Declining production + increased domestic demand = Less oil available for export
But…
Revenues from oil exports must at least remain stable, if not increase, to meet domestic budget needs
Therefore…
Oil export prices must increase.
Reason 2: Natural Gas and Oil – Different Markets, Different Outlooks
Natural gas and oil are both hydrocarbons, and analysts frequently discuss the two as if they are one and the same, but they are very different commodities with completely separate market mechanics. To summarize: oil is a global commodity while natural gas is a regional commodity.
Natural gas can only travel via two methods: through pipelines and as liquefied natural gas (LNG). Engineers have come a long way in building pipelines that traverse thousands of miles or run underneath bodies of water, but pipelines are still limited in their usefulness – we’re never going to build a pipeline from Norway to Japan, for example. The only way to transport natural gas across oceans is as LNG.
In its gaseous form, natural gas takes up far too much room to ship economically, so LNG is natural gas that has been condensed to liquid state. On conversion into a liquid the volume shrinks to just 1/600 of its original size, making it economic for transportation. Unfortunately these liquefaction plants easily take several years and billions of dollars to build. Also, not all gas-hungry countries can take LNG – they must have a regasification facility that accepts the LNG, turns it back into a gas, and sends it through pipelines to consumers.
Many energy-hungry countries, such as Japan, Korea, and Taiwan, have built the necessary infrastructure and are taking all the LNG they can get their hands on. Their competition for LNG cargoes has driven LNG prices far above basic natural gas prices. A quick comparison: Japanese natural gas trades at $16.8 per MMBTU, whereas Henry Hub trades at just $2.11.
What does this mean? Countries with natural-gas-liquefaction facilities are able to get top dollar for their gas in the global market, while countries without LNG capabilities are at the mercy of regional supply and demand.
What about the United States? The United States has no LNG liquefaction plants – the last operating facility, the Kenai plant in Alaska, closed in 2011. This means that the flood of shale gas production in the US will continue to overflow storage facilities and depress US natural gas prices, because domestic demand is not rising as fast as production and there is no other way to get the gas to customers across the oceans who want it.
Oil, however, is a very different story. A barrel of oil produced in Saudi Arabia can be shipped to the United States and sold on that market. This means that if oil cost $10 in Saudi Arabia and $50 in United States, some enterprising business would take oil from Saudi Arabia, ship it to the United States, and sell it for a profit. Of course, the real picture is a bit more complicated than that. Prices do differ somewhat from place to place – Western Canada Select crude, for example, currently sells for $88.98 per barrel, while Brent Crude is priced at $119.17 per barrel – but such divergences simply reflect the costs and constraints of transportation and the range of crude-oil qualities. The general idea is that oil is a global product. As such, dramatic increases in supply in one part of the world can be sold off elsewhere in the global market, creating much less impact on the producing region than with regionally constrained natural gas.
This means that while a rapid increase in natural gas production pummelled gas prices in North America, the same would not happen to oil prices in North America or elsewhere if US oil production suddenly jumped.
An example might help put things in perspective. US natural gas production grew by 30% in the past five years due to the shale gas revolution. If US crude oil production grew by 30% overnight, that would add three million barrels a day to global production. Even though this sounds like a lot of oil, it would represent just 4% of the global supply.
World crude oil production rose 4% from 2003 to 2004. What happened to the price of oil?
It increased by 34%.
Reason 3: Natural Gas is Not Oil
One of the main arguments Porter uses to support a falling price of oil is that the world’s newfound abundance of natural gas is providing an alternative fuel for the future. While there is some truth to that statement, there are more caveats than certainties.
There is no way natural gas will replace even a fragment of oil demand during the time frame in question, which is the next 12 months. Oil is entrenched as the world’s mainstay fuel; gas has always been second or third on the list of energy-resource importance. Changing the ordering on that list will take decades, if not generations. How many natural gas fueling stations do you drive past on your way to work? Not many, I’d bet, especially compared to the number of gas stations in your neighborhood. Do you see that ratio changing much in just 12 months?
In addition, it’s easy to forget that we rely on oil for far more than just fuel. Look around you – chances are good that at least half of the items you see from wherever you’re sitting include at least some oil. We use oil for concrete, shingles, pipes, ink, synthetic fabrics, crayons, computer cases, carpet, paint, Styrofoam, shampoo, helmets, electrical insulation, toothpaste, lipstick, tires, rope, fertilizer, candles, adhesives, refrigerants, artificial turf, pill capsules, soft contact lenses, shaving cream, antifreeze, antihistamines, insecticides, fan belts, hand lotions, caulking, golf balls, credit cards, Formica, footballs, bandages, medical tubing, packing tape, and many, many more items.
Oil is a deeply ingrained part of how our world operates, and demand will continue to rise with population for many decades to come. It will take many years for natural gas to even start to supplant oil as the dominant fuel.
Natural gas will play a growing role in the world’s energy scene, but the timeframe for the shift is very long. Twelve months from now natural gas prices in North America will still be depressed and global oil demand will be almost the same as it is today.
Reason 4: My Country, My Oil
I believe we are in the early stages of the “Decade of Resource Nationalization.” As supplies tighten, natural resources of all kinds will become more and more valuable. Whether to control additional revenues or to secure domestic supplies, governments will nationalize natural resources with gusto.
The latest example of this is Argentina. A beautiful country with incredible geological potential, Argentina’s resources are wasted on a government that is simply unable to incentivize private investment in the country. Now the government is going to try to develop its technologically challenging oil fields alone, and mark my words it will fail.
On April 16, 2012, Argentine President Cristina Kirchner said her government would seek approval from Congress to take a 51% government stake in the YPF, the largest oil producer in the country. Until that announcement, YPF was majority-controlled by Spanish firm Repsol, which just months ago announced the discovery of almost a billion barrels of recoverable resources in the Vaca Muerta (“Dead Cow”) formation in Argentina’s Neuquen province. The nationalization of YPF is very unfortunate for Repsol, which has seen its share price decline dramatically since the announcement, but it is just as unfortunate for all the Argentineans who will not see any oil revenues now that Kirchner has turned the “Dead Cow” into “dead shale.”
YPF may be the first casualty in Kirchner’s oil and gas nationalization spree but it will not be the last, as there is widespread enthusiasm within Argentina for further expropriation and nationalization within the sector. Today’s enthusiasm will become tomorrow’s disappointment as Argentineans taste the bitter reality that government resource nationalization almost always ends badly.
Kirchner is nationalizing Argentina’s oil sector directly, but lots of resource nationalization is done in much more roundabout ways. These devious methods include: increasing the tax levied on oil production (United Kingdom); introducing a windfall tax (Ecuador); or suddenly adding capital-gains tax to sales of oil projects (Uganda). In all these cases, the governments wound up with more money while the oil companies and their investors got stuck with the bill. “Big bad oil companies” are frequently made the bogeyman, but in reality profit margins for oil production keep getting slimmer and slimmer – and the real bogeyman is often a greedy government.
Whether a government is direct or covert about its desire to nationalize its resources, the results are the same for global resource explorer-developers: increased risk. It doesn’t take long before the risk-reward balance becomes skewed toward risk and companies begin to pack up and leave.
Guess where that leads? To lower production volumes and higher prices.
