The Grexit Premium for Oil

In the first post of this blog I mention what a lot of people already know anyway: the best way to lower oil prices is to go into recession. Low demand will result in price drops to suit it. This is what we saw a few days ago when oil prices fell sharply from $98 to, what is now, $93 per barrel. The trigger was the outcome of the recent Greek elections which scared the living **** out of recession hit Eurozone countries as well as markets around the world, who themselves are terrified at the possibly immense cost of a Grexit (Greek Exist from the Euro - JPMorgan estimates immediate costs of $400 billion). Prior to this, on May 1st, poor growth output from China and a revision of their GDP growth sent barrel prices down from $106 to $98 in a matter of days (a good lesson for some US politicians about where the oil price hikes really come from).

The last time deep recession fears caused a significant drop in oil prices was back in the Summer of 2011 when the GOP and Obama squared off on the debt ceiling debate; you know, the debt ceiling? The thing Republicans raised constantly during the Bush years but then figured when a Democrat did it, it violated their religious, constitutional, human and civil rights all at once? Back then the price dropped from $100 to $81 per barrel in just two weeks.

Figure 1: Price of a barrel of crude ($) vs. Time. Source: Plus500.com

Elections in Greece will come again in mid-June and there are now real fears that SyRizA, the radical socialist anti-bailout party, will top the vote. The real question is what the Grexit premium is i.e. how low the price goes until markets are content they have gone down enough to make up for the risk of a deeper European recession. Prevailing opinion is that prices will continue to drop or remain steady next week, so perhaps we are near the Grexit premium (ca. $10)? However, in the medium term, the promising re-opening of talks with Iran, lower forecasts for China's growth and Greek election uncertainty should keep the prices of oil down from where they have been the past months.

Blue State, Red State, Pricey State, Cheaper State

Forgive the Dr. Seuss-eque title, but it serves to illustrate a point. The graph below shows a relationship, which is truly intriguing. US States which lean Republican tend to have lower gas prices than those that lean Democrat. Yet, residents in 'Red' States pay more on average on gas consumption per month owed to them driving more miles in less efficient cars. More here on how an oil glut is creating these price differentials which, historically, were not as pronounced.


The philosophical divide that exists to facilitate the situation shown above is significant; especially since high gas prices are quickly become a top 2012 Election issue. For many Americans in 'Blue' States elevated gas prices are simply not the number one issue at the moment, but for others they do good by making the clean tech industry more viable. Energy Secretary Steven Chu is certainly shared this view. On the other hand, Republican voters are most concerned with high gas prices and aren't fond of the Administration's perceived hostility toward fossil fuels. Electoral math thus begs the question: where do 'Purple' States stand?

It's hard to forecast how heavily gas prices will weigh on swing voters' mind come November. People around the country are in debt and it's hard for a working class family to share the President's long term goal to facilitating nascent renewable technologies.

The Obama Administration understands that in order for the US to lead the future clean tech market, it must be the first to develop its technologies. There are nations around the world which will always produce things at a lower cost than the US, which is why technological expertise will be more a necessity than an advantage for the US. Be that as it may, preparation for the future Energy mix should not get in the way of today's realities. For the President to win in November he needs to convince swing voters that he shares this view. Most importantly, the President will have to sell his 'All of the Above' energy plan as being more than just a slogan. The public wants - deserves - an energy plan.

A Beginner's Guide to the Choice of an Oil Production Method

OIL PRODUCTION PHASES:

Primary Recovery — When the natural pressure of the oil (or gas) is enough to get it out of the ground. The recovery factor is usually low (10-20%). The vast majority of oil production happens this way.

Secondary Recovery — In order to keep the pressure elevated or to force the oil out, water (sometimes gas) is pumped into the reservoir. Recovery of the reservoir can reach as high as 45%. More and more oil fields are being exploited this way because of years of using just the reservoirs natural pressure which has since dropped so low that primary recovery rates became un-economical.

