Easwaran Kanason

Co - founder of PetroEdge
Last Updated: March 21, 2018
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Business Trends
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Last week, OPEC sounded an alarm. Previously hopeful that the global crude markets would be balanced by June, which would allow it to walk back on the supply freeze that propped prices up at the cost of OPEC market share, the OPEC monthly report raised its expectations for non-OPEC supply for a fourth consecutive month. OPEC now expects global oil demand to grow by 1.6 mmb/d this year, which is more than previously expected. However, non-OPEC oil supplies will grow by 1.66 mmb/d, more than covering demand. The culprit, as always, is the US, where output is expected to grow by 12%. And this is not even the most optimistic forecast; the IEA expects non-OPEC supplies to grow by 1.8 mmb/d this year.

While this has near term implications – Saudi Arabia has already signalled that the OPEC supply curbs may have to extend into 2019 – the more important question is, how far can shale go? American oil production can consistently surpassed expectations over the past year, as the recovery in oil prices triggered a return rush to shale drilling. This will help US oil production reach 11 mmb/d by Q418; it could be even earlier, based on current production trends. By 2030, BP expects US shale oil to grow to 10 mmb/d, almost double its current level.

Despite the base case for shale production being constantly revised upwards – requiring lower long-term oil prices to clear – it is worth asking how realistic it is. There are suggestions that American shale production could hitting the wall; not because the of finite reserves in the Permian, but because of technology limitations. The application of new technology does not in itself create new energy, it only improves the recovery of hydrocarbons and at a faster rate. As reported in CNBC, "Mark Papa, a pioneer in the U.S. shale oil revolution, is warning that forecasts for booming U.S. production growth will leave industry watchers disappointed in the coming years as drillers burn through their best wells and tighten their purse strings. The impression of U.S. shale as the big bad wolf is perhaps a bit overstated, Papa told an audience at this year's CERAWeek by IHS Markit in Houston this year. Papa's comments were a stark contrast to the tone of cautious optimism at the conference, where many executives claimed that data analytics and technology, like machine learning, will improve efficiency in the oil patch and fuel further gains." Most people are focused on additions to the US rig count, productivity rates in shale wells are actually declining, while costs per well are rising. Major players seem to be mitigating this by creating larger fields by connecting wells, but there is also a looming logistical and manpower crunch. The WSJ reports that "Oil infrastructure is the most glaring constraint to limitless growth in U.S. shale output, said analysts for Energy Aspects in a recent note. The Permian basin had 10 oil takeaway pipelines with a combined capacity of 2.92 million barrels a day as of February 2018, said analysts. There will be a shortage of takeaway capacity in the Permian by August, which will only get worse into year-end, noted experts." This suggests that while shale production is still on the steep part of its growth curve, that could soon plateau out and that long-term forecasts are overstated. That would be good news for oil prices in the long run.

However, there are signs that the opposite could be true. Investment into shale players is increasing, giving them more funds to play with. With money, come more interest – solving, or at least, mitigating most of the upcoming bottlenecks. It seems that either more debt through borrowings or the capital markets is driving this production surge, particularly in the USA. However it is worth noting that the USA is not the only place the shale revolution is taking place. By the end of this month, Saudi Arabia will have produced its first shale gas from the North Arabia basin. The giant South Ghawar and Jafurah basins – which reportedly rival Eagle Ford in size – are also underway. Promising finds are improving moods in China and Argentina shale as well, while the UK drilled its first shale well last year. Even if the American shale revolution hits the brakes, the movement could continue elsewhere, which would mean that current non-US share oil production forecasts maybe understated? There is little data out there about the profitability or economics of non-US shale fields. 

Both the low and high scenarios make compelling cases. Both, however are closely tied to current developments in US oil production. Ultimately the base case for shale will depend on economics but more importantly the demand for hydrocarbons in the medium to long term. If oil demand keeps growing, so will the need for more oil, but any large surge would only dampen prices all over again, effectively killing shale production. So can shale go far, technically possible, as there are proven reserves all around the world that are still untapped. But like with everything else, it's the economics and geopolitical factors that will define its days ahead. 

