Worried about 2013? You are not alone. There are many rational reasons to be concerned about possible developments in energy markets this year, let alone phobias about the number thirteen (triskaidekaphobia). But hey, this is the first working day of the New Year, so let’s look on the positive side. In fact we are so psyched that we are going to violate the cardinal rule of consulting. We are going to make predictions. Of the future! So hold on to your seat and get ready for our Top Ten Energy Prognostications for 2013, which according to Chinese astrology is the Year of the Snake. Hmm, that doesn’t sound good.
As we enter 2013, the major theme for US hydrocarbon markets must be “surplus”. Who wooda thunk it. We had a white Christmas in Texas, up in the Northeast Tennessee Zone 6 gas at year-end was $10.79/MMbtu, but natural gas inventories are still at multi-year highs and Henry Hub gas is languishing at $3.47/MMbtu. Those low prices have been great for gas demand, with gas duking it out with coal in the power generation market, and winning. Crude production in the Bakken, Eagle Ford and Permian is skyrocketing, Cushing inventories are still high, and that is keeping WTI at Cushing at a $20/Bbbl discount to Brent. Propane production is up 12% in the past year, while propane prices are down 35%. And that looks good compared to ethane, with prices down 70% over the past 12 months to 24.5 cnts/gal at Mont Belvieu, pretty close to parity with natural gas and near a level that would encourage widespread ethane rejection. What’s the world coming to?
Looking into the crystal ball for 2013, it doesn’t appear that the world of US hydrocarbon surpluses will be going away anytime soon. Of course, some wacky weather event or wackier Middle East incident could always turn things upside down, but barring that, the production of natural gas, crude oil and NGLs looks to remain strong. That will keep inventories high, and prices considerably lower than they would be if market supply/demand were balanced. But that doesn’t imply that nothing is going to change. In fact, market conditions are already changing – mostly due to all the new infrastructure that is coming on line. Many of our predictions below are being driven by the impact of the new pipelines, processing plants and terminals that are popping up all over the country.
So let’s get into the specifics. Like any good New Year’s top ten list, we’ll start at number ten and work our way down to number one.
10. Rail will suck crude oil barrels out of pipelines. This has already been happening in the Bakken for several months now. Unit train economics are attractive, and each one of these trains moves 70,000 barrels to higher priced markets, bypassing the still-glutted Midcontinent/Cushing regions. But not only do the numbers look good, producers committed their barrels to rail terminal operators so they could get the terminals financed and built. So contractual obligations are also creating that giant sucking sound at the pipeline receipt points. Expect this phenomenon to expand during 2013 as the economic advantage of moving barrels to the East and West coasts grows.
9. 2013 Will Not be the year of Natural Gas Price Recovery. Gas producer hope springs eternal, but it looks like 2013 will be another year below $4.00 for most of the time. The problem is that the producers are just too good at what they do. With each well they drill they learn to reduce drilling time, minimize costs, produce larger volumes over longer periods of time and generally improve their cost per unit of production. And Econ 101 tells us what that does, right? Only demand will save producers from themselves, and there is just not enough new demand slated for 2013 to suck up all that production. It will get here someday soon. Just not 2013. BTW, as we said many times early in 2012, announcements of production shut-ins are publicity stunts that are irrelevant to supply, demand and ultimately price. Pay no attention to that man behind the press release.
8. The Enterprise Propane export terminal expansion won’t solve the propane oversupply problem. Propane inventories remain 25% over this time last year and way above the five year average for this point in the heating season. According to our good friends at Waterborne Energy, the new Enterprise dock facility will begin the tie-in progress in the next week or so, achieve mechanical completion mid-January and be in operation by February. This will give Enterprise the ability to export between 10 and 11 VLGC's (Very Large Gas Carriers) each month – at about 550 MBbls per ship, or a total of almost 200 Mb/d. That is a 70 Mb/d increase over the existing capacity (7 VLGCs per month). That’s a good thing for the market, but to put that volume in perspective, since September of last year gas plant production of propane is up 115 Mb/d. It won’t take long for propane supplies to catch up again. The Targa dock expansion will provide enough additional capacity to balance the market, but it is not scheduled to be online until sometime in Q3 2013. If it turns out to be late in Q3, there is still going to be a lot of propane around during the summer of 2013.