Tertiary Recovery — Also known as Enhanced Oil Recovery (EOR), includes methods which inject fluids to make the oil easier to flow. Solvents could be injected to dissolve into the oil, hot gases or fluids could be injected to make it 'lighter' or chemicals may be injected to reduce oil tension with the rock and water. Depending on the EOR method, another 5 - 20% could be added to the recovery. A small percentage of oil production, though growing, happens using EOR.

CHOOSING THE EXTRACTION METHOD:

However as oil prices rise and more unconventional sources of oil become profitable, oil companies find it in their interest to consider different extraction methods as early as the initial production phase.

A useful illustration of when certain methods are used can be found below:



The x-axis measures the heterogeneity of the reservoir. That is to say, the 'uniformity' of the rock, oil and water properties and compositions. If some parts of the reservoir allow for flow to pass easier than other parts, then the heterogeneity of the reservoir is low.

The y-axis measures the 'quality' of the oil. If the oil is light and flows easily, the quality is high and production is easier. If the oil is heavy and viscous (doesn't flow as readily) then production is more complex.

Cold Production

When the solid and fluid composition of the reservoir is fairly uniform and the oil quality is high, primary production is employed. For reservoirs with heavier oil, cold heavy oil production with sand (CHOPS) is used. This type of production is mostly prevalent in the heavy oil fields of Venezuela. There is also the option of drilling a very high concentration of multilateral wells in a specific area so as to make sure even the least readily flowing oil is produced.

Less prevalent of a method, but one which produces 20% of Texan oil, is CO2 injection. The CO2 dissolves into the oil and changes it's chemical composition making it easier to flow. Other fluids, such as light hydrocarbon gases, could be used as solvents. However CO2 is more readily available. This type of extraction is called Miscible EOR because the CO2 and Oil are miscible with one another; that is to say they can 'mix'. Immiscible EOR involves injecting fluids which do not combine with the oil and simply 'push' it along to the collector well.

All these processes have in common the fact that they can operate at reservoir temperature.

Hot Production

When the oil quality is low thermal methods must be used. When heavier oils are heated the lighter oil fractions within it evaporate. Heavy oils are made up of long hydrocarbon chains, so the remaining heavy residue will be chemically cracked into light components. Thus, thermal EOR has the advantage that it can 'upgrade' the oil quality within the reservoir itself.

Most heavy oil deposits are relatively shallow, which usually means reservoir heterogeneity is high. This means that if a hot gas (be it steam or air) is injected to upgrade the oil, it might not reach the majority of the oil because it is channeled to regions of the rock which are more permitting to fluid flow. To cut a long story short, THAI (toe to heel air injection) and SAGD (steam assisted gravity drainage) work around the problem of heterogeneity by injecting hot air and steam horizontally. This way gravity does most of the work of in terms of distributing the fluid and sweeps the reservoir uniformly. SAGD and THAI are new methods but they are very promising and are being pioneered in Canada.

Finally CSS (cyclic steam stimulation) is a popular technique in heavy oil fields which works at a short range and thus is able to overcome heterogeneity problems.

Final thoughts

If you realize that I have oversimplified a lot of aspects of this post, please don't be too critical. It's not meant to be addressed to those who are familiar with these methods, but rather to those who really have no idea how oil is extracted.

Hydraulic fracturing: how technology outpaces legislation

What is fracking?

Induced hydraulic fracturing is a process whereby highly pressurized fluids are injected into a horizontal or vertical well in order to enhance recoverability of an oil or gas field by creating new flow channels in the rock. Vertical 'fracking' is an older technique which uses a relatively low volume of water in order to increase the lifetime of an oil field. On the other hand, the more recent and controversial technique, horizontal fracking uses very high volumes of water (of the order of millions of gallons per well) as well as many chemicals (up to 596 by one count, most of which are proprietary).

Why is it significant?

By 2035, world gas use is expected to rise by 50%, making up 25% of our energy usage according to the IEA. This achievement would be in no small part attributed to the availability of Shale Gas made possible by fracking. This application of fracking was enough to help turn the US from a net petroleum product importer to a net exporter (DOE, 2012). Further to this, liquid oil that is trapped in tight shale deposits is also now accessible. Both these achievements combined have contributed to making the US a net petroleum product exporter, after many decades of being a net importer.

