Renewables No Impact with Low Oil Price – False

Renewables No Impact with Low Oil Price – False

The belief that low oil prices will have no impact on renewable is very misguided and optimistically biased.  The practical reality is the path of renewables will be altered with continued low oil prices.   Many of those focused on renewables, having nothing to do with oil, are focused on the power sector being isolated from the rest of the world.  It is a true statement that renewable generation is likely less costly than oil generation even at $50/bbl.   However, in the power sector, the competition is not with oil directly but with natural gas and coal.

The coal market benefits when oil prices are low as transportation can make up over 50% of the end cost of coal.   The natural gas markets may results in higher prices as economics of some oil field gets reduced, thereby, reducing the associated natural gas production.  However, this may lead to more focus on natural gas finds versus oil finds increasing gas production.  At best I think the impact of low oil prices on natural gas may only slightly increase gas prices.

Given renewables connection to electric generation, the amount of renewable will be highly dependent on the amount of electric demand.   Also one of the largest mechanisms to de-carbonize came from the conversion of vehicles to electric vehicle as renewable generation offered a potential zero carbon source.  Therefore, one of the largest anticipated sources of electric demand in the future was going to come from electric vehicles.   However, with low oil prices, this makes the economics of mass electric vehicle adoption very unlikely.

In most cases, the economic break-even of electric vehicles vs. gasoline vehicles requires gasoline prices north of $4/gallon.   More likely it would be north of $5/gallon given most of these economic analysis were based on a huge advantage of gasoline vehicles paying for the road infrastructure.   This is unsustainable once EV vehicles grow in usage – eventually the road tax will be collected from EV vehicles.  Nonetheless $4+/gallon prices are now diminishing in probability as oil price remain below $100/bbl.  With low oil prices, this transition to electric vehicles will be limited.   In order to transition, a much larger carbon price will be needed which will not likely be politically sustainable.  The sacrifice for saving a potential disaster may just be too high for society.

Low oil prices will limit the ability for renewables to grow in the energy mix.  The portability of energy is superior in petroleum products relative to any other forms of energy including batteries.   This physical attribute of petroleum will require a monetary mechanism to allow a switch to greater renewable forms of energy.   A rising crude oil price with transportation north of $4/gallon, and with an expected small impact of carbon allowed many to discuss the potential of a zero carbon system.   However, with the recent changes in oil prices and potentially a protracted time period below the $100/bbl mark, many dreams of the zero-carbon world are likely shattered.

The energy markets are intertwined.   High oil prices lead to greater opportunities for change.   A low oil price supports the status quo.  Renewables can continue to grow with current societal goals within the power sector – but the potential will be so much less now than when oil was north of $100/bbl.

Your All Forms of Energy Analyst,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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Oil Market Outlook Change – Too Low Demand Expectations

Oil Market Outlook Change – Too Low Demand Expectations

BP released their 2015 Energy Outlook.  As noted by their Chief Economist this is not to address prices or near term events.  However, price, in the end, is the meat of a discussion for an energy outlook as price and outlook for supply and demand are intertwined.

The outlook by itself is useful to gather facts and trends.   The real value for someone like me comes from the change in the outlook.  In theory, the process of formulating these outlooks should not change.  Therefore a change in outlooks signifies a change in market place expectations.   The best slide in reviewing the change to show the dramatic shift in expectations is slide 13 in the presentation.   The latest forecast for 2035 shows a very small call in OPEC <5 million barrels/day see figure below.

If we go back into time and look at the very same slide in 2011, we see the call for OPEC in 2030 (even less demand requirement given 20 year gap vs. 22 year gap in current forecast) amounts to over 10 million b/d.  This is a dramatic swing see figure below for 2011 BP Energy Outlook.

IF one believed in the process and the forecast output, the shift between the two forecasts would dramatically drop the expectations of crude oil price.   As a longtime forecaster of the crude oil markets, the call on OPEC is key component on price forecast.  This piece of the puzzle represented the additional swing from OPEC who, in theory, purposely holds spare capacity to sustain a reasonable market level.  With the need of OPEC being diminished, the overall pressure for oil prices to move upwards is limited.

Obviously, BP cannot state or present a price view given its role in the market place, but if their trade floor was made well aware of this trend and believed it, they would have made a good call over the last year.  However, the long-term aspect of this trend does not bode well for BP as a company.   In fact, the overall energy sector would not benefit from this including renewable energy and refining industry.

The demand side also shows some major shift in expectations.  In 2011, the expectation for China oil growth was nearly 10 million b/d more than the base year (2010).  Now expectations have fallen to around 5 million b/d from the base year (2013).  The interesting outcome of this is whether BP flowed back the price response from the expectations of lower prices per the lower call in OPEC to the response of China demand.   To lose 5 million b/d would require a much lower expectations of GDP outlook, in addition a very  inelastic response to the price of oil is needed to maintain such a drop in demand.  OECD demand decline is nearly the same – yet the price expectations from 2011 to 2015 must have dropped.