7. Crude Oil rig count will continue to fall, but it won’t matter. The crude oil rig count growth that saw astronomical growth from 200 rigs in mid-2009 to a peak at 1,432 in August has stalled out, falling back to 1,340 today. But don’t extrapolate from this an impending decline in crude oil drilling activity. Just like the relationship between natural gas rig count and natural gas production broke down five years ago, the same thing is happening in crude oil production. Faster drill times, more efficient operations, multi-pad drilling and a variety of technological enhancements have resulted in increasing productivity from each rig, which translates into more barrels from each rig that is working. So less rigs are needed to generate the same number of new barrels. The link between rig count and production is a dead concept for natural gas, and now it is dying for crude oil production.
6. We will see the first inkling of Gulf Coast Crude Prices declining below world levels. Sometime during 2013 about 1.1 MMb/d of new crude oil pipeline capacity from the Seaway expansion and the Keystone Gulf Coast project will bring Cushing barrels to the Gulf Coast. Then there is another 0.4 MMb/d coming in from West Texas (see The New Adventures of Good Ole Boy Permian – The Race to the Gulf Coast). As all those barrels blast into the Gulf, waterborne imports will be pushed out of the market, refiners will have to deal with a generally lighter crude slate and supplies will be ample – all factors likely to put downward pressure on Gulf Coast crude prices relative to world price levels. See After the Flood for our scenario of how this plays out.
5. Natural gas pipeline quality will become a nationwide issue as ethane rejection accelerates. Ethane prices in Mont Belvieu are low. Conway prices are lower. It looks like the onslaught of ethane rejection that many (including RBN) were projecting for 2014-2016 could be hitting a year early. On the supply side, gas processing plants are popping up like mushrooms (28 new plants or expansions, 5.7 Bcf/d capacity planned for 2013). If we assume that the average new capacity additions in 2013 will be 50% of 5.7 Bcf/d, or 2.9 Bcf/d, that the capacity will be filled when completed, and the gas averages 4.8 GPM, that would crank out 230 Mb/d of additional ethane. It sounds like a lot, but we added 100 Mb/d per year in both 2010 and 2011. Only rejection kept producers from adding another 100 in 2012. So it could happen.
On the demand side, the petchem industry is adding to ethane capacity in 2013, but only about 75 Mb/d. That’s not nearly enough to absorb all of the new potential supply. So the inevitable result is that ethane supply is growing faster than demand. If the gas gets produced processed but the ethane is rejected, there is only one place for it to go, and that is back into the residue gas stream. So the problem with “hot” or high BTU gas above pipeline specifications that has been such a problem in the Marcellus for the past year or so will start becoming a problem in the rest of the country as ethane rejection grows.
4. The natural gas market will awaken to the full potential impact of Marcellus natural gas flow reversals. In The End of the World as We Know It, we talked about how North America pipeline flows are about to reverse. The Northeast will become a net supply region, flipping the flows on north-to-south and west-to-east pipelines to move the opposite direction resulting in what could be some of the biggest changes in the natural gas industry since FERC decontrolled the market in the late 1980s. In 2013 the Northeast market will become a net exporter to Canada, flows into the Northeast on Midcontinent and Gulf pipes will continue to decline, and the long term prospects for widespread flow reversals will become apparent.
Traditionally Northeast prices have exhibited a positive basis differential to Henry Hub. These days those differentials have flipped, with Columbia Gas Appalachia under Henry by about $0.03/MMbtu. The forward curve (CME Clearport basis swap) shows that number at about even to Henry during 2013, and only getting to $.03/MMbtu under Henry again in 2014. It will be interesting to see if these numbers hold up in 2013, or if they start getting weighed down by the continued increases in Marcellus and Utica natural gas production that are expected over the next few years.
