As the global price of crude oil continues to hover around $50 per barrel and low liquefied natural gas pricing raises questions over the future of a hoped for Alaska LNG project, what is happening in world oil and gas markets, and how will this impact Alaska? On March 29 Marianne Kah, ConocoPhillips chief economist, presented her views on the current situation, explained ConocoPhillips’ strategy for dealing with the current price environment and talked about how the price situation may continue to impact Alaska.
In Alaska ConocoPhillips operates the Kuparuk River and Alpine oil fields, as well as having ownership positions in the Prudhoe Bay and Point Thomson fields. The company has an active exploration and development program in the northeastern National Petroleum Reserve-Alaska.
The shale revolution
Kah’s overriding message was that the shale oil and gas revolution in North America has upended the international oil and gas markets. This revolution has driven a need to focus investment and effort on resources with the lowest possible cost of supply. And in that situation, Alaska, while occupying a spot in the oil supply curve where viable oil development remains feasible, the state’s industry is in a challenging situation, where any significant cost increase could put the industry at risk.
“I would say that Alaska is in a slightly precarious position,” Kah said. “Right now you’re not quite at the margin. I would say you’re in a reasonably good position, given the status quo business climate.”
Kah also expressed optimism about the potential for a state-led Alaska LNG project, given the state’s potential to significantly reduce the cost of the project through, in particular, the possibility of a federal tax exemption and the fact that the state would have lower return on equity requirement than a private company.
“I’m actually jazzed about the idea of a state-led LNG project,” Kah said. “I realize it has issues. You have ways of reducing the costs so dramatically that it can keep you in the game.”
From decline to growth
Reviewing the shale oil and gas revolution, Kah said that as recently as 2005 there was a forecast of a continuing decline in U.S. oil production and a general belief that the United States was running out of low-cost natural gas.
“Many companies, including ours, actually built re-gasification terminals to bring LNG into the U.S.,” she said.
But following the widespread development of tight oil and gas resources in North America, U.S. oil production is now moving beyond the previous peak that production had hit in 1970. The country is also moving towards becoming a net exporter of LNG. While tight oil plays in the Permian basin, the Eagle Ford and the Bakken are each larger than the Prudhoe Bay field in Alaska, people continue to find new opportunities, Kah said. And the same is true for gas, she said.
“This is a very large production phenomenon and probably one of the key drivers of the oil (price) downturn,” Kah said.
Alaska production stabilized
Despite this huge upsurge in Lower 48 oil production, Alaska production has stabilized and actually increased slightly in 2016. Kah attributed this resilience in part to Senate Bill 21, the bill passed in 2013 that reformed Alaska’s oil production tax.
However, the rapid climb in Lower 48 oil production dropped sharply following the crash in the price of oil after the summer of 2014, as global oil supplies surged ahead of demand: The active rig count in the Lower 48 dropped from about 1,600 to around 450 in just a year. Houston, Texas, was particularly hard hit, with many personnel layoffs.
Now, with the oil price moving towards $50 per barrel, the industry is starting to pick up again, with a doubling of the rig count for horizontal drilling and U.S. production expected to reach a new record by the end of 2018. Continuing productivity improvements in the tight oil industry have kept pushing the supply cost for tight oil ever lower. Oil companies have also seen a major deflation in service industry costs.
The two major questions relating to where oil production may go from here are the extent to which the productivity decline from tight oil wells can be stemmed, and the extent to which this productivity improvement will be offset by service cost inflation as the oil industry recovers, Kah said. Production rates from tight oil wells have been continuously improving, while the time taken to drill wells has dropped. That has pushed the cost per barrel of oil down, moving the target cost for beating shale oil economics from a range of $50 to $80 down to a range of $30 to $50 barrels, Kah said.
And technical innovation continues, with, for example, new perforating techniques and technology for using data to determine the optimum spots to drill into. Recent discoveries concerning the need for a higher density of wells to fully access the oil in a tight oil play have enabled ConocoPhillips to up its own tight oil resource estimates by 40 percent, Kah said.
The supply curve
Shale oil appears at several positions on the worldwide oil supply curve, the curve plotting the supply cost for incremental oil production in different worldwide regions. However, a common feature of shale oil is that the incremental volume occupied by the resource on the curve keeps stretching out, thus pushing more expensive oil resources higher up the incremental production table, knocking some of that higher cost resource out of contention for meeting future world oil demand. Alaska is in a slightly precarious position, on the margin for competitiveness but better than oil sands, for example, Kah said.
