Tag Archives: shale oil

the Obama $10 per barrel oil tax

February 8, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , 1 Comment

Last week, the Obama administration said its upcoming budget will contain a proposal for a $1o a barrel tax on oil.  Its purpose would be to fund infrastructure, as well as to use price as a tool to redirect Americans toward other forms of energy.

Anything more than these bare bones is still a puzzle.

Clues:

–the adminstration says the tax would not be collected from oil producers at the wellhead, i.e., it isn’t a tax on crude oil

–nevertheless, the tax would be collected by oil companies

–the levy would not apply to oil products refined in the US and then exported

–it would apply to oil products refined abroad and imported, though.

Effect:

A barrel (42 gallons) of crude oil refined in the US ends up on average as 19 gallons of gasoline, 12 of diesel/heating oil and 10 of other stuff.

If passed on to end users completely and evenly by the as yet unspecified collectors, a $20 a barrel ta would mean a $.24 per gallon increase in the retail price of each product.

This would be a baby step along the road to lessening dependence on OPEC already traveled by every other country in the developed world in the 1970s.  Better late than never, in my view.

My take:

We’ll hear more later this week, I guess.  But it strikes me from what has been said so far that the proposal has been defined more by what Mr. Obama doesn’t want to do than by anything positive he intends to accomplish.

–I think collecting the $10 at the wellhead from producers would likely tip some shaky shale oil producers into bankruptcy and discourage others from doing any development.  After all, in a world awash in extra crude oil being stored in bunkers and even on ships tethered off the shores of producing countries, how is any independent US producer going to be able to pass on any part of the $10 to its refinery customers?

The waning of US shale would also have the disastrous consequence of handing control of the crude oil market back to OPEC and Russia.

–adding $.25 to the federal tax on gasoline and diesel fuel, which I think would be the simplest and most economically sound alternative, would upset the US auto companies, who are now raking in money from selling gas-guzzling SUVs.  Autos are a traditional Democratic constituency and a perennial problem-child industry that the government rescued from bankruptcy less than a decade ago.  So a gas tax is likely off the table.

In addition, a Republican congressman already raised the gasoline tax issue last year.  He got a lot of grief and no support from anyone on either side of the aisle.

–This leaves refiners and/or distributors is most likely to be the parties taxed.  To me, this implies that the $10 cost would be shared among producers, refiners and end users according to who has the most market clout.  2015 results from refiners and distributors tell us that they have already been keeping a substantial portion of the benefits of lower crude oil prices for themselves, rather than passing them on to customers.  My guess is that shrinking margins for refiners and middlemen would be the primary effect of the proposed new levy.

Also, if the past is any guide, the issue of tracking and differentiating between refined products for export and those for domestic use would be a regulatory/compliance–and a fertile field for fraud.

 

As we get more details, we’ll be able to decide whether the oil tax is something concrete or just wishful thinking.

 

 

 

more on oil

August 4, 2015 By in emerging markets, Energy, Industry Analysis, shale oil Tags: , , , , , , , , 1 Comment

As I was thinking about this post, I knew that oil is a complicated subject and that there’s a risk of getting lost in the details.  So I decided to sketch out the structure of the post carefully on paper before I began to write.  Several pages of notes later, I abandoned the attempt, in favor of extreme simplicity (I hope).

oil

Like any other mineral commodity, oil is subject to boom and bust cycles.  We’re now in bust, meaning that supply is structurally higher than demand, exerting continuous downward pressure on prices.

As with any other commodity, prices will stay low until supply and demand come back into balance.  The slow way for this to happen is for demand, now at about 93 million barrels per day and growing at 1%+ per year, to expand.  The fast way is for prices to stay low enough, long enough for high-cost producers to go out of business.  As I see it, adjustment will primarily come the fast way.

Oil is peculiar, though, in two respects, both of which argue that prices will stay low for a considerable time:

–many major oil producing countries (e.g., the Middle East, Russia) have relatively simple economies that are radically dependent on exports of oil for government income.  Over the past year, OPEC oil output has actually risen by about 1.5 million barrels per day, despite the expanding glut.  This indicates that, unlike prior periods of oversupply, the group has no desire to try to moderate the downturn.

–the long-term geological damage to a big oilfield from turning the taps off and on can be great.  So producers are more hesitant than in other industries to do so.

the catalyst

Arguably, what has upset the pricing applecart is the unanticipated surge in oil production in the US, which was 5.6 million barrels per day this time in 2011 and is 9.5 million today.  Hydraulic fracturing is the reason for this.

where to from here?

US oil production is still averaging more than a million barrels per day higher than in 2014.  However, the steady month by month march upward of output figures may have been broken in May, when liftings were about 200,000 barrels a day less than in April.