Various production forecasts for American shale tight oil production 

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In RAPID Succession

Less than two weeks ago, the VLCC Navarin arrived at Tanjung Pengerang, at the southern end of Peninsular Malaysia. It was carrying two million barrels of crude oil, split equally between Saudi Arab Medium and Iraqi Basra Light grades.

Its destination? 

The RAPID refinery in Johor. An equal joint partnership between Malaysia’s Petronas and Saudi Aramco whose 300 kb/d mega refinery is nearing completion. Once questioned for its economic viability, RAPID is now scheduled to start up in early 2019, entering a market that is still booming and in demand of the higher quality, Euro IV and Euro V level fuels RAPID will produce.

Beyond fuel products, RAPID will also have massive petrochemical capacity. Meant to come on online at a later date, RAPID will have a collective capacity of some 7.7 million tons per annum of differentiated and specialty chemicals, including 3 mtpa of propylene. To be completed in stages, Petronas nonetheless projects that it will add some 3.3 million tons of petrochemicals to the Asia market by the end of next year. That’s blockbuster numbers, and it will elevate Petronas’ stature in downstream, bringing more international appeal to a refining network previously focused mainly on Malaysia. For its partner Saudi Aramco, RAPID is part of a multi-pronged strategy of investing mega refineries in key parts of the world, to diversify its business and ensure demand for its crude flows as it edges towards an IPO.

RAPID won’t be alone. Vietnam’s second refinery – the 200 kb/d Nghi Son – has finally started up this year after multiple delays. And in the same timeframe as RAPID, the Zhejiang refinery by Rongsheng Petro Chemical and the Dalian refinery by Hengli Petrochemical in China are both due to start up. At 400 kb/d each, that could add 1.1 mmb/d of new refining capacity in Asia within 1H19. And there’s more coming. Hengli’s Pulau Muara Besar project in Brunei is also aiming for a 2019 start, potentially adding another 175 kb/d of capacity. And just like RAPID, each of these new or recent projects has substantial petrochemical capacity planned.

That’s okay for now, since demand remains strong. But the danger is that this could all unravel. With American sanctions on Iran due to kick in November, even existing refineries are fleeing from contributing to Tehran in favour of other crude grades. The new refineries will be entering a tight market that could become even tighter. RAPID can rely on Saudi Arabia and Nghi Son can depend on Kuwait, both the Chinese projects are having to scramble to find alternate supplies for their designed diet of heavy sour crude. This race to find supplies has already sent Brent prices to four-year highs, and most in the industry are already predicting that crude oil prices will rise to US$100/b by the year’s end. At prices like this, demand destruction begins and the current massive growth – fuelled by cheap oil prices – could come to an end. The market can rapidly change again, and by the end of this decade, Asia could be swirling with far more oil products that it can handle.

Upcoming and recent Asia refineries:

  • Nghi Son (Vietnam): 200 kb/d crude capacity, 700,000 tpa petrochemicals
  • RAPID (Malaysia): 300 kb/d crude capacity, 7.7 mtpa petrochemicals
  • Zhejiang (China): 400 kb/d crude capacity, 10 mtpa petrochemicals
  • Dalian (China): 400 kb/d crude capacity, 8 mtpa petrochemicals
  • Pulau Muara Besar (Brunei): 175 kb/d crude capacity, 3.5 mtpa petrochemicals
October, 10 2018
Your Weekly Update: 8 - 12 October 2018

Market Watch

Headline crude prices for the week beginning 8 October 2018 – Brent: US$84/b; WTI: US$74/b