China also stands to gain much from this new technology, as it seeks to transform its energy landscape by using now accessible shale gas to power its stations. Between 2015 and 2020, China says it wants to increase its shale gas output by a factor of ten (though admittedly their current production levels are low)!

Where is the problem?

In many US States there has been considerable opposition. Also, France became the first country to ban fracking, citing groundwater contamination concerns. There is an ongoing campaign in New York to place a moratorium on fracking, while countries such as the UK, Poland and Germany all have internal campaigns to ban the technique. The contamination arises when natural gas and/or some of the chemicals used in the fracking fluid, find their way into the water supply.

Regulation vs. a total ban

The opportunities that arise from hydraulic fracturing are simply too great to give up. Increased energy independence and access to cleaner burning natural gas is an attractive prospect for any country. An outright ban assumes that fracking is inherently a 'dirty' method. However, some environmentalists and many who are knowledgable on the issue, are coming to the realization that improvements in how fracking is actually done would drastically decrease the risk of contamination.

Shale gas and shale oil reservoirs are relatively deep (of the order of kilometres below the ground), whereas the aquifers we get our water from are shallow (several meters to ca. 100m below ground). So the issue isn't the fracking fluids not being removed from the gas/oil reservoir. Scott Anderson writes that "the groundwater pollution incidents that have come to light to date have all been caused by well construction problems". When the steel pipe casing or the well cement wall aren't placed properly or are not strong enough, fluids will leak out.

It seems that horizontal hydraulic fracturing suffers from the serious deficiency of evolving much more rapidly than any legislation that would seek to properly regulate it. If governments are concerned about the potential risks of fracturing, they should make sure that companies go through rigorous measures to place the steel casings properly and to let the cement settle before they test it for its durability. The required research and experience for drafting appropriate legislation is out there: It's been several years since this method first started to be used for shale gas and oil extraction, so there is definitely no deficiency in project and research data!

There has, admittedly, been some progress. Ohio, Pennsylvania and New York have introduced new industry standards for proper well drilling and completion, while the University of Texas Energy Institute has compiled a report detailing the required steps and technical data for appropriate legislation passage. On the other hand, the EU recently concluded that existing regulations on water and drilling are enough to regulate fracking. The main difference between the EU and US is that the US Clean Water Act exempts natural gas extraction from certain requirements.

But, at the end of the day, the public requires extra re-assurance. When it comes to the water we drink, it's always a sensitive issue. Many Americans and Europeans are not comforted by existing legislation, otherwise they wouldn't be so opposed to the technology. New pieces of legislation that would specifically address fracking safety standards - even if they were mostly based on existing laws - would offer re-assurance to the public but also guarantee the protection of aquifers.

If some governments and environmental groups were less reactionary, we all might have a lot more energy and cleaner water. Especially in the case of energy dependent countries, an outright ban on hydraulic fracturing is an immature and irresponsible response in a time when economic growth and new jobs are so vital. Hopefully, some bans are put in place so that they may one day be lifted.

What is making the cost of oil go up (and what won't bring it down).

Around 1 year ago, average oil prices stood at around $3.50/gallon. Currently they are 33 cents higher than last year, something which the Huffington post notes equates to a $44 billion federal tax.

As in any year, and especially a US election year, high gas prices give rise to a plethora of opinions from politicians as to why they are doing so. While Recessions are typically the best fix for Oil Prices, you can be sure no politician will be suggesting that. However, some of the things they are suggesting the US do in order to lower prices in the long run, are in most cases, not bound to help much. Let's first look at what's causing prices to steadily rise and then close with two popular solutions, which will likely do little to temper this rise.

What are the major causes of oil prices going up?

1. Geopolitics

Over the years, events in the Middle East have time and time again driven prices up. Most recently, the crisis in Syria has added much to the uncertainty of the region's stability, but tensions with Iran continue to be a main driver of high oil prices. The strait of Hormuz - through which 1/5 of the world's oil flows - was threatened with blockade by Iran, due to tensions with the US and the EU. This led to a great deal of panic buying by traders in Europe and Asia and drove oil prices higher.

