Navigant Research Blog

Oil-Gas Price Swings Slow New Energy Investment

— February 18, 2015

As I wrote in this blog in 2012 and in 2013, rising volatility in the oil-to-gas ratio points to a substantial shift in market dynamics for clean energy. Even if short-lived, this shift will have substantial implications for investment in new energy technologies.

In recent years, as the price of oil climbed to over $100 a barrel, the oil-to-gas ratio—which compares the price of a barrel of crude oil to that of a million Btu (mmBtu) of natural gas—spiked to as high as 52:1 in a single month from a relative constant of around 10:1. While this apparent equilibrium had held steady since the mid-1980s, the widening gap between the price of oil and that of gas seemed to represent a new reality, with natural gas prices holding below $3 per mmBtu (Henry Hub).

In the last several months, as oil prices have slid to less than $50 per barrel, that ratio has come crashing back down to Earth. At a current 13:1, the oil-to-gas ratio is once again nearing historic levels—and again reshuffling the deck for a cleantech industry yearning for macroeconomic certainty.

Ratio of Crude Oil to Natural Gas: 1990-2015

Oil-Gas

(Source: Navigant Research)

While the boom in shale oil and gas recovery (among other factors) has ushered in an apparent return to historical equilibrium, experts are divided on what the future holds. Some argue that the recent spike in the oil-to-gas ratio was a short-term anomaly and that forces will continue to act to bring prices back into their long run equilibrium. Others question whether a stable long-term relationship between crude oil prices and natural gas prices even existed in the first place.

While the jury is still out on the putative correlation between oil and gas prices, we can expect continued volatility in the oil-to-gas ratio. This creates a challenging environment for new energy technologies going head-to-head with existing infrastructure.

The Incumbent Edge

Volatility dampens growth in new energy technologies in several ways. First, it cools investors’ appetite for clean energy ventures, due to the potential risk that seemingly profitable investments one day may turn out to be unprofitable due to changing fuel costs. Building natural gas infrastructure may look attractive in 2012 if you’re in the United States, for example, but not so wise when the price of a barrel of crude oil drops by more than 50% in 2014. This is an issue of asset stranding.

Second, it lowers customers’ tolerance for risk. As noted in our recently published report, Combined Heat and Power for Commercial Buildings, the impact of price swings are most acutely felt by consumers looking to hedge with one fuel against the other. When oil prices accelerated past $100, consumers of heating oil and gasoline, for example, began looking to natural gas alternatives. These decisions can be straightforward when price signals are stable, but actual (or even perceived) volatility favors a wait-and-see approach.

The Underminer

Third, it undermines the role of incentives and other mechanisms for stimulating the deployment of new energy technologies. Still more expensive than incumbent technology in most cases, clean energy has enjoyed incentives that put emerging energy technologies on an even playing field with fossil fuels. Fuel price volatility can make it especially challenging to establish reasonable incentive levels for the long term.

While Navigant Research’s forecasts for distributed generation technologies like solar PV (see our Global Distributed Generation Deployment Forecast report) and energy storage (see our Community, Residential, and Commercial Energy Storage report) in the United States remain strong despite lower energy prices, volatility is likely to mostly benefit the status quo.

 

With Cheap Oil Flowing, U.S. Looks to Next Energy Revolution

— January 26, 2015

With oil prices continuing to languish and Saudi Arabia moving through a royal succession upon the death of King Abdullah, the idea that the “OPEC era is over” has gained credence among government officials and industry analysts. “Did the United States kill OPEC?” asks New York Times economics reporter Eduardo Porter. The answer, he argues, is essentially yes: “The Nixon administration and Congress laid the foundation of an industrial policy that over the span of four decades developed the technologies needed to unleash American shale oil and natural gas onto world markets,” thus loosening OPEC’s grip.

The reality is a bit more complicated than that: OPEC still produces nearly 40% of the world’s oil; the United States produces less than 18%. And oil at $50 a barrel could actually increase OPEC’s power as producers of unconventional reserves, which are more costly to produce, are driven from the market. Like the coal industry, OPEC is not going anywhere anytime soon.

The Big Opportunity

The shale revolution does, however, offer some other welcome knock-on effects, if policymakers are alert and astute enough to take advantage of them.  “Cheaper oil and gas will contribute an estimated $2,000 per American household this year, and $74 billion to state and federal governments coffers,” note Ted Nordhaus and Michael Shellenberger of the Breakthrough Institute, a San Francisco-based energy and climate think tank. The Breakthrough Institute has done extensive research on the role of public-private partnerships in the development of the seismic and drilling technology advances that underlie the shale revolution. Should the government choose to take advantage of it, this windfall could fund a multi-decade R&D program for renewable energy similar to the one that led to the shale boom.

“We can afford to spend a tiny fraction of the benefits of the bounty that cheap oil and gas have brought so that our children and grandchildren can similarly benefit from cheap and clean energy in the future,” declare Nordhaus and Shellenberger.

The Gas Tax Solution

That’s an inspiring concept. The execution is likely to be messy, though. Any such spending would probably need congressional support, or at least consent – and the U.S. Senate only last week finally reached agreement that “climate change is real and not a hoax.” That’s a long way from dedicating billions to develop alternative energy sources.

One suggestion put forth by clean energy activists is an increase in the U.S. gas tax. A few cents extra per gallon (on gas that’s about half the price it was a year ago) could help fund a massive crash program to develop inexpensive, clean energy technology (not to mention shore up the failing U.S. Highway Trust Fund).

