Accelerated Coal and Nuclear Retirements case, the natural gas share of total generation in 2040 grows to 47%.”

What if there isn’t sufficient natural gas available, at least at reasonable costs? That would create a serious economic hardship on Americans and the American economy. We suspect one immediate remedy would be to ban the export of all LNG from this country. If possible, there could also be some restrictions imposed on gas exports to Canada and Mexico. If the gas shortage proved even more severe, we would probably begin restarting coal-fired power plants, much like the UK is doing this winter at a significant cost merely to ensure that the UK has sufficient power generating capacity available. What would that cost our economy both financially and in greater carbon emissions? Maybe by the time the gas shortages become severe, we will have addressed the storage challenge for intermittent renewable power sources. Building new nuclear power plants might become an option, but we know that they take years to be constructed so they are not a short-term solution. In either case, the EPA is counting on the EIA’s abundant gas supply scenario as it moves forward with power plant shutdowns.

While this debate over gas production forecasts may seem like a tempest in a teapot, its significance should not be understated. The impact on the future economic strength of the United States if insufficient gas resources are available cannot be underestimated. Not only would we have misallocated energy capital for decades, but we would have significantly altered the health of our public utility industry, possibly leaving it so weak it could not meet the needs of its customers, forcing the federal and state governments to have to bail out the industry. Maybe we need a “time out” before we rush to implement the EPA’s plan to restrict the carbon emissions for power plants to the degree that we force the retirement of much of our coal-fired generation capacity. Rest assured that the gas production forecast debate, while seemingly academic at the moment, will become a much more serious and a more mainstream issue in the coming years.

Eoin Treacy's view

Shale gas has, as predicted, been a true game changer for the energy sector. Let’s look at this question from both the supply and demand sides of the equation. 

On the demand side the EPA is wholeheartedly devoted to the climate change hypothesis. In order to deliver upon commitments to reduce carbon emissions, it is imposing progressively more stringent regulations on coal fired power stations. Since natural gas prices are competitive with coal at current levels this has had little effect on consumers. However it is worth considering that coal is the largest fuel for electricity generation at present and the USA is by far the world’s largest economy. Replacing even more coal with natural gas is going to require a great deal more natural gas than is currently used.

On the supply side the prolific supply of gas and equally abrupt decline profile of shale gas wells necessitates that new wells are constantly drilled in order to maintain the supply profile of a basin and to ensure that sweet spots are exploited efficiently. This is not cheap but it has resulted in massive volumes being delivered over the last number of years. Analysts justifiably question how sustainable the situation is with prices at close to $3. 

Here is a link to the full report.

The last time natural gas prices traded below $3 was in 2012. This is an uneconomic level for the majority of drillers and prompted many to move to liquids rich plays, not least shale oil. With oil prices still trending lower, the outlet for drillers to move to an additional region appears limited. They are understandably retiring drilling equipment at this price level.

Today’s 50% decline by Civeo, a provider of oil worker accommodation, is a testament to the slowdown in drilling activity resulting from the fall in oil and gas prices. 

Natural gas has at least stabilised near $3 but a clear upward dynamic will be required to pressure shorts and signal more than a temporary return to demand dominance. 


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