From my experience, the demand piece is typically the flawed portion of the forecast after coming off a major supply shift.   Supply can be well understood in terms of cost of development and potential technology improvement curves.  It is my belief that the demand outlook presented is too low.   The expectations of this come from both the price feedback of consumers and the fact that the demand side has included a significant portion of efficiency improvements over the past few years.

Efficiency improvements do not lead to reduce consumption of a commodity without a continued price increase.  This is supported by the Khazzoom-Brookes postulate and Jevons Paradox.  My caveat to the theory is to add the price component.  Improving efficiency of a commodity leads to more use of that product without a corresponding price increase.   I also expect this with electricity as we make up for the large efficiency improvement by having more devices and more appliance than we had a decade ago, even though, a single appliance may be 50% more efficient.

I do not expect our human desires to have a car that is faster and bigger to be different by region or time.   Corporate Average Fleet Efficiency (CAFE) improvements have and will result in near-term gasoline demand improvement in the US, but eventually with the falling prices and the improved efficiency improvement the auto manufacturer can produce an SUV with mass appeal and size that can go 0 to 60 in few seconds yet offer 25-40 mpg.   Auto manufacturers who ignore this trend will be left in the dust as was seen last time SUV sales outsold compact vehicles.  This move to this larger and faster car will swallow the small vehicles leading to overall growth in oil demand while maintaining the CAFE standards.

This mass appeal will also eventually migrate to other areas of the world.  The ability to stop this rebound is the corresponding price.  In the oil markets that seems to be muted as expectations of price is likely between $50 to $100/bbl and not rising over $100/bbl for the next decade or so.  Power markets may thwart the rebound given the trend in transmission and distribution cost, but this will be highly dependent on the region.  Obviously adding a carbon tax would increase the cost curtailing the demand.

Please consider All Energy Consulting for your energy consulting needs.  We offer a unique and fresh perspective on the energy markets to help you succeed

Your Fundamental Supply / Demand Energy Analyst,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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Eagle Ford What Are You?

Eagle Ford What Are You?

“May the real Eagle Ford stand up” is another title I was thinking for this article.  As I get ready to launch Oil Market Analysis,one of the areas I have been focusing in is the condensate issues in the Gulf.  In particular, the production from the Eagle Ford region – see figure below.

There is much discussion on this production being mainly condensate.  Condensate is a crude oil – just a really light crude oil.  A common unit of measurement for the density/gravity of the crude is API.  The higher the API, the lighter the crude oil becomes.  Some consider 45+API to be condensate.  Most condensates are also extremely low in sulfur – very sweet.   To put it into context LLS is around 36 and WTI is around 41 API.  There is an issue in being too light – but you can never be too sweet (such is life).   Your product yields will suffer particularly in the No. 2 cut (Diesel, Heating Oil, and Jet).   Also being so light, in a refining region not expecting this trend, causes operational issues that can be addressed overtime given the right pricing incentive.

I have gathered 4 different assays of Eagle Ford.  They range from 47 to 64 API.   Platts own price marker methodology notes the range of assays from 40.1-62.3 .   They settled upon a 47 API.   They also note the cut range used and I adjusted another assay to reflect the Platts assessment seen in the figure below. The other interesting thing to note is there seems to be an Eagle Ford and an Eagle Ford Condensate marketed.   This may explain the large variance.   However, regardless of the marketing, the value of your Eagle Ford as a refiner can swing significantly.   Below is the cracking value of the various Eagle Ford assays relative to LLS from our USGC cracking model, from our Oil Market Analysis Platform using the futures market strip on 2/11/15.

Cracking valuation models are strictly based on the yield and product value.   This does not take into account the logistic issues of having to truck condensate, which could easily add another few dollars to the discount of Eagle Ford.   The model does take into account the quality issues for both octane and sulfur.   Having run and managed the South Louisiana Quality Bank, crude quality can have significant ramifications.   Declaring a label of Eagle Ford, given the variations of quality, will likely not mean much.   Contracts dealing with Eagle Ford will have to have quality specifications and processes to deal with variations.

The largest driver among the various assays is the amount of diesel and jet produced.  In some assays, we produce too much light ends, making a limited amount of finished gasoline and left with Naphtha.   This drives the discount seen in the Eagle Ford 64.  Increasing the reformer capacity is needed.

