The big picture

Perry Fischer

January 9, 2013

US crude and condensate production has been falling since 1972 with only a couple brief periods of respite or flattening downward. Most analysts felt that the decline was irreversible. The decline flattened in 1991, 1997 and 2001 and, as a result of a dramatic jump in oil prices, production began a steep upward climb in 2007. While the financial collapse of late 2008/09 pulled rigs and cut back production, operators in areas needing a lot of fractured, horizontal wells, especially those with short lease terms, continued to drill, especially in the Bakken. With recovering economics, that trend continues and is forecast to rise sharply this year, according to the EIA, with annual production growth averaging 234,000b/d through 2019, when production reaches 7.5 million b/d (Figure 1). After about 2020, the EIA forecasts production to decline gradually to 6.1 million b/d, as depletion of the sweet spots that were drilled first gives way to less productive acreage.

graphFigure 1. US crude oil production 1990-2040 (million b/d). Source: US EIA.

Offshore, crude oil production is forecast to undulate between 1.4 and 1.8 million b/d. Development activity will quicken as large projects in the deep and ultra-deepwater areas of the Gulf of Mexico are brought online.

The final leg of the Keystone XL pipeline will provide a major new supply line. Although much of the crude will be refined and shipped overseas, the rest of the gooey Canadian bitumen will add to US supply. Interestingly, George Littell of the forecasting firm Groppe, Long & Littell gave OE this insight: ‘If the Keystone pipeline were to get cancelled, it would probably be the best thing for Canada, because it would force the Canadians to build the pipeline to their West Coast, which is a necessity that they should have started five years ago. It’s clearly in their best interest to do so, to open up access to Asia.’ Most experts, however, expect the Keystone will be completed to the US Gulf Coast.

It should be stressed that the above numbers refer to crude and lease condensate only. When including all liquids, that is, crude, condensate, natural gas liquids (NGLs), refinery gain, biofuels and others, the ‘all liquids’ supply jumps to more than 11 million b/d – well over half of US consumption. A similar measure of ‘liquid fuels supply’ shows imports below 45% and rapidly falling – an unthinkable thing just five years ago when it appeared a certainty that imports of 60% were headed much higher (Figure 2).

graphFigure 2. US liquid fuels supply (million b/d). Source: EIA.

Gas Production Softens

The US gas glut hangs over the domestic E&P industry, and a warm winter thus far is not helping matters. As Littell quipped: ‘In the gas industry you can never escape the weather.’

Drilling activity has held up fairly well despite low gas prices, in part a result of high crude oil prices, which improve the economics of natural gas plays that have relatively high liquids content. Conversely, these high GOR wells will cause the falloff in gas production to be slower than might otherwise be indicated by the gas-directed rig count. Still, a number of producers have cut back or shut-in gas production – a luxury that most offshore operators just don’t have – to alleviate the glut that developed at the beginning of last year. By February 2012, gas prices had dipped below $2 per thousand cubic feet, cheaper than coal by any measure. A cash-based pricing system with mandatory shut-ins was narrowly avoided by the beginning of last summer as the US approached maximum storage levels, and prices have improved since then to over $3 per thousand cubic feet.

As Figure 3 shows, total US gas production should remain relatively flat for the next two years as industry works out the oversupply problem.

Offshore US gas production is forecast to be mostly steady the next few years at about 1.8tcf, and then is expected to reverse a year-long overall decline by about 2015. Thereafter, it should increase to 2.8tcf by 2035. Larger-volume development projects, particularly in the deepwater Gulf of Mexico, remain directed principally toward liquids rather than gas. The big story is the radical about-face with LNG.

The EIA forecasts the US to be a net exporter of LNG starting in 2016, and an overall net exporter of natural gas in 2020. US exports of LNG from new liquefaction capacity are assumed to start at a level of 0.6bcf/d in 2016 and increase to 4.5bcf/d in 2027, as peak export volumes are shipped out of facilities in the Gulf Coast and Alaska. EIA says the US will become a net pipeline exporter of natural gas in 2021, as pipeline imports from Canada steadily fall and net pipeline exports to Mexico grow by 387%.

graphFigure 3. US gas production 1990-2040. Source: EIA.

The EIA also assumes that the Alaska natural gas pipeline does not get built, owing to high capital costs and low gas prices.

US Gas Prices

Using a new methodology, the EIA forecasts Henry Hub spot natural gas prices to remain below $4/mmBtu (in 2011 dollars) through 2018. In other words, it cannot foresee any shortfall of supply and thinks that demand will pick up at least a little.

Littell comments: ‘I’d just say that when Henry Hub is trading in the low $3 and LNG to northwest Europe in the low $10 – that’s a situation that cannot persist indefinitely. The supply/demand gap is clearly visible and there are folks working both sides of it to make it go away. There are recent announcements to export more gas by pipeline to Mexico; we’ll build a couple more ammonia plants, we’ll run ethylene plants at higher rates, LNG exports, and so on . . . the usual fashion of those things is that they overcorrect.’ Maybe that’s why the chart (Figure 3) shows such an upswing after 2014.

US LNG

Under the heading of ‘Tis truly an ill wind that doesn’t blow some good’, the current low prices and abundant gas production in the US have been a joy of the petrochemical industry, utility industry and consumers in general, not to mention the economy, adding a conservative estimate of $300 billion. Electricity is cheap, as are all things related to gas. Still, $3-or-so gas doesn’t help a final investment decision (FID), especially with the high gas-oil ratios (GORs) common in deepwater fields and some of the liquids-rich plays on land.

To the rescue (at least for producers and drillers) is the new North America LNG export frenzy. To date, 20 applications have been filed with the US DOE to export 28.67bcf/d of LNG to free trade agreement countries. This equates to approximately 45% of US daily consumption. And four Canadian LNG export facilities have been proposed. Some have begun the lengthy paperwork process; one is about to begin construction. The two that are furthest along are Chenier on the Gulf Coast and Kitimat in British Columbia.

Fighting the US export terminals are the petrochemical and fertilizer industries, consumer groups and resource nationalists that don’t want to see natural gas prices increase. They are backed by two US EIA reports that echo each other, with the just-released January 2013 report stating the commonsense notion: ‘Increased natural gas exports lead to higher domestic natural gas prices, increased domestic natural gas production, reduced domestic natural gas consumption and increased natural gas imports from Canada via pipeline.’

Littell adds: ‘The Pangea LNG project just got added to the list – there are now 20 export projects proposed. I think that at least two of them will get built. There’s definitely a first-mover advantage. I suffer from a long memory and fi ve years ago there were, I think, 37 proposed import terminals.’ For the record, five of those actually got built.

NGL Overload

When talking about the US oil production boom, it’s good to remember the huge NGL component in these ‘fractazontal’ gas plays – it’s not really the same as oil, nor is it priced the same. The NGLs typically ‘break’ into seven or eight commonly used oily components, propane and ethane (think: ethylene plastics) being two of the more common fractions. Each component has its own market. And ethane made in America stays in America. Products can be manufactured and shipped, but vapor pressures are problematic in pure ethane.

If you thought that $2 gas prices in early 2012 were bad, consider the NGL folks. Continued drilling, even for more liquids-rich plays, still produces an abundance of NGLs. And even LNG exports won’t help the glut, as NGLs get stripped out in the liquefaction process. ‘After this natural gas pricing disaster, another disaster is brewing for the liquids,’ says Littell. OE