Energy Megatrends April 2014

An update on Trends Related to the Shale Oil/Gas Revolution – Power Production & Crude Oil Transport

Continuum Advisory Group is continually tracking trends that will drive your business now and in the future. In this blog post I’ve provided a summary of the latest data and shared my insights on what it means for the future.

The rapid development of shale oil and gas resources has been a major driver of market changes affecting a wide range of industries including utilities, pipeline owners and operators, pipeline contractors and other service providers, power producers and petrochemical manufactures, to name a few. The latest data from the US Energy Information Administration (EIA) (@EIAgov) and the United States Census Bureau (@uscensusbureau) provides some new insight into how key trends driven by shale are developing. Highlights include the following:

• The three year decline in US electric power demand stopped in 2013. It is unclear if electric power demand growth is back or if this is a short term pause in the decline. Demand numbers for the second half of 2014 will provide clarity.
• The five year decline in coal fired electric generation also stopped in 2013. This is more likely a short term pause as continuing coal plant retirements will reduce overall coal generation. Increased natural gas fired electric generation will continue through the decade with a strong focus on the Southeast.
• The initial phase of shale oil development characterized by production exceeding local takeaway capacity and bottlenecks in midstream infrastructure leading to supply gluts is passing. The liquid transportation market will continue to stabilize though significant investment in new liquid transportation infrastructure will continue for another three to five years.
• Shale oil & gas was by far the largest driver of new US employment from 2007 to 2012. The mining, quarrying, and oil and gas extraction sector grew employment by 23.7% with payroll up 51% from 2007 to 2012. As other sectors of the economy continue to recover, the war for talent among companies operating in this space combined with other companies seeking individuals with similar skills will intensify. Finding and retaining employees, particularly engineers, managers and skilled trades, will be a key element of success over the next decade.

Electric Power Trends

Shale gas, in combination with increasing regulation of coal and falling electric demand, is reshaping the electric power industry. The winning fuels in this environment have been Natural Gas and Renewables. Beginning in 2008, net generation provided by Coal began to fall rapidly. At the same time net generation from Natural Gas began to accelerate. Generation from renewable sources has experienced steady growth for the last decade.

Total Power Generation in the US fell rapidly in 2009, before recovering in 2010, only to begin a slow decline over the next two years. The EIA’s Electric Power Monthly provides detailed data around these issues. The latest update provides final numbers for 2013 along with January 2014 data. This year appears to be a reprieve for a few industries (Coal & Electric Power) that have been down lately.

Coal had a strong winter in 2013, followed by a summer with generation holding near 2012 levels. December 2013, and January 2014, again saw Coal outpace its performance in previous years.

Total electric generation also improved in 2013, with generation up 0.26% after declines in 2011 & 2012. This return to slow electric demand growth would appear in line with EIA projections for future electric growth. The trend appears to continue with January 2014 generation up 8.2% from January 2013.

A closer look at the data raises some doubts that we are moving beyond the period of electric demand decline. During the first 8 months of 2013 electric demand continued to fall, down 0.9%. It was only during that last four months of 2013 that generation increased, up 2.7%. Anyone living east of the Rockies is painfully aware of the potential driver of this demand. The winter in the east has been brutal, particularly in the heavily populated Midwest.

 

 

 

 

 

January in particular was very cold with several states recording temperature averages that ranked in the top ten coldest Januarys since 1894. This was particularly disruptive to energy markets, and those unfortunate enough to live there, as the last decade has typically seen winters well above the long term averages in terms of temperatures.  A good example of this disruption is natural gas prices over the last few months.

 

 

The details behind the growth in electric demand also offer some insight into the cause to the growth experienced over the last several months. In January 2014, generation to residential customers was up 11.5%, commercial was up 6.4% while industrial was down 0.7% relative to January 2013. Like the EIA, we do expect electric demand in the US to stabilize soon and resume very slow growth. What is not clear is if this stabilization is already occurring. The spring/summer/fall numbers from EIA will be very telling in terms of the future outlook for the power sector.

 

The stemming of the decline in coal power generation in 2013 is much more likely to be short lived. The most recent EIA projections for new power plants and retirements through 2018 heavily favor natural gas and renewables. In excess of 20,000 megawatts of coal generation is scheduled for retirement by 2018. The vast majority of this will be replaced by a combination of Natural Gas and Solar/Wind.

 

Despite the recent volatility in natural gas prices, long term forecasts of low (below $4) gas prices are still valid, making natural gas the most cost effective replacement for utilities forced to retire coal generation assets. The somewhat uncertain future of electric demand will have little effect on the future of coal, as regulation is the primary driver of the decline. Future electric demand will have some effect on the level of opportunity related to new natural gas fired power plants and the pipeline activity necessary to support them. Overall the long term trend of power generation being the primary driver of increased natural gas demand will continue.

Shale Oil Trends

The rapid drop in natural gas prices in combination with sustained high oil prices led to a historic shift in the focus of US energy exploration in 2009. Data from Baker Hughes rig count database shows the change.

 

 

The rapid shift in focus to oil has created many opportunities related to crude oil production, transportation and refining. Moving this oil to refineries has been a challenge that is reflected in the price spread between WTI and Brent Crude.

Starting in early 2011, as the shale oil boom accelerated, rising inventories in places like Cushing, OK led to falling WTI prices and a persistent spread between WTI and Brent Crude pricing. A recent report by the EIA indicates that the significant investment in midstream infrastructure is beginning to have an effect as Cushing inventories have fallen below recent peaks.

The report highlights the following reasons for declining Cushing inventory:

• The startup of TransCanada’s Cushing Marketlink pipeline, which is now moving crude oil from Cushing to the US Gulf Coast
• Sustained high crude oil runs at refineries in Petroleum Administration for Defense Districts (PADD) 2 (Midwest) and 3 (Gulf Coast), which are partially supplied from Cushing
• Expanded pipeline infrastructure and railroad shipments that have made it possible for crude oil to bypass Cushing storage and move directly to refining centers in PADDs 1 (East Coast), 3 (Gulf Coast), and 5 (West Coast)

This data indicates that we are catching up with takeaway capacity needed to service the largest US shale plays. New rail facilities, new pipelines, and gas to liquid pipeline conversions, such as Energy Transfers Trunkline and Kinder Morgan’s Pony Express, will continue to improve crude oil transportation capacity regardless of the decision to approve KeystoneXL. For contractors and service providers focused on new liquid transportation projects there is still likely 3 to 5 years of strong activity ahead. Beyond that, activity will likely shift to smaller lateral, capacity expansion, and O&M work to support continued high levels of domestic crude production.

One last item on the overall effect of the Shale Oil/Gas Boom comes from Ben Casselman (@bencasselman) writing for Nate Silver’s new FiveThirtyEight site. Casselman looks at the latest census data and notes:

“Oil and gas states dominated the list of fastest-growing cities: Six of the top 10 were in Texas, North Dakota or Wyoming, where an oil and gas boom has brought unemployment rates below 5 percent. A separate census report on Wednesday showed just how powerful an economic engine the drilling bonanza has been. Employment in the mining sector grew 23.7 percent between 2007 and 2012, and total payroll by 51 percent, by far the fastest growth of any industry.”

 

Continuum will continue to monitor the major trends related to the shale oil & gas revolution and provide periodic updates to keep you informed.