My guess (and I’m doing little more than plucking numbers out of the air) is that at $50 a barrel or below, new fracking projects won’t get started. Under $40 a barrel, some wells may be shut in.  If a production falloff comes solely through the former mechanism, we’re probably a year away from a meaningful (translation:  more than a million barrels, but after that, who knows) decline in fracking output.

That would likely mean a higher oil price then than now, IF (…a big “if”) OPEC nations desperate for cash don’t up their production further.

what I’m doing

I have no desire to buy oil stocks today, because I think we’re not that far along in getting supply and demand back into balance.  In the early 1980s, for example, the entire process from top to bottom took about half a decade.  I’m also thinking that there might either be another sharp price decline, or simply a further sharp selloff in oil stocks before the current oversupply is over.  I’ve just started to think about what I might buy if either were to happen.  One thing is certain, though.  It won’t be the big oils, or tar sands, or LNG.

more than you ever wanted to know

When I started on Wall Street as an oil analyst, oil and natural gas sold for roughly the same price per unit of heating power.  Natural gas has been less than half the cost of oil on a heating equivalent basis for many years, however, because it isn’t in widespread use as a transportation fuel and because it takes a pipeline to deliver it to customers.  Natural gas is already being substituted for coal in power generation.  Will it ever have a dampening effect on the ability of the oil price to rise?

thinking about the oil price

March 26, 2015 By in Energy, Industry Analysis, shale oil Tags: , , , , , , Leave a comment

I’ve been reading lately that many US oil companies are continuing to drill for shale oil, despite the fall in the price of crude.  However, while they are finishing drilling holes in the ground, they’re not yet “completing” the wells.  That is, they’re not fracking the underground deposits by pumping in water/sand/chemicals to create a path for the hydrocarbons to get to the well.  Nor are they installing the equipment a working well requires.

There’s even a name for these already drilled but not completed wells–fracklog.

The decision not to complete is easy to understand.  There’s already too much oil sloshing around in the world.  Why spend money to add to the problem–maybe even pushing prices down enough to make your own efforts unprofitable.

Why continue to drill, though?

Lots of potential reasons.

A drilling rig may be under contract, so the oil explorer has to pay for it whether used or not.  Drilling a certain number of wells may be necessary to keep mineral rights to specific acreage.  In the case of companies with too much debt, the bankers may be calling the shots (although such wells will surely be completed as fast as possible).  Some exploration firms have also made it clear that they consider today’s oil price to be a purely temporary dip.  So they’re going to continue to drill no matter what.

What’s important for investors, though, is how the fracklog may affect any rebound in the oil price.

My picture is that oil is bouncing along at or near the bottom, waiting for high cost production to leave the market.  As/when that happens, and as world GDP growth gradually increases demand for petroleum, the oil price will begin to rise again.

I think the fracklog creates a ceiling above which oil will find it difficult to rise.  It implies that when these backlogged wells become profitable enough, a rush of new output will hit the market.  Maybe the appropriate price is $70 a barrel.  $60, anyone?  It’s almost certainly below $100.

If I’m correct, an eventual oil price rise will be unpleasant for consumers but not devastating.  Also, the buy/sell decision for any oil producer becomes much more a sharp pencil exercise than a thematic call on the possibility of boundless price increases for output.

 

 

oil: how the price dynamic has changed

February 4, 2015 By in Current Market Thoughts, Energy, Industry Analysis, oil and natural gas, shale oil, Strategy Tags: , , , , , , , Leave a comment

Value Line vs. O”Neil

My first Wall Street job was with Value Line, a firm which has seen better days but which dominated the retail market for investment information in the 1970s – 1980s.  It still publishes the Value Line Investment Survey, a newsprint weekly that over a 13-week cycle provides historical data, analyst commentary (generally not good nowadays) and a computer-generated comparison of relative investment attractiveness (based on PE and earnings growth) for a universe of around 1800 stocks.  As I recall, the Survey cost about $250 a year back then and had about 80,000 subscribers.

Analysts and portfolio managers who worked for the company couldn’t understand why the price was so low.  We all thought the publication should sell for at least double the going price.  Since the main costs of publication were for printing and postage (sadly, not for salaries), the company could triple or quadruple its profits by charging $500.  The publication was surely worth it.  Yet the firm’s owner adamantly refused to budge.  A real head scratcher.

Then we found out why.

A rival emerged in the form of William O’Neil and Company, a suppliers of very detailed price charts and other technical information to individuals and institutions. O’Neil launched a chart-based weekly service covering the same universe of stocks, cpriced at $125 a year.  No analysis, but similar historical data, loads of technical information and highly detailed charts that put Value Line’s to shame.

The publication lasted about a year and then folded (I Googled O’Neil just before writing this.  The firm appears to have revived the idea and to now be selling a similar service.  I didn’t investigate, though.)

