New-found stability can help Trump meet US energy goals
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President Trump’s call for U.S. energy “dominance,” if not an especially coherent policy goal, certainly represents a dramatic tonal shift for the nation’s energy policy objectives.

Apart from the broadsides leveled at the U.S. energy and environmental regulatory framework earlier this summer, Trump’s vision of surging U.S. energy exports underpinning a new era of American prosperity rests largely on continued strong growth in U.S. oil and natural gas production.

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Linked to that prospect is the U.S. Energy Information Administration’s (EIA) projection, from the 2017 Annual Energy Outlook (AEO), that the U.S. will become a net energy exporter by 2026. The nation has been a net importer of energy since the 1950s, according to the EIA.

 

The U.S. was put on the net energy exports path in late 2015, when Congress passed and President Obama signed legislation ending the nation’s 40-year-old ban on crude oil exports. A few months later, Cheniere Energy’s LNG terminal at Sabine Pass, Texas, shipped the first-ever commercial cargo of liquefied natural gas from the coterminous U.S.

The Cheniere LNG start-up, along with burgeoning gas pipeline volumes sent to Mexico and Canada, enabled the U.S. to become a net exporter of natural gas for the first time in more than 60 years — a monthly milestone first reported by S&P Global Platts in November 2016.

Production potential

But sustaining U.S. oil and gas exports over the long term requires a robust foundation for continued growth in production of the two hydrocarbons.

Certainly, the domestic oil and gas industry’s recent track record bodes well for that growth, thanks to the prolific shale and other unconventional “tight” oil and gas resources under development. The EIA’s AEO 2017 forecasts a steady level of oil production over the next three decades-plus that on average would be almost 15-percent greater than the 2015–2017 average. But natural gas production is the real difference-maker for the president’s import-export expectations, growing by almost 50 percent in that same time span.

Is that a realistic scenario? Certainly the resources are there. The EIA has estimated that the U.S. has technically recoverable conventional resources of 220 billion barrels of oil and 2,200 trillion cubic feet of natural gas. Of course, getting from technically recoverable resources to proved reserves is a function of economics and energy policy. But if the shale boom has taught us anything, it’s that the presumptive economic recovery of oil and gas can be leapfrogged with technology. 

Industry capacity concerns with cycles

Americans can feel confident in their massive endowment of producible oil and gas to serve most of their energy needs for the foreseeable future, as well as the benefits that would flow from rising exports of hydrocarbons.

Because of its perpetual propensity for boom-and-bust cycles, the domestic oil and gas industry’s capacity to make that future happen has at times come into question. During the latest boom period, the costs to hire drilling rigs and to man the rig crews inflated rapidly with demand for rigs — especially the preferred rigs purpose-built for efficiently developing the tight oil and gas formations that have upended the global energy picture.

Less than three years ago, contract drilling executives were bemoaning the difficulty of hiring enough quality personnel for the rigs, while operating companies scrambled to mitigate rig-cost inflation by locking in day rates for the prized high-spec rigs under long-term contracts of three-to-five-year duration. The consequent surge in U.S. oil and gas production swamped global markets, and commodity prices plummeted.

With the bust that ensued at the end of 2014, the U.S. drilling business collapsed. The U.S. active rig count, as Platts RigData tracks it, fell by 81 percent from zenith to nadir. Thousands were laid off, drillers went bankrupt, and once again, the domestic oil and gas industry was a victim of its own success.

But after a partial commodity price recovery — especially for oil — U.S. companies ramped up their rig counts and capital spending anew. Our tally of U.S. active rigs rebounded by 166 percent, even though oil prices remained below $50 a barrel and gas prices below $4 per million British thermal units, and we began to caution that the rapid run-up in rigs wasn’t warranted by where oil and gas prices had settled.

After declining monthly for two years, rig day rates spiked in the first quarter of this year. Anecdotally, we learned of some drillers having to turn down already scarce jobs because of their difficulty in securing quality personnel. (With each bust, the industry experiences a spasm of lost workers that never return to this wildly cyclical business.)

Now the questions arise anew: Will rig cost inflation be held in check? Will drillers be able to staff up again?

Our earlier concerns notwithstanding, we see some recent positive signs for the U.S. drilling sector. After spiking in the first quarter by the greatest quarter-to-quarter amount (+3.5 percent) since 2010, day-rate increases have settled down to manageable gains (most recently +0.2 percent). Additionally, rig crew wages have risen by almost 16 percent this year vs. 2015 but remain nearly 3-percent below that of 2014.

The day-rate turnaround was especially stunning. Early this year, many drillers running top-tier rigs were offering discounts to operators to secure term contracts of just six months to one year. Within just another two months, many drillers were seeking premiums for the same, and within just another month afterward, that practice evaporated alongside bullish expectations for oil prices this year.

Additionally, our recent conversations with drillers inform us that the scramble for rig personnel has cooled. The speed and abruptness of these turnarounds was unprecedented.

Experience tells us that a reasonable inference is that operators and drillers are being more sensitive to vagaries in rig markets than ever before. Much of this lies not only with continuing commodity price uncertainty but also with the increasing consensus that the aforementioned preferred purpose-built rig model (highly automated, drilling-pad mobile and 1,500 horsepower drawworks capacity) now drives the market. Streamlined demand drivers beget faster market responses.

This suggests that the drilling activity trend line going forward is going to look more like an undulating plateau than like the hills and valleys of the past.

Sometimes commodity-price uncertainty can be a good thing, if it acts as an innate governor against booms and busts. And therein lies greater confidence for a stable foundation for U.S. oil and gas production and exports over the long term.

Bob Williams is  an analyst with Platts RigData, a unit of S&P Global Platts.


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