Kah said that ConocoPhillips has lined up its own resource portfolio on a supply curve and now has a policy of only investing in the lower cost of supply projects. The company plans to continue with this strategy to maintain an immunity against oil price changes, even if oil prices increase.
“We are deciding that we are going to live in a lower cost of supply world, whether or not the world stays in a low price situation,” Kah said.
However, ConocoPhillips has not reduced its Alaska spend by much, in part because the state did not see the huge ramp up of production seen in the Lower 48, she commented. On the other hand, the recent disposal of ConocoPhillips oil sands position in Canada provides an example of the company cutting some of its higher supply cost assets.
Increased price volatility
Kah thinks that the relatively short development timeframes for shale oil will cause shale oil to trigger increased oil price volatility, a volatility also heightened by the fact that most oil demand growth is now coming from China, India and other developing countries. The international pricing of oil with an appreciating U.S. dollar may also impact the world oil market. Other uncertainties potentially affecting global economic growth and hence the oil market include the stability of Chinese economic deceleration and the departure of the United Kingdom from the European Union.
Kah said that she does not agree with the theory that the world is about to hit peak oil demand, as a consequence of emerging technologies such as autonomous road vehicles. The widespread use of these technologies still lies quite a few years in the future, and the impact of the technologies on fuel demand is unknown, she suggested.
And the history of the oil price has displayed such volatility and unpredictability in the past that ConocoPhillips has begun to take a view that the complexity of the oil market may prevent the market ever establishing an equilibrium price - rather than trying to predict that equilibrium position, the company now spends more time trying to figure out what the price trajectory may be, Kah said.
Analysts are forecasting oil prices in the range of $50 to $80 in 2020. Proponents of the $50 level argue that continuing innovation in tight oil production will hold prices down, while advocates for a higher price believe that oil from the more expensive end of the supply curve will continue to be needed and will thus set the price.
Kah said that her view lies somewhere between these extremes. It does not appear that between now and 2020 the world will need more oil than can be provided by countries in the Organization of Petroleum Exporting Countries, tight oil, and from development projects that are already underway, she said.
The gas market
From the perspective of natural gas, the relative ease of producing tight gas from shale gas plays has resulted in a huge ramp up of U.S. gas production, with the Marcellus Shale on the eastern side of the country leading the pack when it comes to gas producing regions. The fact that much of the gas lies in privately owned land has contributed to the speed of development, Kah commented.
The major gas price decline that has resulted from the gas glut has caused production to flatten. But, as productivity from gas wells improves, using lessons learned from tight oil production, gas production will probably start rising again, Kah suggested.
Although this abundant gas can act as a clean and relatively inexpensive fuel for power generation, mandates and tax credits for wind power in regions such as Texas have distorted the economics, pushing down the use of gas as a bridge fuel in the transition to a low carbon future, Kah said. The same issue arises in Europe, she said.
As a consequence, the biggest source of demand growth for U.S. gas is the export of LNG from the Gulf Coast, where the construction of LNG plants is relatively cheap. The demand for low-cost gas in petrochemical facilities is also buoyant, Kah said. In addition, the pipeline export of gas to Mexico presents a major opportunity, she said.
With a worldwide oversupply of LNG, much new Gulf Coast LNG capacity will not be used, especially given the fact that the feedstock for these plants is more expensive than in regions that have stranded gas to sell. Australia, for example, has lower fuel prices and is closer to Asian markets than the Gulf of Mexico, Kah said. And as global LNG prices have dropped, the pricing in different regions of the world has converged.
LNG growth potential
However, worldwide LNG demand continues to grow, with the strongest growth expected to come from China and India. Moreover, the abundance of cheap LNG opens markets in smaller countries such as Pakistan and Argentina. Given the inability to store LNG in large quantities, there will not be a world surplus of LNG. Instead, the LNG price will drop to a level where demand moves into balance with supply, Kah said. However, sooner or later the world will need new LNG capacity. And, as demand starts to move ahead of supply once more, European and Japanese prices can be expected to increase relative to prices in other regions, she suggested.
Kah said that an Alaska LNG project could work, given the state’s ability to reduce the cost of the project. Bearing in mind the long-term nature of the project, it is possible that the project could come on line at a propitious time in relation to the world LNG market.
“I certainly think it is still on the plate of opportunity for Alaska,” Kah said.
In general, for Alaska to remain competitive in the global oil and gas market, the state needs a competitive and stable fiscal policy. Greater access to federal land, with a reliable and timely federal permitting process, is also required, Kah said.
