The LNG demand issue is actually worse than I thought when I wrote about it several weeks ago. If the Dept of Energy continues to approve exports we are going to be in a world of pain.
To put this topic into context the EIA said U.S. natural gas production rose to a record 76.68 Bcf per day in March. That is an increase of 4.34 Bcfpd from March 2013. Despite rising production natural gas inventories hit an 11 year low at 822 Bcf for the week ended February 28th.
Gas production was not keeping up with demand until gas prices began to rise. Once they were comfortably over $3.00 the demand began to decline as it became cheaper to burn coal. Peabody Energy said last week that 90% of the excess electricity used over the harsh winter for heating was generated by coal. In March, despite the lingering winter weather gas demand was down -1.42 Bcfd over the same period in 2013.
Last week the Obama administration followed through on the president's threat to shutdown the coal companies by proposing regulations to reduce power plant emissions by 30% by 2020. While I applaud the sentiment to reduce emissions it is simply not practical and would be a nightmare for consumers.
I just told you that coal usage was spiking because of high gas prices. If we remove coal as a fuel then gas demand is going to rocket higher, a lot higher. As gas demand rises so will the prices. Do you remember the utility bills from 2008 when gas prices were nearly $14 per Mcf compared to $4 at the end of 2013. If we return to the $12-$14 level today it won't be a temporary spike. If coal is removed from the equation it will be a permanent spike but coal is not the only determining factor for the future.
We know our production is going to climb thanks to the active shale drilling. However, the number of active gas rigs hit a 19 year low back in early March. Until prices climb significantly there is no real incentive for a boom in gas drilling. It will increase slowly but as long as oil prices remain over $90 it makes a lot more sense for exploration companies to drill for oil instead of gas. That alone is a pretty convincing reason why gas prices are going higher as demand increases.
At our current rate of gas injection into storage our inventories are going to be well below normal when the heating season begins in November. The five year average of gas in storage on November 1st is 3,832 Bcf. Currently we have 1,499 Bcf and we are injecting about 115 Bcf per week into storage. To reach the five-year average we need to inject nearly 6 Bcf per day more than the current average or roughly 40 Bcf per week more. That is a lot of gas when the five year average injection rate for the summer injection period is only 65.3 Bcf. We are injecting more today because the weather has not turned hot yet. We are in the low demand spring period. Once nationwide cooling begins the injections will decline.
Current projections put us around 3,400 Bcf in storage by November 1st. Assuming we don't have a repeat of last winter that would be barely enough. However, with global warming wreaking havoc on the seasonal cycles we can't guarantee it will be a mild winter.
At any rate we should just barely have enough gas for next winter despite the record gas production growing by about 4 Bcf per day per year. Gas prices are still going to rise to incentivize drillers to produce more gas.
We will need significantly more drilling since shale gas wells deplete rapidly. The maximum gas is produced in the first three years of a well's life. Nearly 75% of the available gas is produced in the first three years. The remaining 25% can continue to trickle out for the next decade or more.
This puts gas producers on a treadmill to disaster. They have to drill more wells every year than they did the last just to keep production accelerating slightly. Once the sweet spots are drilled and new wells begin to decline the rate of production will begin to decline rather than grow. That is anticipated to happen around 2017 according to the EIA.
The topic of this article is LNG. I know I took a long time to get to the meat of the discussion but I had to establish the base case. That case is that we barely have enough gas to supply the current demand and if coal is pushed out of consideration as a fuel the demand for gas is going to skyrocket.
I think we would be fine with the above scenario if we had a decade or more to adjust the fuel levels and ramp up drilling for gas. Unfortunately we have an 800 pound gorilla about to enter the room. The Dept of Energy has 37 LNG export applications they have either approved or are in the process of reviewing. The total export capacity for all those applications is 38.56 Bcfpd. That is roughly 55% of our current production.
Think about that for a minute. The DOE has either approved or is in the process of approving the potential export of 55% of our total production.
If that came to pass it would be a nightmare for consumers. I already showed you that we are barely covering our own demand with record production of 76 Bcfpd. If we allowed companies to export 38.56 Bcfpd two things would happen. First there would not be enough gas to go around. Second there would be a bidding war for the available gas. The $14 per mcf in 2008 would be the likely price today. Your utility bills would double if not triple.