  • Oil prices are retreating from recent highs as a rush of pronouncements to mollify the market over concerns of a supply crunch were issued
  • President Donald Trump continues to berate OPEC over high oil prices and the US State Department took the unusual step of issuing a demand to OPEC, requesting that it raise collective output by 1.4 mmb/d
  • Saudi Arabia responded by saying that it is fulfilling promises made to America to replace lost Iranian crude supplies, boosting its current output to 10.7 mmb/d and the ability to add another 1.3 mmb/d if needed; Iraq is also benefitting as it chalked a second consecutive month of exports exceeding 4 mmb/d
  • Russian production also rose to a record 11.356 mmb/d in September, raising worries about shrinking spare capacity in oil markets as producers up output; Russian Premier Vladimir Putin fired back at Trump’s tantrums, stating ‘Donald should look in the mirror’ when complaining about high oil prices
  • There continue to be varying responses to the looming American sanctions against Iran; the UAE – which usually talks tough but still accepts Iranian oil – appears to be taking steps to reduce its purchases, with Dubai imports of Iranian condensate dropping by half in September and customs officials at Fujairah now asking for certification of origins for oil tankers docking there
  • Meanwhile, despite overtures to reduce Iranian imports by India to qualify for mooted American waivers, India is planning to purchase some 9 million barrels of Iranian oil in November, with liftings past the US deadline of November 4
  • On another battlefront, China is sticking to its guns and shunning purchase of American crude over the boiling trade war, boosting its imports of West African crude to their highest level in seven years
  • American oil prices are also drawing strength after falling last week on swelling stockpiles as Hurricane Michael heads inland towards Florida after shutting down some 19% of oil production in the Gulf of Mexico
  • Surprisingly, despite prices being attractive, American drillers remain cautious over introducing new rigs; the active US rig count actually lost two sites last week – both oil rigs – a second week of decline in the US oil rig count
  • Crude price outlook: Evidence that OPEC+ is responding with increased supply should pressure prices downwards this week, but a longer term risk remains of US$100/b crude oil, especially if Saudi Arabia and Russia run out of capacity to turn their taps on. We see Brent trading in the US$81-83/b and WTI in the US$70-73/b range.


Headlines of the week

Upstream

  • Equinor will take over Chevron’s 40% operating interest in the UK’s Rosebank project, one of the largest undeveloped fields on the UK Continental Shelf, with potential volumes of some 300 million barrels recoverable
  • Equinor has also confirmed a boost in its Norwegian assets, with the Cape Vulture discovery adding some 50-70 million barrels of recoverable oil, doubling the remaining oil reserves at the aging Norne field
  • Savannah Petroleum has made a fifth discovery in Zomo-1 well, locating in the R3 portion of the R3/R4 Adaem Rift Basin area in southeast Nigeria
  • Chevron will be proceeding with drilling a test well at the Mississippi Canyon Block 607, hoping to add to the deepwater Ballymore discovery that it made in the same area last year
  • Saudi Arabia’s crown prince hopes to be able to resolve an impasse with Kuwait over the Khafji and Wafra fields in the Neutral Zone ‘soon’, an area along the border that has been undefined for near a hundred years, which could unlock up to 500,000 b/d of crude production

Downstream

  • Pakistan will be building a new oil refinery at its deepwater Gwadar port, part of an ‘oil city’ project that Saudi Aramco is expected to invest in
  • Saudi International Petrochemical Co (Sipchem) has acquired fellow Saudi Arabian firm Sahara Petrochemical in a deal worth US$2.2 billion
  • Vietnam’s Petrolimex wants to halt the US$5 billion, 200 kb/d Nam Van Phong refining and petrochemical project with Japan’s JXTG Holdings to ‘focus its resources on executing other projects’
  • ExxonMobil is considering a multi-billion dollar investment at its 592 kb/d Singapore refinery – the largest in its system – to meet demand for low sulphur shipping fuels as the IMO’s strict new rules on marine fuels starts in 2020
  • India is reducing the pump prices of gasoline and diesel by 2.50 rupees (US$0.03 per litre) to ease the pain of rising crude prices and a weak rupee; this includes a reduction in excise duty of 1.50 rupee per litre

