Monthly Archives: July 2016

Shale Oil’s Comeback – 7/30/16

Shale oil drilling was largely to blame for the recent glut that sent oil prices below $30 a barrel from over $100 a barrel only a few years ago. Yet, that glut hurt shale drillers as much, if not more, than conventional oil companies and about 70 shale-related firms have gone bust in America since the start of 2015.

The questions now are how quickly can shale drillers recover and what will happen when they start ramping up output again. Shale drilling is known for quick turnaround times measured in months compared to the years conventional oil can take to start operations in earnest. Drillers still have the technology that allowed created the oil glut; however, they have many psychological and technical barriers to a quick resurgence.

On the physical side, idled rigs may require months of maintenance before they can be brought back into service and workers need to be convinced that the time is right to return to the shale fields. The rate limiting step in shale drilling won’t be setting up rigs though. There are plenty of pre-drilled but untapped wells leftover from the awkward period between prices too low to pump oil and not so low to stop preparations for a recovery.

A lot of what will hold back a revitalization of the shale drilling industry will come from the mental side of markets.

Many drillers were burned when they increased spending during a false rally in prices and are reluctant to jump back into the fray. It could take months of prices above $50 a barrel before investment starts flowing back into shale oil projects in any meaningful amount.

Many are also aware that Saudi Arabia has the capacity to raise production substantially. Ahead of the planned initial public offering of Saudi Aramco, the kingdom might see fit to pump more oil just to inflate the company’s value. The Saudis seem increasingly committed to reducing their oil dependency by selling stakes in the state oil company to mitigate the risk that technological changes or policies aimed at fighting climate change will make their oil assets worthless.

Is Shale Heading for a Revival Already? – 7/29/16

Shale oil accessed via fracking is the marginal supply source for crude oil because it is relatively costly with a quick turnaround time. And as the marginal supply source, shale-oil was hit the hardest when oil prices started to fall.

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After a brutal price collapse that resulted in 429 rigs going out of service in less than two years, it appears that shale drilling operations are stabilizing as oil prices rise past the mid-$40 range. Now with future prices for delivery around $50 a barrel, operators are able lock in a decent profit and many companies are feeling comfortable restarting rigs.

Rigs targeting crude in the U.S. rose by 11 to 341, after 7 were dropped last week, according to Bloomberg.

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Higher and more stable crude oil prices are contributing to the increased drilling in the United States. Although declines from existing wells are expected to result in a net decrease in production, increased drilling and higher well productivity are expected to partially offset the decline. EIA data shows that the average productivity of rigs has continued to increase substantially, as shown in the graph below.

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The July Short-Term Energy Outlook (STEO) forecasts crude oil production from the U.S. mainland to continue to decline through the rest of 2016 before stabilizing in early 2017.


A rebound in sand mining companies provides another indication that fracking is making a recovery as four publicly traded miners of sand have seen their share prices rally by an average of 320% from their 52-week lows. Fracking an average well uses over 4,000 tons of sand to hold open tiny cracks in the rock that allow oil and gas to flow out of it.


Production from the U.S. may also get a boost from the usage of horizontal drilling techniques on old conventional wells, research firm IHS Markit Energy said. The firm claims that there are significant cost savings from using the older wells since there is no cost for the initial vertical drilling and existing infrastructure in place.

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Electric Cars and Tight Oil’s Price Problem – 7/26/16

Cheap electric cars and large scale fracking of tight oil are two of the most interesting developments in recent history for oil markets.

First some context from the Energy Information Agency (EIA). The EIA projects that U.S. liquid fuels production is set to grow substantially in the coming decades. The EIA AEO2016 includes several possible cases, but all have the shares of tight oil and natural gas continuing to grow significantly for decades.

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The EIA also provides a large amount of data useful in determining where oil prices might eventually go with five cases serving as possible paths to 2040 prices from $50 a barrel to over $200 a barrel.