But raising the gas tax is like the National Popular Vote – a terrific idea that’s unlikely to happen in our lifetimes. Even though polls consistently indicate that consumers are willing to spend slightly more for the energy they consume in order to limit climate change, actually slapping extra taxes on motorists at the pump is unlikely to be a winning move in Washington – which explains why President Obama left it out of his call for a “bipartisan infrastructure plan” in his State of the Union address.

 

How Oversupply Could Benefit the World Oil Market

— January 19, 2015

For economists, it has been fascinating to watch what’s been happening in the oil & gas market since OPEC’s meeting in November, when it decided (driven by Saudia Arabia) to maintain production of 30 million barrels of oil per day.  This decision, combined with the sharp rise in U.S. production and a decrease in demand driven from China’s slowing economy, has sent oil prices to their lowest levels since May 2009.  Saudi Oil Minister Ali al-Naimi has explained that OPEC’s reason for maintaining the production level is to recoup market share lost to what he considers high-cost or inefficient non-OPEC oil producers, such as Russia, Brazil, and Canadian tar sands producers.  Of course, there’s also a geopolitical side to the story, but let’s take a deeper look at the situation in economic terms.

The demand for oil is fairly inelastic to price; that is, as the price changes, demand stays relatively consistent, especially in developed countries.  As such, OPEC has been able to essentially set the price of oil by choosing how much to produce.  Over the past 5 years, however, non-OPEC oil production has exploded, especially in the United States.  The country, which was OPEC’s biggest customer only 10 years ago, is now the world’s largest producer of total oil (crude and natural gas liquids) and moving toward self-sufficiency.

Consumers’ Delight

OPEC has typically responded to increases in non-OPEC oil supply by cutting its own production in order to keep the price of oil above $80 per barrel.  Now it appears the oil market and OPEC have reached a turning point as the huge influx of supply and a slowing of demand growth from China and Europe (among other reasons) have sent the price of oil on a steady decline since June.

At the meeting in November, OPEC ministers faced unenviable choices.  They could cut production in order to raise the price of oil and increase their margins in the short term, but this would not have served them in the long run.  If only OPEC cuts production, not only do their competitors share the benefit of higher margins, but also OPEC concedes more market share.  Instead, OPEC decided to forego profits in order to thin out the herd.  By declining to cut production, the Saudis hopes to drive higher cost producers out of business while giving oil-consuming economies a shot in the arm.

Thinning the Herd

As my colleague Richard Martin has pointed out, the stronger members of OPEC (i.e., Saudi Arabia and Kuwait) can likely withstand drastic price declines, while the weaker members (Venezuela, Iran, Nigeria, and Algeria) could face economic disaster.

The current market trajectory will end up benefiting those countries that have a comparative advantage in oil production, as it should, and it’s likely that the market will be left more efficient and better off in 2 to 5 years as a result.  According to some, the U.S. might actually be better positioned for a price war than Saudi Arabia, which as a society has grown accustomed to the benefits of $100/barrel oil.  According to Naimi, we may never see $100/barrel oil again.  As far as he’s concerned, Saudi Arabia and OPEC will see this price war through, regardless of how low it goes: “Whether it goes down to $20, $40, $50, $60, it is irrelevant.”

As for the effects of all this on the natural gas market and renewables, that’s for another blog.  The December issue of Navigant’s NG Market Notes includes a great infographic about the breakeven prices of oil for producers around the world.

 

Have Oil Prices Peaked?

— December 30, 2014

Increasing non-Organization of the Petroleum Exporting Countries (OPEC) oil supply and waning worldwide demand has resulted in an oil price dive.  The U.S. average retail price of gasoline is now at its lowest point since 2009, and given OPEC’s commitment to maintaining current production rates, the dive has no clear end.  The far-reaching implications of this plunge are explored in the latest issue of NG Market Notes from Navigant’s Global Energy Practice.  The most likely impacts will be on energy sector job growth, oil production expansion, and the hotly debated Keystone XL pipeline.

The historic volatility of oil prices leaves little certainty that current low prices will persist.  However, increased and sustained production capacity growth from non-OPEC sources appears to provide predictable downward pressure.  Given that, OPEC expects that the U.S. oil boom will last until 2020 before declining.  By then, the shale boom enjoyed by the United States is unlikely to be an isolated North American occurrence.

A Spreading Boom

Instead, the technological innovations that have enabled the extraction of tight oil at competitive prices in the United States are likely to migrate to a number of plentiful basins in Russia, China, South America, and elsewhere.  As a result, low prices could become the new norm.  Similarly, thanks to a combination of energy efficiency technologies and tightening government policies, world energy demand is likely to remain sluggish, further sustaining the oil glut.

The BP Statistical Review of World Energy indicates that annual global production of oil was around 4.1 billion metric tons (4.5 billion U.S. tons) in 2013, while Navigant Research’s report, Transportation Forecast: Global Fuel Consumption, projects that the global road transportation sector will consume nearly 1.7 billion metric (1.87 U.S. tons) in 2014, over 41% of production.  In North America, Europe, and some developed Asia Pacific nations, demand from this sector is anticipated to drop significantly from 2014 to 2035.  The increasing use of biofuels, plug-in electric light duty vehicles, natural gas-powered commercial trucks and buses, and national fuel efficiency standards will all contribute to this fall.

The Peak Behind Us

The Navigant Research report anticipates that global oil consumption will continue to grow, despite the above trends.  But that growth is peaking and is entirely dependent on increasing vehicle ownership in rapidly growing economies that already have significant traffic congestion and environmental concerns.

All of this is likely to temper new vehicle sales and increase government adoption of alternative fuels and fuel efficiency standards.  As a result, current low oil prices may not be temporary, after all.  Peak oil price may be reached before peak oil.

 

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