Why?

I remember figuring at the time that O’Neil needed at least 5,000 subscribers to be cash flow positive (this was a long time ago, so my numbers may be way off.  Their accuracy isn’t necessary for my point, though.).  If it got there, it could gradually add features and increase marketing   …and start to grow itself into a serious competitor to Value Line.  O’Neil couldn’t get north of 2,000 with its service, however, and quickly got tired of bleeding red ink.

Suppose the VLIS had been priced at $500 instead of $250?  O’Neil could have priced his service at, say, $250   …or even $350 and still offered a generous discount.  At 2,000 subscribers he would have been in the black–and growing into an increasingly sharp thorn in Value Line’s side.

The clear economic response to this development would have been for VL to cut its price to $250 to make O’Neil unviable.  But that would have been psychologically very hard to do.  It would have created internal morale problems as belt-tightening took hold.   And it might also draw the attention of the Justice Department.  Waiting two or three years, hoping (in vain) for the competitive dynamic to change, would only compound the problem.

pricing umbrella

That was my introduction to the concept of a pricing umbrella, the idea that high margins creates a fertile, sheltered environment in which competition can grow.

why it’s bad

Two negative consequences:

–competition can gain critical mass, and

–even if it can’t, if newcomers have made significant capital investment they will continue to operate–at a loss–to extract whatever cash they can from their failing businesses.

OPEC’s umbrella

More or less, this is the messy situation that OPEC has created in the oil market.

Under the protection of a $100 a barrel price, unconventional, technology-based competitors have emerged, mostly in the US so far.  This happened about half a decade ago.  The newcomers were initially able to extract oil profitably at $80 a barrel (as opposed to less than $10 for Saudi Arabia).  But they’ve improved their techniques to the point that many can make money at $40.

results of the oil price halving

In the near term, highly financially leveraged high-cost oil producers will be forced by their creditors to stop spending on new projects.  They will continue to produce from existing wells until they run dry, however.  It’s just that all their cash flow will be devoted to repaying debt.

The long-term problem for OPEC is that the new technology–whose development high prices stimulated–won’t go away.  As/when prices rebound to, say, $60 a barrel, hydraulic fracturing will begin to expand aggressively again.  I think shale oil output will rise relatively quickly, as solvent oil development firms take over in-the-ground infrastructure left idle by their bankrupt brethren.

At some point, the oil price will bottom.  I don’t know whether that point is now or not, but I’ve been thinking that something like $40 a barrel will be the floor.  On the other hand, I don’t see the market returning to the status quo ante within any reasonable amount of time.

How this affects oil stocks tomorrow.

crude oil

January 7, 2015 By in Energy, Industry Analysis, shale oil Tags: , , , , , , , 3 Comments

starting with the basics…

A barrel of crude oil is a container filled with flammable liquid that weighs about 300 lb and occupies a volume of about 5.6 cubic feet.  A cube measuring a yard on each side would hold about 7 barrels and weigh a ton.  In other words, storing and transporting oil is a major issue.

According to OPEC, world oil demand is now about 91 million barrels daily.  That figure is likely to grow by about a million barrels daily during 2015.

World supply is just under 93 million barrels daily.  The difference between supply and demand, 2 million barrels daily, is enough each week to fill three of the largest oil tankers around.

Oil producers prefer to keep output steady,  because that optimizes the amount of oil that can be recovered through a given well.  Oil usage, on the other hand, is seasonal, with peaks in the US–the world’s largest consumer of petroleum products–during the summer driving season and the winter heating oil season.  Temporary storage, either in tanks or on the seas in oil tankers, holds the “extra” oil in the slack seasons.

…and on from there

What happens to the 2 million barrels of daily output that consumers more or less don’t want?

The standard answer is that speculators with access to storage bid a price on the spot market that they figure will allow them to cover their costs and make a profit when they eventually sell.

There have also been press reports that China has been buying large amounts of oil recently to build its strategic oil reserve.

The issue of imbalance between supply and demand has been developing for several years.  High prices prompt conservation, for one thing.  They also make high-cost shale and tar sands extraction economically feasible.  And until  relatively recently continuing instability in the Middle East has kept output from this important producing region below normal–offsetting the growth of shale oil from the US.

near-term potholes

In a few weeks, we’ll be entering the lowest-demand time of the year for oil.  It will be too late to manufacture and deliver heating oil to customers for winter use; driving doesn’t pick up until April-May.

Paradoxically, lower prices can trigger a spate of new output entering the market.  This could come from oil-producing countries trying to offset the price-related shortfall in their inflows of hard currency, or from financially leveraged private companies needing cash to service bank loans, or from companies whose oil inventories now look much too big.

 

More tomorrow.