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In the case of high prices, the EIA expects increased energy efficiency, conservation, and fuel switching will reduce projected consumption. For the low price case, quantity demanded is relatively high on the lower prices.

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In the resource and technology cases, the estimated recovery and rates of technological improvement in the United States are 50% higher or 50% lower than in the Reference case.

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What the EIA does not currently have is a case considering widespread adoption of electric cars by 2025 as is expected by Bloomberg New Energy Finance (BNEF).

rise of electric cars

Note that the U.S. currently has about 250 million cars on the road, and BNEF is forecasting cumulative sales of electric cars to exceed that amount as soon as 2035. Transportation sector demand accounts for over 60% of global consumption of oil. If the BNEF forecast is correct, then demand for oil is set for total collapse within two decades at most and will see steep declines every year from 2025 on.

I say total collapse because the loss of transportation sector demand due to electric cars would not just force some companies out of business. The substitution would have oil permanently lose its role as the main motive fuel source. Such a loss would devastate oil companies similar to how cheap, plentiful natural gas is devastating coal (since 2011, the value of publicly traded coal companies is down over 90% resulting in the bankruptcy of many, including coal giant Peabody Energy). A large majority of oil companies cannot survive in a world where U.S. cars run on electricity instead of gasoline and over half the demand for their product vanishes.

Another issue is of low oil prices brought on by the fracking revolution. Tight oil reserves unlocked by fracking represent a significant buffer to prices rising back above $50 a barrel. The break-even point for shale drillers is already somewhere around the low-$50 range with a turnaround time for new projects measured in months rather than the years that conventional wells take to get operational. So long the shale drillers exist, they will continue to put downward pressure on prices in a fraction of the time conventional drillers used to.

Strangely enough, electric cars may make the issue of the “new normal” moot.

Look below at the EIA graph that was shown at the beginning of this post.

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The graph clearly shows tight oil making up a majority of the increase in U.S. production. As marginal producers with break-even points below the oil price points the EIA expects, those producers would do well up through 2040 and beyond in the EIA reference case. Yet, they are also the most vulnerable to the widespread adoption of electric cars, which the EIA does not account for.

For all the talk about the fracking revolution unlocking shale oil, it is still a relatively expensive source of crude. Though fast and requiring less capital to start up compared to conventional wells, shale drilling operations cannot compete with rigs that can make a profit when oil prices fall below $40 a barrel. So when those millions of cars start running on electricity and demand for crude starts to dry up, shale drillers will disappear first, just as they have for the last few months of the glut.

Carbon Markets in Trouble – 7/25/16

Carbon markets are in trouble.

The system, under which businesses buy and sell permits for their carbon emissions, was meant encourage early adoption of low carbon technologies, but new mandates and messy politics have created a mismatch in supply and demand so large that permit prices are plunging. According to Bloomberg, the price of carbon permits in the U.S. has dropped 40% since the start of 2016.

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Instead of weathering the storm of lobbying efforts that would come before, during, and after attempts to strengthen caps on emissions, many policymakers have chosen to pursue more inconspicuous, if less efficient, measures. California, for example, now requires less carbon intense gasoline and mandates that utilities to buy more solar and wind power. With other policies driving down emissions faster than politicians can lower caps on overall emissions, demand for permits is falling fast and carbon markets are fast losing their purpose.

Carbon markets were meant to be a free market solution to climate change; they were supposed to be the most cost-effective, dollar per ton of CO2, means of fighting emissions. Instead, more money is flowing to things like renewable-energy subsidies directly from the government. That’s not to say that it is bad to have money flowing to solar and wind, it’s just that there might’ve been a better method that fell by the wayside.

A carbon market could easily encourage investment in alternative energy if the officials behind it had the political will to run it the way it was meant to be run. In theory, well-implemented carbon markets with a steadily falling caps on total emissions would distribute capital faster and with less wasteful spending than the government could hope to. Sadly, not all ideas that make sense in theory survive real world testing and, for now at least, carbon markets seem like a smart idea that stumbles when up against a less than logical political scene.

