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Taking a long-term view on pricing The sudden fall in oil prices is hitting Alaska, but what might the short-term outlook lead to for the state’s oil and gas industry Alan Bailey Petroleum News
It takes a brave person to attempt to predict the price of oil and gas more than, say, a few hours ahead. So, what does the current plunge in oil prices really mean for Alaska’s oil and gas future? And is there any solace to be found in what appears to be a descent into a world of declining oilfield returns and falling state revenues?
On Dec. 8 during Law Seminar International’s annual Energy Markets and Regulation in Alaska conference, Paul Carpenter, principal and chairman of the Brattle Group, cautioned about the importance of taking a long-term view of oil and gas markets, suggesting that some of the current market dynamics could end up working in Alaska’s favor.
“We can get awfully wrapped up in assessing what we think the effect of short-term events in the market are, particularly in commodity markets like this, and miss the longer-term trends,” Carpenter said. “We have to understand what’s going on today but keep a sober view of where it may all shake out.”
With oil prices dropping in a market-share war between Saudi Arabian crude and U.S. shale oil, some high-cost production may be forced out of the market. And, with liquids production in shale plays currently subsidizing North American gas production, low oil prices could have the converse effect of pushing gas prices up. Then, if oil prices rebound in the future, that could enable Alaska North Slope oil production to increase and could favor Alaska liquefied natural gas exports, Carpenter said.
Volatile market Citing the late Morris Adelman, a noted energy economist, Carpenter said that while the potential availability of expensive oil production coupled with the dampening impact of high oil prices on consumer demand places an upper ceiling on the price of oil, instabilities within the Organization of the Petroleum Exporting Countries, the cartel that tries to control the world oil market, can lead to oil price volatility. And once the price starts falling as at present, the price can go very low. Currently the marginal cost of production from Saudi oil wells, probably $10 to $20 per barrel, would presumably set a threshold below which current production would no longer prove viable.
But viable investment in new wells, to increase production, would require a somewhat higher price level. Some consultants have suggested that prices in the range of $50 to $60 are required for the continued growth of U.S. shale oil production, Carpenter said. However, with oil companies hedging oil prices a few years into the future as part of their risk management strategies, low oil prices may not start having a significant impact until around 2016, he commented.
On the other hand, there have already been reports of drilling cutbacks in 2015. And, with small independent oil companies accounting for perhaps 18 percent of high-yield bonds in the bond market, low oil prices could cause significant financial distress for these companies which have been drivers behind some shale gas development, especially in the Marcellus shale, Carpenter said.
However, there has been an emphasis on drilling liquids-rich gas wells in recent years - the Energy Information Administration estimates that about 60 percent of new gas wells produce both oil and gas. So, if the gas-subsidizing impact of oil production from these wells is hit by low oil prices, the price of gas should rise. One consultancy has estimated the need for a breakeven gas price of $5 or $6 per million British thermal units if oil prices drop to $50 or $60 per barrel, Carpenter said.
Price gap But that potential trend leads to interesting questions over the comparative price of oil and gas, and the impact of the price gap between the two commodities on the liquefied natural gas market - the contract price of LNG in Asia is typically indexed to the price of oil.
“That (price) gap is critical to new LNG export projects, because they are all about geographic price arbitrage between oil-linked Asian contract prices and North American gas prices,” Carpenter said.
Recent data do seem to point to some price convergence. A Credit Suisse evaluation in the last couple of weeks indicated that, with Brent crude priced between $60 and $85, the price of LNG delivered in Japan would lie in the range $10 to $13 per million British thermal units. At the same time, if the price of natural gas on the U.S. Henry Hub market is about $4, that should translate to an LNG cost when delivered in Asia of about $10.40 - Cheniere Energy, a U.S. LNG company, has been forecasting a delivered price for LNG in Asia of about $11.90, based on a $4 Henry Hub price, Carpenter said. At a Henry Hub price of $6, the cost of LNG in Asia would be about $12.70, he said.
Alaska gas has the advantage of not being tied to the Henry Hub market. An estimated cost of $45 billion to $65 billion for the project to export Alaska LNG, using North Slope gas, translates to a gas price of $8.50 at Nikiski on the Kenai Peninsula, from where the LNG would be shipped to Asia, Carpenter said. Then, factoring in the cost of transportation to Asia, the cost in Asia would be in the $9 to $10 range, he said.
“So, all of this stuff seems to be converging at the moment, if you believe that the oil price we’re seeing now is sustainable for a long period of time,” Carpenter said.
LNG demand But the viability of an Alaska LNG project will depend on future world LNG demand and on competition from other potential LNG exporters. With LNG projects currently under construction likely to meet predicted demand through to 2020, the questions for Alaska will revolve particularly around demand beyond that time. And the International Energy Authority has identified India and China as the likely main sources of LNG demand growth in the longer term, with demand in countries such as Japan remaining somewhat static.
But, although a desire by the Chinese government to improve air quality in China has been driving an increased demand for gas in that country, future Chinese demand is uncertain, in part because of competition from renewable energy sources, from wind energy in particular. Also, the economics of shale gas production in China are not looking particularly favorable - China has entered into an arrangement with Russia for the supply of gas through two Russian pipelines, Carpenter said.
Russia is particularly anxious to export gas to Asia by pipeline, to support large-scale gas production and marketing from so-far undeveloped gas resources in Siberia, with economies of scale potentially making the export of LNG from Siberia viable.
A shakeout? On the other hand, European gas demand has dropped, leading to a growth in the spot market for LNG and a potential glut in LNG spot trading. A glut of this type could bode ill for short-term LNG prices, placing some of the currently proposed LNG projects at risk. A shakeout of LNG projects could work to Alaska’s advantages if the LNG markets pick up in the 2020s, at a time when Alaska exports are able to hit the market.
“As with everything, timing is important,” Carpenter said, cautioning that when uncertainties reign in the market, there is value in deferring investment decisions. People have been waiting for 40 years to monetize North Slope gas, he said.
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