Navigant Research Blog

Oil Price Crash Rocks Producers’ Worlds

— December 22, 2014

The effects on U.S. consumers of the steep decline of oil prices in recent months have been very welcome: in mid-December, average nationwide gas prices dropped below $2.50 a gallon, leading some analysts to predict a very green and merry Christmas.

The geopolitical ramifications, however, are much less benign.  They can be seen most visibly in Russia, where the value of the ruble is collapsing and the economy is slipping into recession.  The impacts of a crippled economy, clobbered by plummeting oil prices and economic sanctions over the annexation of Crimea, on the government of Vladimir Putin are impossible to predict.  But Russia in chaos is not a good thing for international security.

The December issue of Navigant’s NG Market Notes examines the likely implications of the current price dive on the global oil and gas industry.  Below is a rundown on the consequences in three critical OPEC countries.

Venezuela

Plunging oil prices have deepened Venezuela’s economic crisis, bringing “massive shortages of basic goods, the world’s highest inflation rate, and a steep currency devaluation,” according to Bloomberg Businessweek.  The decline poses a serious threat to the government of President Nicolas Maduro, who has attempted to continue Hugo Chavez’s program of massive socialized welfare and subsidized prices.  In mid-December, Fitch Ratings downgraded Venezuela’s credit rating to “CCC,” which signals a strong possibility of default.  Low oil prices also deepen Venezuela’s dependence on China, which has lent some $40 billion to prop up the faltering Venezuelan economy through loans and other credits.  Venezuela now exports about 540,000 barrels of oil a day to China, most of which is unprofitable because it goes to repay Chinese loans.

Iran

Overruled at the November OPEC meetings in its bid to push the producing countries to cut production, the Islamic Republic of Iran has moved to the paranoid phase.  Oil minister Bijan Zanganeh declared, “The prolongation of the downward trend of the oil price in world markets is a political conspiracy going to extremes,” according to the British newspaper The Telegraph.  Iran’s currency, the rial, has lost 8% of its value against the dollar in recent weeks as Iran copes with not only plummeting oil prices, but also the crippling effects of economic sanctions from Western nations over its pursuit of nuclear weapons technology.  The impact is also being felt in neighboring Syria, where the Assad regime is propped up in the country’s 4-year-old civil war by support from Shi’ite Iran.  Iranian officials have insisted that support for Syria will continue.  But the steep price fall “will break Iran’s back, not just the level of support for Assad,” a Syrian businessman told Reuters.

Saudi Arabia

Perhaps the most significant effects of falling oil prices can be seen in the Kingdom of Saudi Arabia, the world’s biggest oil producer for decades until being overtaken by Russia and, more recently, the United States.  The Saudis, who can produce oil from their desert fields at a cost of as low as a few dollars per barrel, have calculated that, at least for the time being, they can endure the effects of very low-priced oil.  In so doing, they are choosing to price other, higher-cost producers out of the market.  Already, production in the North Sea and western Canada is jeopardized, although the common notion that the Saudis are waging a “war on shale” by making U.S. shale oil production uneconomical is probably wrong.  U.S. shale producers can still make money with prices as low as $30 a barrel, according to Morgan Stanley.  How long Saudi Arabia can put up with oil below $70 a barrel, however, is an open question.  The desert kingdom has spent billions on defense, largely with U.S. material, in the last 5 years.  According to RBC Capital Markets analyst Helima Croft, whose calculations were presented on BusinessInsider.com, if prices persist at around $75/barrel, Saudi Arabia’s government reserves could be depleted by 2018.

 

As Demand Soars, Construction of LNG Terminals Booms

— November 24, 2014

International marine construction companies are seeing a bonanza of new projects as countries around the world approve massive new terminals for liquefied natural gas (LNG) – for imports in most cases, and for exports from North America, Australia, and some Southeast Asian countries.  Altogether, this frenzy of port building could amount to hundreds of billions of dollars over the next decade as seaborne trade in LNG climbs to meet spiraling demand, particularly in the energy-hungry countries of China, India, and other Asian nations.

Total deliveries of LNG were flat in 2013 compared to 2012, according to the BG Group, but this masks pent-up demand, as producers in the United States are ramping up export capacity and importing countries are scrambling to build import terminals.  BG Group forecasts that worldwide LNG demand is expected to increase at a rate of 5% annually through 2025, with much higher rates in the developing countries of Asia.