Who’s Buying Green Power? – 7/22/16

Green power has only recently started to get competitive with conventional power on a cost basis so why are so many major organizations buying in already? According to the Bloomberg New Energy Finance database of more than 600 corporate power-purchase agreements (PPA), buyers range from the Pentagon and Google to Wal-Mart and Procter & Gamble with more companies buying more clean power each year.

Part of the explanation is that renewable power costs have been falling at relative large and consistent rates, and really are reaching competitive price levels in some areas. As illustrated in the BNEF graph below, PPA prices are only a fraction of what they once were for wind and solar with solar in particular seeing massive declines in price.

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Another BNEF graph shows that the trend is expected to continue thanks to the permanent technological improvements to solar cells that have brought down hard costs.

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As a result of similar improvements in turbines, wind has already become competitive with conventional sources of energy in many places, particularly the Great Plains region. The Plains region includes part of Texas, a state where wind has done remarkably well even beating out natural gas for new electric generation capacity additions in 2015.

by state

Besides the underlying economics, there is a more subtle incentive driving adoption of clean power. A desire to appear “green” to an increasingly climate conscious society is tipping the scales in favor of investment in renewables; it is changing equations for decision making by adding in perceived goodwill to outweigh the added costs. The Pentagon is no exception to return on investment principles that ask it to get the most bang for its buck and clearly showing a progressive stance has some value to the Department of Defense, at least while a progressive president is in office.

Other big buyers of PPA contracts are the large companies you might expect. Google, Amazon, Microsoft, Apple and Facebook all make the list as the power hungry that can afford to pay a little extra for their power and need a lot of it, and it shouldn’t be surprising to see a lot of California ties on the list.

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The Great Plains dominate in wind but California is certainly the sunshine state when it comes to solar development.

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Record breaking investment in green power is happening at a time when the shale-gas revolution has sent conventional power prices plummeting. With short-term prices for natural gas so low and unlikely to rise much with the U.S. access to massive domestic deposits, decision makers must have a good reason for buying into alternative energy.

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Fuel Source of the Future – 7/21/16

With 30+ year lives, power plants are a very long-term investment. This longevity was rarely a problem in the past century when coal was the only fuel source worth considering for large scale usage, but the falling costs of natural gas, wind, and solar power have made things much more complicated. Ironically, the most constant feature of analyses of the energy industry is the fact that coal will definitely not be the fuel of the future.

Using the projections of the EIA AEO2016 Outlook as a conservative estimate of the future based on current technology and policies, it is clear that coal is giving up market share to natural gas and looking deeper into “other renewables” shows most of its gains are from wind and solar.

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So there are really three viable candidates for the fuel source of the future and choosing incorrectly could result in relatively poor cash flows.

First is natural gas which the EIA sees as the likely replacement for coal. Natural gas is an incredibly cheap fuel source at the moment due to fracking shale gas and tight oil plays.

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Short of those gas deposits suddenly disappearing, coal is doomed to lose market share to its cleaner burning and more profitable fellow fossil fuel.

Of course, the way that the climate change debate is going there is always the risk that even the reduced emissions from natural gas will be too much and the gas plants will wind up as stranded assets. In that case, a healthy alternative could come in the form of wind power, either onshore or offshore. Offshore wind is much more expensive relative to onshore in the U.S. so for now it would be best just to consider onshore wind farms.

The U.S. benefits from an abundance of land suitable for wind farms when compared to Europe, especially in the Great Plains region. However, wind’s gains in the U.S. are also largely limited to states in said region and, short of a massive system of transmission lines stretching from Texas and Oklahoma to other states, it is hard to see wind beating out natural gas in most of the country any time soon.

by state

With natural gas being ubiquitous but unclean and wind being clean but rare, we are left with solar.

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solar power

Like wind, solar costs have plummeted resulting in near exponential growth. And like wind turbines, solar panels work best in certain regions, namely those with lots of sun and not so many clouds.