The DOE alluded to this problem last week when they said they were no longer going to issue conditional export approvals. They are only going to consider future export approvals if the company has already received a Federal Energy Regulatory Commission (FERC) approval. That process cost about $100 million so only well financed companies are going to complete the process.
Secondly, the DOE said it was going to undertake a study to determine if it was in the national interest to export 12-20 Bcfpd. They have already approved for export a significantly higher amount but most of those companies have not received the FERC approvals and may never receive approval so the DOE export conditional approval will be null and void.
However, Cheniere Energy (LNG) has already received approvals for about 6 Bcfpd and other companies have either been approved or they are very close for roughly 9 Bcfpd. If the DOE were to stop approvals today those existing approvals equate to about 20% of our existing production. That means gas prices are going higher.
The limiting factor on all these exports is price. Japan and Asia pays about $17 per mmBtu or roughly the equivalent of our $4.70 per Mcf today. The contracts being signed today for export overseas are based on the Henry Hub futures prices plus a liquefaction premium. Hypothetically the cost of the gas at the Hub is $4.70. Add in the premium for liquefying the gas ($3) and the cost of shipping to Asia ($4) and the cost delivered to Asia today would be around $12. Asia is paying $17 so that equates to a nice profit.
However, what happens when U.S. demand is fighting against the exporters for the available gas? The price will go up. In the example above the profits will get squeezed because everything else is fixed. Shipping will cost the same and liquefaction is a fixed cost. As the cost of gas rises the profits will decline. These same countries will be getting gas from Australia and the Middle East so they have other sources. When the price to Asia hits a ceiling we will know what our gas at home will cost. If the ceiling is $17 and we deduct the fixed costs our local prices will probably be around $9-$10 per Mcf.
As our demand rises against a shrinking supply we can probably expect to pay a little more than $10 depending on the rate of new gas wells being drilled. At $10 the producers will have plenty of incentive to drill new wells but as we know from experience there is a 5-7 year lead time between needing to boost drilling and actually getting the gas into a pipeline.
To summarize the DOE has either issued conditional approvals or are in the process on 38.5 Bcfpd. Current production is 76 Bcfpd. Our current annual production increase is roughly 4 Bcfpd. Coal is going away as a prime energy fuel and that will significantly increase demand. There is a major train wreck ahead and the U.S. consumer is going to pay the price in their utility bills.
Crude inventories declined -3.4 million barrels last week as a result of refiners increasing production and a decline of -690,000 bpd in crude imports. Since refiner inputs only rose +210,000 bpd the drop in inventories was mostly related to the drop in imports. This was probably a blip in the data or fog in the Houston ship channel.
Inventories at Cushing Oklahoma declined to 21.4 million barrels and moved ever so close to the 20 million barrel threshold for operational capability. Inventories under 20 million barrels and the facility may not be able to perform the blending processes to push the right grades of oil down the pipelines to the Gulf refiners.
Gasoline inventories rose slightly by +200,000 barrels. Gasoline demand at 9.1 mbpd remained over 9 million barrels for the fourth consecutive week.
Distillate inventories rose +2.0 million barrels while demand declined only 40,000 bpd. Both gasoline and distillate demand is rising into the summer driving season.
Refinery utilization rose from 89.9% to 90.8% and should remain over 90% for the rest of the summer unless it drops due to hurricanes. NOAA believes this will be a calm hurricane season but a monkey flipping coins would have about the same statistical success as NOAA in predicting storms.
In the graphic below green represents a recent high and yellow a recent low.
Propane inventories are recovering from their winter lows with whopping +3.686 million barrel rise to 45.775 million. That was more than an 8% increase in only one week. After the propane shortage that drove retail prices over $4 in February you can bet suppliers are going to stock up this year.
The majority of the indexes have broken out to new highs and there are no bears in sight. The economic calendar is light this week and we have not yet reached the earnings warning period for Q2 so traders are in charge of their own fate.
I would not be surprised to see some profit taking but we are in buy the dip mode until proven wrong.
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