North America

In September, the U.S. Federal Energy Regulatory Commission (FERC) gave final approval to the Cove Point LNG facility, overruling the objections of environmental groups and bringing to four the number of U.S. export terminals officially approved and under construction.  All told, 14 terminals are seeking approval by federal regulators in the United States, on the Gulf Coast, the East Coast, and the Pacific Northwest.  The Northwest facilities, in particular, face fierce opposition from environmentalists opposed to the increased fracking that large quantities of U.S. exports will entail.  With big potential markets waiting not only across the Pacific, but also in Europe, U.S. oil & gas companies and their representatives in Washington, D.C. are eager for more export capacity to come online.  There are also at least a dozen LNG terminals proposed along the coast of British Columbia.

Europe

With unrest in Ukraine giving rise to fears of disruptions of natural gas supplies from Russia, which provides 30% of Europe’s natural gas, European governments and companies are scrambling to build new import facilities.  Paradoxically, with international supplies limited and with Japan, which relies more heavily on imported natural gas for its energy supply than any other country, soaking up much of the available supply at inflated prices, imports to Europe have declined in the last couple of years.  The Gate terminal on the North Sea coast near Rotterdam was built with the support of the Dutch government to maintain the Netherlands’ status as a regional gas hub.  It is now running at 10% of capacity, according to The Economist.

Nevertheless, imports from the United States are sure to increase, and the European Union sees the construction of new import terminals as a critical matter of regional energy security.  Lithuania, for example, is due to open a massive new floating terminal this year or in early 2015.  New terminals are especially important along Europe’s vulnerable southeastern coast, as currently countries in the area are essentially captive customers to Russia’s Gazprom.

Amos Hochstein, the acting U.S. special envoy and coordinator for international energy affairs, testified recently before the Senate Foreign Relations Committee, saying that “[there is a] critical need for Europe to improve its energy infrastructure by constructing new pipelines, upgrading interconnectors to allow bidirectional flow, and building new LNG terminals to diversify fuel sources … We support proposals to build LNG terminals at critical points on European coasts, from Poland to Croatia to the Baltics.”

Asia

The biggest building boom is underway in China, where three import new terminals came online in 2013 and at least two more are expected begin operation before the end of this year.  Already, half of the world’s capacity for regasification (the conversion of LNG to conventional natural gas, for transport by pipeline) is located in Asia.

“China’s imports of liquefied natural gas (LNG) are growing at a record pace,” reported Reuters earlier this year, “as it aims to use cleaner fuels to cut smog in big cities, creating a powerful new source of demand that has the potential to reshape the market for the super-chilled gas.”  China’s LNG imports grew 35% in the first quarter of this year compared to the same period in 2013.

Meanwhile, new production is emerging from Southeast Asia, particularly in Indonesia and Papua New Guinea.  Also, Singapore, which sits at the mouth of the Strait of Malacca, through which passes more than half of the world’s seaborne LNG, has formed ambitious plans to be the LNG trading hub for Southeast and East Asia.

These LNG terminals tend to cost around $10 billion apiece.  It’s a good time to be in the business of building them.

 

Finally, Germany Makes Progress on Coal

— November 2, 2014

For critics who scoff that Europe’s carbon emission reduction goals are unachievable, Germany has become Exhibit No. 1.  Since Chancellor Angela Merkel decreed in the wake of the Fukushima Daiichi nuclear accident that Germany would phase out its nuclear power industry, coal use in Germany has been on the rise, and the country’s carbon emissions have remained stubbornly high.

Now it appears that tide may be turning.  According to AG Energiebilanzen (“Working Group on Energy Balances”), an energy research firm, total energy consumption in Germany is projected to fall by 5% in 2014, compared to 2013, to the lowest level since the fall of the Berlin Wall.  Coal consumption for the year is expected to be down more than 9%.

Those declines are due mostly to the mild winter in 2013-2014, but clean energy is expanding as well: Renewable energy use grew by 1.6% over the first 9 months of 2014, compared to the previous year.