Yet, solar is not limited to those regions to the same degree as wind nor is it so obtrusive that it can’t be placed directly on the buildings to which it provides power, something that greatly reduces the need for costly infrastructure. Although solar will give the most bang per buck in isolated, desert-like regions that aren’t already connected to an electrical grid, solar power has the potential to get so cheap that any area with high enough electricity rates would become fair game as shown below.

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So although solar has a clear area where it will always work best, it is still an option in many parts of the U.S. as long as the cost of panels continues to drop as projected. Whether or not it will be the best option in the area will depend very much on proximity to cheap wind (Plains region) or cheap gas (shale/tight oil regions) as well as local electricity rates.

It will interesting to see which energy source dominants in each part of the country, but it is likely that each will have a part to play and see appropriate investment as befits a free market… except coal, I guess.

EIA Projections on Natural Gas – 7/20/16

U.S. consumption of natural gas is projected to rise from 28 trillion cubic feet (Tcf) in 2015 to 34 Tcf in 2040, according to EIA’s Annual Energy Outlook 2016 (AEO2016) Reference case. The industrial and electric power sectors make up 49% and 34% of this growth, respectively.

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The rise in natural gas consumption coincides with the relatively low prices caused by the boom in shale fracking. In the AEO2016 Reference case, average annual U.S. natural gas prices are expected to rise through 2020 on export demand to Mexico via pipeline, and others via LNG exports, before stabilizing at a still relatively cheap spot price.

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Because gas-fired electricity generation produces fewer carbon dioxide emissions than coal-fired generation, natural gas is expected to play a large role in compliance with the Clean Power Plan(CPP), which takes effect in 2022, provided that the CPP survives the court challenges brought against it.

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Growth in U.S. natural gas production is expected to come mostly from fracking of shale gas and tight oil plays. The EIA projects that, by 2018, the United States will be a net exporter of natural gas for the first time since the 1950s.

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The cheapness of natural gas in the U.S. has decimated coal-burning plants and left the coal industry valued at less than 10% of what it was worth a decade ago. Coal closures are expected to drastically reduce U.S. carbon emissions and air pollution related health risks.

The closures are also in part the result of U.S. EPA pollution regulation, which has recently added more stringent limits on mercury and other toxins that can be met with the installation of costly scrubbers that reduce the profitability of coal plants. A similar decline in coal is likely once the CPP comes into force in 2022 if it survives its Supreme Court case as was the case with the mercury rule in 2015.

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EIA Projections on Energy Consumption – 7/19/16

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Source: U.S. Energy Information Administration, Monthly Energy Review

Petroleum, natural gas, and coal made up 81.5% of total U.S. energy consumption in 2015, their lowest share since surpassing hydropower more than a century ago. At their expense, non-hydro renewable energy consumption has expanded rapidly especially in the case of solar and wind, which have seen growth skyrocket the last few years.

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On the other end of the spectrum, U.S. coal consumption fell 13% in 2015 on competition from natural gas and renewables, as well as regulation on pollution that forced older plants to retire. The decline is only matched by one in 2009, the start of the Great Recession, and another in 2012, when coal use fell 12% below the level in the previous year. Coal consumption is expected to continue its decline, especially if the Clean Power Plan survives.

The EIA’s Reference case projects petroleum consumption will remain stable through 2040 as fuel economy improvements and other changes offset growth in population and travel. The EIA projections are conservative by design so those “other changes” do not include the possibility of truly disruptive technological changes such as mass market adoption of electric and/or self-driving vehicles. Expect a substantially revised projection in 2025 by which time most major automotive companies would have had their affordable electric car models, costing around $30,000 after incentives programs, released for about 5 years.

Nuclear and hydroelectric are expected to remain relatively flat in growth through 2040.