To deal with the lighter crudes, more reformer capacity will be needed along with greater alkylation.  The octane values from these lighters crudes are not high, at least from the data I have.  The discount to Eagle Ford will come in some, over time.  This will not be due to the ability to export the crude oil.   The export market is expected to be ultra-competitive when it comes to condensates (discussed at a later time).  There will be operation issues in the US as refiners adapt to the new feedstock.  These issues could include needing to run your crackers less; thereby, likely impacting heat balances.  However, these are solvable engineering issues, given an economic incentive.   The infrastructure of Eagle Ford is being built out.  This will lead to a reduction in discount as the transportation cost is reduced.   Eventually the market will see a uniform stabilized Eagle Ford blend.  Until then, pay attention to your quality specifications in your contract and hopefully leave room for adjustments.

By the way, I will be speaking at the Platts 4th Annual Refining Convention in May – See agenda.   I will be addressing the issue of condensate and NGL’s in the market and what we can expect to see in terms of market forces in the future.  I hope to see you there or even sooner.  Please do consider All Energy Consulting to help you in the crude oil and refined products market space.

Your Crude Processing Energy Analyst,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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Oil Price Drop Impacts Part 2 – The Bright Side!

Oil Price Drop Impacts Part 2 – The Bright Side!

The oil price drop is not all bad for the energy sector.   In our first part on the Oil Price Drop, we examined the fallout that will occur with Renewable Fuel Standard as a result of the price drop.  With the completion of our USGC Refining Models, we review the dynamics in the region and have great news for those downstream and a positive highlight for certain upstream players.

For this analysis, we present the information ignoring the dynamics of the renewable fuels standard, which we will discuss at a later time.   The focus is to compare the change from 2014 to 2015 therefore any issue of RFS will be reduced given similar circumstances for 2014 and 2015.  The figures below represent the calculated margins from our USGC Cracking configuration refinery for LLS and WTI.  The 2014 figures represent last year actual results whereas the 2015 uses the futures market on 1/28/15 to represent 2015 March through September (longer time period available – please contact us for information).   With Oil Market Analysis (OMA) product/service, we will actively publish the results daily using the latest futures market with an ability to go back into time.  You will be able to also upload your own forecast of products to recompute expected margins based on our yields per our refinery configurations.

Given the drastic swings in crude oil price over the last decade, I focus on the returns versus the absolute cracking margin.     Returns are calculated by taking the value of refinery yield over the cost of the feedstock.  Being able to sustain reasonable returns supports the industry.  Producing a $10/bbl margin in a $100/bbl feedstock world is not sustainable given the risk in the market place even though $10/bbl margin historically would have been a wonderful dream for many refineries in 80’s and 90’s.   The bright side is the refining world is showing returns of over 20% compared to the low teens observed in 2014.   Also I suspect, even though the absolute margins are down from 2014, refineries may be able to make up the dollars through increased volume as demand will be much higher in 2015 vs. 2014.

Not to leave out the upstream folks completely out of the bright side, we examined the changing landscape of condensate given the enormous production growth from Eagle Ford.   Though the indexed crude oil price is down over 50% from last year, the discount to the condensate has narrowed given the futures product prices outlook.   Refiners should not be so aggressive in asking for discounts to Eagle Ford.  This could change as Naphtha price and octane value could move in opposite direction (Naphtha down and Octane Up) increasing the discount asked by refiners.

All Energy Consulting offers our market based approach on refining to assist producers and downstream participants in understanding the market risk.   We work with you to develop a collaborative view of the future and the risk it holds.  Please do consider us for your consulting needs as we are here for your success and have a proven track record of successfully identifying the paradigm shifts.

Your Energy Analyst,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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Modeling the USGC Refining Market

Modeling the USGC Refining Market

I had planned to continue to discuss the impact of oil prices beyond the obvious.  In the first report on the impact of oil prices in the non-obvious areas, I discussed the likely impact to the Renewable Fuel Standards.   I was hoping to follow up that report with the impact on condensate value as a result of the crude oil collapse.  However, this has lead us into reviewing our refining models and also how the refining industry will likely have to evolve to handle the RFS.

As with many things in the energy market, you start with a hypothesis and investigate it only to be compelled to look at other areas in the market place.  We are almost ready to release our first oil product, Oil Market Analysis (OMA), but first we had to make sure the refining models represented the USGC and was designed to incorporate the impacts of RFS.  In this article, I have decided to go ahead and give you a tour of my problem solving methods when it comes to modeling USGC Refining Markets.

A key path for how I analyze the energy markets is to take a walk back in time.

Historical Changes in Refining

The yields of the USGC refiners have changed.   Distillate yields rose while gasoline yields had the largest drop off.

This was not a result of refiners’ strategy from the 90’s nor was it because of the crude slate changes.   The primary driver for this change came from the market price change starting in 2005.

The EIA Annual Energy Outlook  (AEO) was forecasting distillate spread to gasoline to be negative until the 2010 AEO release. The current AEO 2014 shows the spread averaging over $0.3/gallon.   As with all free markets, they adapt to the pricing incentive.  This change necessitates the adaption of the USGC refining configurations.  This is also one of the reasons condensates are poor crudes relative to other crudes in the market as the distillate yield is very small.