Natural Gas/LNG

  • After PetroChina and Korea Gas gave their blessing last week, Shell and its remaining partners have given the go-ahead for Kitimat LNG project in Canada, bucking trends by sanctioning construction without having signed any long-term LNG sales deals
  • G3 Exploration has been given approval to proceed with the development of the Chengzhuang Block in Shanxi, splitting the estimated recoverable gas volumes of 176 bcf with its partner CNPC
  • Qatar Petroleum will continue to supply the United Arab Emirates with piped natural gas, shunning bringing ‘politics into commercial business’ as the standoff between Qatar against Saudi Arabia and its allies continues

Corporate

  • Saudi Arabia’s crown prince is insisting that Saudi Aramco’s planned IPO will go ahead by 2021, after the sale was put on hold by Aramco’s plan to purchase a controlling stake in SABIC
  • BP and Norway’s Aker BP have signed a new cooperation agreement to explore development and deployment of advanced technologies in their businesses
  • Ensco and Rowan Companies have agreed to a US12 billion merger that will create a global powerhouse offshore drilling company covering 82 rigs
October, 11 2018
The United States continues to increase production of lighter crude oil

monthly lower 48 states crude oil production

Source: U.S. Energy Information Administration, Monthly Crude Oil and Natural Gas Production

As domestic production continues to increase, the average density of crude oil produced in the United States continues to become lighter. The average API gravity—a measure of a crude oil’s density where higher numbers mean lower density—of U.S. crude oil increased in 2017 and through the first six months of 2018. Crude oil production with an API gravity greater than 40 degrees grew by 310,000 barrels per day (b/d) to more than 4.6 million b/d in 2017. This increase represents 53% of total Lower 48 production in 2017, an increase from 50% in 2015, the earliest year for which EIA has oil production data by API gravity.

API gravity is measured as the inverse of the density of a petroleum liquid relative to water. The higher the API gravity, the lower the density of the petroleum liquid, meaning lighter oils have higher API gravities. The increase in light crude oil production is the result of the growth in crude oil production from tight formations enabled by improvements in horizontal drilling and hydraulic fracturing.

Along with sulfur content, API gravity determines the type of processing needed to refine crude oil into fuel and other petroleum products, all of which factor into refineries’ profits. Overall U.S. refining capacity is geared toward a diverse range of crude oil inputs, so it can be uneconomic to run some refineries solely on light crude oil. Conversely, it is impossible to run some refineries on heavy crude oil without producing significant quantities of low-valued heavy products such as residual fuel.

selected regions' crude oil production

Source: U.S. Energy Information Administration, Monthly Crude Oil and Natural Gas Production

API gravity can differ greatly by production area. For example, oil produced in Texas—the largest crude oil-producing state—has a relatively broad distribution of API gravities with most production ranging from 30 to 50 degrees API. However, crude oil with API gravity of 40 to 50 degrees accounted for the largest share of Texas production, at 55%, in 2017. This category was also the fastest growing, reaching 1.9 million b/d, driven by increasing production in the tight oil plays of the Permian and Eagle Ford.

Oil produced in North Dakota’s Bakken formation also tends to be less dense and lighter. About 90% of North Dakota’s 2017 crude oil production had an API gravity of 40 to 50 degrees. The oil coming from the Federal Gulf of Mexico (GOM) tends to be more dense and heavier. More than 34% of the crude oil produced in the GOM in 2017 had an API gravity of lower than 30 degrees and 65% had an API gravity of 30 to 40 degrees.

imported and domestic crude oil by API gravity

Source: U.S. Energy Information Administration, Monthly Crude Oil and Natural Gas Production and Monthly Imports Report

In contrast to the increasing production of light crude oil in the United States, imported crude oil continues to be heavier. In 2017, 7.6 million b/d (96%) of imported crude oil had an API gravity of 40 or below, compared with 4.2 million b/d (48%) of domestic production.

EIA collects API gravity production data by state in the monthly crude oil and natural gas production report as well as crude oil quality by company level imports to better inform analysis of refinery inputs and utilization, crude oil trade, and regional crude oil pricing. API gravity is also projected to continue changing: EIA’s Annual Energy Outlook 2018 Reference case projects that U.S. oil production from tight formations will continue to increase in the coming decades.

October, 10 2018