The Brown Stuff

Germany’s coal use carries particular importance not only because it is Europe’s biggest economy, but also because Germany burns mostly lignite or “brown coal,” the dirtiest form of coal, and because Germany’s green energy program, known as the Energiewende, is among the most ambitious in the world.  While renewable energy production has expanded rapidly in Germany – accounting, at times, for 100% of the country’s power demand and forcing utilities to pay customers to consume electricity from conventional power plants – the nuclear phase-out has led to a rise in the burning of coal for baseload power supply.

Now, the government is at least considering shutting down coal plants.  German minister Rainer Baake of the Green Party told reporters in late October that the government could come up with a plan as early as December to eliminate coal-fired capacity and boost energy efficiency programs.  Earlier Der Spiegel reported that the government wants to eliminate as much as 10 GW of coal capacity.  A decision will likely not come until next year.

Please Exit

Getting rid of coal is critical if Germany is to reach its target of cutting greenhouse gas emissions 40% compared to 1990 levels by 2020.  The environment ministry has said that if current trends continue, the country will fall short of that goal by 5 to 8 percentage points.

Meanwhile Swedish energy giant Vattenfall, one of Europe’s largest operators of power plants, said it will seek to sell off its coal-fired plants in Germany.  Vattenfall’s coal operations in Germany produce some 60 million tons of carbon dioxide (CO2) a year – more than Sweden’s total CO2 emissions.

Like a drunk uncle at a wedding, Germany’s coal industry is an embarrassing and unwelcome guest that everyone would like to usher to the exit.  Getting it out the door, though, remains a tough task.

 

As Rail Congestion Crimps Coal Supplies, Calls for Expansion Grow Louder

— October 27, 2014

Even as power plant operators are warning of coal supply shortages come winter, the U.S. government has predicted that congestion on the nation’s railways is likely to get much worse in coming years.

Increased freight traffic traveling by rail – particularly crude oil from the Great Plains and grain from a bumper crop this year – has led to significant bottlenecks across the railway network, the Government Accountability Office (GAO) said in a report issued in September.  Rail traffic has reached the levels last seen in 2007, before the global recession, and “recent trends in freight flows, if they continue as expected, may exacerbate congestion issues in communities, particularly along certain corridors,” the GAO concluded.

Sounding a more dire warning, Hunter Harrison, the CEO of Canadian Pacific, said during a recent analyst briefing that the entire North American railway system is headed toward a cliff.  “We’re quickly approaching a time where none of this works,” Harrison said, according to the Financial Times.  “We cannot continue to go down the road that we’re going down and be successful and not have gridlock beyond anything we’ve experienced before.”

On to Chicago, Slowly

Like a slow train spotted in the distance, this fall’s tie-up of train traffic has been anticipated for years.  The domestic oil & gas boom, centered in the Bakken formation in North Dakota, has had ripple effects across the upper Midwest, the Rocky Mountains, and the Pacific Northwest.  Chicago, where all seven of the Class I railroad companies have major yards, is one of the biggest bottlenecks.  Rail transport is relatively low-cost and emits less CO2 than shipping by plane or truck, but investment in rail infrastructure has been slow.  Producers and consumers of coal, in particular, have traditionally been trapped in exclusive contracts that give them little leverage in negotiations with rail providers.  In September, Democratic Senator Jay Rockefeller of West Virginia introduced the Surface Transportation Board Reauthorization Act, which would increase the authority of the Surface Transportation Board, which regulates railroads, to force them to remedy service delays and justify rate hikes.  Lawmakers chided rail executives at a September 10 hearing in Washington for their failure to anticipate and keep up with increased demands on the railway system.

The problem is especially acute for mines in Wyoming’s Powder River Basin trying to ship coal to customers.  Big coal-burning utilities have already begun running coal plants at below capacity in order to conserve coal stocks.

Ship Gas, Not Coal

Some of this alarm is likely overstated; no one has suggested that coal plants are actually in danger of running out of fuel this winter.  And despite the transport constriction, the price of Powder River Basin coal remains stubbornly low; the price of a ton has dropped 8%, to $10.80, according to Bloomberg.  As a matter of national policy, it makes sense to reduce shipments of dirty coal by diesel-burning trains to supply aging power plants that are quickly becoming uneconomical anyway.  Meanwhile, tight coal supplies will inevitably lead to louder calls for other types of energy transport infrastructure: namely, natural gas pipelines.

There are good reasons to invest in expanding the nation’s railway infrastructure; shipping more coal is probably not one of them.

 

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