3. Condensates will emerge as a market in their own right. We spent many blogs in 2012 reviewing the developments in condensate markets (including the Fifty Shades Lighter series – Part I, Part II, Part III, Part IV). Historically condensates have been the backwater market of liquid hydrocarbons– opaque, buried inside crude blend cocktails, occasionally breaking out into the domain of naphtha and natural gasoline. That’s all changing. At least five major factors will impact condensates in 2013: (1) condensate production is increasing rapidly and growing as a percentage of total crude oil production, (2) pipeline and splitter infrastructure is being built to handle the additional condensates, (3) condensate pricing is becoming somewhat less opaque (see Clash of the Titans - The New Eagle Ford Crude Oil Marker Price), (4) the demand for condensate and other natural gasoline/ naphtha range products for diluent is growing, and (5) condensates are exacerbating the light-crude surplus situation that is developing on the Gulf Coast (After the Flood). Put all of this together and you have a recipe for a condensate market in its own right, with flows, qualities and price relationships understood by more than the handful of specialists that are active in that market today.
2. Production growth is coming on fast, but not as fast as new pipeline and processing infrastructure. The energy business is notorious for building more stuff than the industry needs. The huge natural gas pipeline construction boom of 2008-10 is one recent example where $25 billion or so was spend to move gas eastward into what has now become the most prolific gas producing region in the country. But go back to other boom times, and you’ll see the same behavior -- opportunity begets investment, the herd instinct ensnares investors all competing for the same market, and that results in an overbuild. We talked about one possible contemporary example a few weeks back in Whoville, the Big New NGL Hub in Marcellus/Utica where new fractionation capacity is expected to get up to 600 Mb/d in a couple of years while production is projected to reach only 450 Mb/d two years later in 2017. But it is not just NGLs. The same thing is happening in parts of the crude oil market (re. Prediction #10 above). Watch this development carefully. A lot of that infrastructure investment is heavily leveraged.
And the #1 Prognostication for 2013?
- Natural gas inventories will never hit the capacity wall. Not in 2013. Not in any other year. Oops. You should never say never, particularly not in the consulting business. But heck, it is 2013 so let’s go for it.
Ever since the shale thing started, the natural gas market in North America has flirted with the possibility of running out of storage capacity. Each year EIA has dutifully trotted out their latest estimate of total operational capacity (measured by a variety of yardsticks), and analysts by the score run spreadsheets that show projections of inventories exceeding capacity before the end of injection season. And since that can’t really happen, the debates start as to what ensues when inventories hit the capacity wall. Right here at RBN we did at least seven blogs on the topic during 2012. It’s been the same drill for several years now. We’ve talked about the same wall-hitting possibilities ever since lower-48 dry gas production breached 55 Bcf/d in mid-2008 and spot gas prices simultaneously dropped below $5.00/MMbtu that year – then stayed there.
Now lower-48 dry gas production is 64 Bcf/d. If we had too much at 55 Bcf/d, how is it that supply and demand still seem to balance – albeit with historically high inventories – at today’s production level 9 Bcf/d higher. The answer, of course is demand. One of the most important things we learned in 2012 is that natural gas demand, particularly in the power sector, is far more elastic than just about anyone believed. Prices got cheap, and the power sector burned more. Bentek’s Power Burn numbers show an increase year-on-year of 4 Bcf/d in 2012 versus 2011. Power burn in 2011 was already up about 2 Bcf/d versus two years earlier. In effect, the power industry has saved the gas industry producers from themselves.
But beyond this short term conclusion, we believe that the real story here is that the natural gas market works. When supply gets too high and is at risk of hitting the wall, the market reacts. If gas fired demand had not kicked in, then prices would really have been crushed and supply curtailments would have balanced the market. The market is simply too ‘smart’ collectively to allow itself to reach an untenable outcome. If the market gets out of balance, price will respond and the market will lumber back into balance. It may not be pretty, and it may be difficult to predict. But unless something really wacky happens (like the government getting involved), the natural gas market can take care of itself.
That’s it for our 2013 top ten energy prognostications. Please let us know if you think we missed something or are simply dead wrong about any of this. Either comment in the blog or send an email to firstname.lastname@example.org. And remember -- this is 2013, Year of the Snake. According to a Google search of the internet, “delusion and deception are common in the Year of the Snake”. Given the source, it must be true. So here are our recommendations for 2013 New Year’s resolutions: (a) pay close attention to market fundamentals, (2) don’t believe simplistic explanations of complex market phenomena, and (3) stay away from snakes. Happy New Year!