The current oil embargo by the US and the EU on Iran has resulted in it losing out on as much as 300,000 barels of crude export per day. While large oil importers such as India and China have stated they will not stop importing Iran's crude, the shear number of countries participating in the embargo has led to a lack of buyers for Iran.

So, while it is almost universally accepted that Iran does not have the capability to block the strait, in the face of superior US Naval force, potential Iranian backlash is what speculators fear: the sabotage of an oil pipeline or internal hardliners taking matters in their own hands. Whatever the Islamic nation can do to raise the price of oil to cover their losses, analysts are fearing they will.

2. Speculators

Commodities Futures Trading Commissioner Bart Chilton recently told ABC that a "Goldman Sachs study last year stated that each million barrels of net speculative length in the markets adds as much as eight to 10 cents to the price of a barrel of crude oil." He further claimed that, on average, Wall Street will collect ca. 22% of the price the average US consumer pays at the pump. While the veracity of the statement has been contested by Wall Street (it's now suing the commission), Forbes contributor Robert Lenzner reported that "if there were no speculation in oil futures on commodities exchange, the price of a barrel of oil might be as low as $74.61", which equates to a speculative premium of more than $25.

The Arab Spring saw prices spike when traders worried about oil shortages and recent tensions with Iran led to the panic buy described in the previous section. Saudi Arabia has pledged to match the oil exports that would have come from Iran, leading to a four year high Saudi rig use. Even so, rapid responses to ultimately false price signals (like the fabricated Iranian TV report that there had been a Saudi pipeline explosion) are sending prices up, telling us that the Markets are indeed on edge and indicating that speculation will continue to drive prices higher.

3. Demand

In the US, demand for gas is at a 12-year low and U.S. gas consumption so far in 2012 is at its lowest point since 2000. This graph from the Centre for Global Energy Studies shows that demand in Europe will actually decrease in the coming years, while in the US it will more or less flatten out. So where is this demand coming from? You probably know the answer already, and looking at the previous graph one can see that Asia (mostly China and India) will continue their path of major energy consumers. Citizens in China and India are buying cars at ever increasing rates , while Brazil saw its oil imports rise by 224% from Nov. 2010 - Nov. 2011.

These three countries (Brazil, India and China) are easily making up for the drop in US demand, resulting in US based refineries exporting larger volumes of finished gasoline and diesel. In fact, recent increases in diesel exports can be partially explained by India's shift to diesel fueled cars from the more expensive gasoline fuel.

What 'quick-fix' solutions won't drastically bring oil prices down?

1. The Keystone XL Pipeline

The Keystone XL expansion is expected to transport 800,000 barels per day from Alberta, Canada to the refineries of Texas, however the crude has already been earmarked for export outside the US at higher global prices. Added to this, the Keystone XL pipeline is estimated to increase prices in the midwest by 20 cents, because of drop in crude Midwestern refineries will receive from Canada.

A recent article in Bloomberg lists the various opinions from different consultants on what direction prices will take if the Keystone XL is built. Quoting directly from the article: "Canadian producers will be able to charge more for their oil after Keystone XL is built, boosting revenues by $2 billion to $3.9 billion, Canada’s National Energy (TAQA) Board said in the 2010 report approving of TransCanada’s pipeline plan". It is mostly agreed that oil prices would rise in the Rockies and the Midwest, while those in the South might drop. Whether the net balance will be slightly negative or positive, it's pretty clear that the Keystone XL will not be a game changer for prices.

2. Taping into the Strategic Petroleum Reserve

Other than the fact that there is no severe disruption in energy supply that would excuse opening up the SPR, the reserve contains only a little under 40 days worth of total US consumption of crude. What little the US would open up to the markets, hasn't been refined and needs to be replaced. A short term reduction in prices, of the tune of 11 cents last time 60 million barels were opened up to the market, would not be expected to do much in the face of the recent volatility oil markets have been subjected to.


So, when it comes to lowering oil prices, don't listen to what most politicians are telling you these days. I'll bet you $10,000 the issues at hand aren't so easily solved.