According to the EIA, energy consumption in the U.S. should increase greatly by 2040 as shown below (again the assumptions used by the EIA are conservative and all trends show should be taken with a grain of salt). That said cheap natural gas and renewable energy are expected to eat into much of coal’s current role in electricity generation in any imagined scenario.

Any politician promising a preservation or return of coal industry jobs is either ignorant of economic reality or stupid enough to lie and think it won’t backfire.

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Source: U.S. Energy Information Administration, Monthly Energy Review, Annual Energy Outlook 2016

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Source: EIA, International Energy Outlook 2016, International Energy Statistics, and Oxford Economics

Worldwide energy intensity decreased by about 30% between 1990 and 2015. The reduction has occurred in nearly all regions of the world, in both developed economies and emerging ones.

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Source: EIA, International Energy Outlook 2016, International Energy Statistics, and Oxford Economics

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Source: EIA, International Energy Outlook 2016, International Energy Statistics and Oxford Economics

Autonomous Vehicles: Programs and Laws – 7/18/16

The autonomous vehicle revolution may be closer than you think.

Much like electric cars, self-driving cars developed a reputation for always being a decade away from changing the auto industry. However, that may soon change thanks to the falling cost of electronics and investment from major tech and auto companies. For instance, General Motors Co. and Lyft Inc. will begin testing a fleet of self-driving Chevrolet Bolt electric taxis on public roads this year, in a challenge to Google and Uber programs in the same vein.

Meanwhile, Alphabet, Google’s parent company, is years into testing its vehicles already and recently reached a minivan-supply agreement with Fiat Chrysler. It has promised to make cars available to the public around the end of 2019, under the assumption that market will be ready.

Volvo has also been a leader in the autonomous car race with its Drive Me program which is currently testing 100 fully self-driving cars.


As more companies test their self-driving cars, regulation of the new technology is heating up.

Lobbyists in favor of establishing federal legislation to standardize rules are already aiming to convince politicians to take on the issue despite current political deadlock. Though the proposals aren’t likely to gain immediate traction on Capitol Hill, where deadlock is still a defining feature, many are optimistic that a national policy can be reached which will help encourage adoption of technologically advanced vehicles.

U.S. regulators are expected to release preliminary guidelines for driverless car rules this summer.

On the state-level, some legislatures are hoping to attract investment by pushing favorable legislation. Michigan lawmakers have already introduced bills to allow for public sales and operation, end the human operator requirement, and help create a highway speeds testing facility, which are all significant moves beyond states that allow only testing or require a driver be ready to take the wheel.

Under the updated laws, General Motors, Fiat Chrysler and Ford would be authorized to run networks of on-demand self-driving vehicles without drivers. Other states authorizing self-driving cars include Nevada, California, Florida, North Dakota, Tennessee and Utah.

EIA Construction Costs by Energy Technology – 7/15/16

The EIA publishes a large number of informative articles and data sets. Below you will find a summary of a recent article focused on the average construction costs of various electricity generation technologies.

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Source: U.S. Energy Information Administration, Form EIA-860, Electric Generator Construction Costs

The cost data charted above does not include government grants, tax benefits, or other incentives. In particular, the PTC and ITC tax credit programs for wind and solar extended in late 2015 significantly change the economic situation for those resources, but not expected to survive Congressional conflicts when the data was collected in 2013.

In addition, construction costs are only one of the fundamental factors deciding which electricity generating methods are favored. The relative economics of each electricity generation technology also depend heavily on the cost of fuel or lack thereof. For example, in the case of wind and solar plants, the initial construction cost constitutes most of the plant’s total costs.

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Source: U.S. Energy Information Administration, Form EIA-860, Electric Generator Construction Costs

Solar. Solar additions in 2013 had average construction costs of $3,705/kW. The data, which are for utility-scale plants only (capacity of 1 MW or more), do not include distributed solar installations, such as those found on residential and commercial rooftops.

Wind. The average construction cost of wind generators in 2013 was $1,895/kW, the lowest of all renewable technologies.

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