The quality changes did help the refineries produce more distillate, but many planned to expand and run their Catalytic Crackers and Hydocrackers.   The price incentive has resulted in cutting back how hard those units run.

Calibrating USGC Refining Model

The first piece for calibration is putting a recipe of crude oil entering the USGC cracking and coking refineries.   The average API for the last 12 months average around 30.2 API and 1.7 %S.   The import data shows the major importers of oil for USGC are the Saudis, Venezuela, and Mexico.   A crude slate from each of the countries were selected.  Most of the import volumes were sent through the coking refinery.  For those not knowledgeable in refinery – all coking refineries do have “cracking” capability via hydrocracker or cat. cracker.  A blend of LLS, WTI, Mars, and Condensate represented the domestic blend.  The volume on the domestic side went through both a cracking and coking refinery.  The final recipe produced an average 30.5 API and 1.7% S.

Both refinery configurations were then adapted to produce similar yield seen in the market place.   The refinery levers represented modification in cuts going into the various units along with conversion capabilities.   We also looked at the market signals from octane values to maximize the refinery capability to produce high octane components.

Octane pricing is a story in itself.   The increase in value corresponds with the increase in condensate production.   Condensates typically produce low octane products – another issue for condensates.

The final production of our represented cracking and coking unit in the USGC produced the following yields compared to the actual market production.

We then review the historical refining margins produced by the model depending on configuration and crude oil.  The issue is whether we account for the ethanol requirement.  As a crude produces more gasoline, the requirement for ethanol purchases are needed.  Balancing some of the cost is ethanol octane is at 115 vs. 87 spec.  For comparison, we use the simple 3-2-1 crack spread commonly used in the market place ( [2 x Gasoline Price + 1 x diesel]/3 – Crude Reference Price).

The yield and final market margins are the key step to how well your model is performing.  Similar to our extensive work in calibrating our power models, we put the same effort into the refining models.   We believe in transparency and show all our calibrations.   As with any model, one can continue to improve upon it over time, but we will not be stuck in analysis paralysis.   For vintage #1, we are pleased with the results.

Work in Progress

The results are promising.  We will be filling our yield tables with various crude assays.   The outcome of the work – Oil Market Analysis (OMA) – will produce monthly market expected refining margins based on the future markets.  There is no need to wait for your consultants to put out a report days to months after the market has moved.  OMA will be updated at the end of every business day keeping you on top of the market changes.  The analysis will indicate the expected refining margins for gulf coast refiners.   This will be helpful in guiding the valuation and expected earnings for USGC refiners.

An interactive website will be developed allowing users to select various crudes.  This can be used to help guide crude oil optimization from pricing for contracts to informing buyers and sellers of arbitrage opportunities.   The interface will also allow users to upload their own forecast of petroleum products or choose from All Energy Consulting custom forecast.  With this capability, a user can customize and create endless amounts of insights.   An end goal will also be to allow users to upload their own assays to be automatically run through our models.   Currently, we can do this manually as this process requires some tricky programming to automate this feature.

Another thing we can offer is generating a model for East Coast, Midwest, and West Coast.   The process and procedure will be similar to the above.   Also, an international model could also be possible if we can find the information needed for calibration.   Using this model, I plan to produce a report to calculate the value of condensates and further delve into the rapid growth in octane value.

Lots of fun analysis to do – who needs to sleep or eat?

“People who love what they do wear themselves down doing it, they even forget to wash or eat….When they’re really possessed by what they do, they’d rather stop eating and sleeping than give up practicing their arts.” Marcus Aurelius, Meditations

Your Tireless Energy Analyst,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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Oil price drop impacts beyond the obvious – Part 1

Oil price drop impacts beyond the obvious – Part 1

I am analyzing many areas as a result of the oil price drop.  There are a ton of discussions of oil price drop and the impact it will have on oil production and economy.  However there are impacts at the secondary level which can have billions of dollars of impact on the market.

The oil market drop will impact the Renewable Fuel Standard (RFS).  EPA suspiciously delayed the  release of the Renewable Volume Obligations (RVO) for 2014 twice.   With the latest oil price drop, I suspect they will have support for revising and recalculating gasoline demand expectations, which will then thwart any attempts to modify the RFS.   Most of the support for revising the RFS requirements was due to falling US gasoline demand and the theoretical limit of the amount of ethanol allowed in the market – aka “blend wall”.   This is based on gasoline with greater than 10% ethanol will impact the mechanical aspect of the existing auto fleet.  I will not argue the point surrounding this and save that discussion for another time.   Given this conclusion, I do anticipate you will see renewable identification number (RIN) prices move up once they do finalize the 2014 and 2015 volumes in the spring.

What are RIN?

For those not involved in the power markets, you will be slightly lost.  For those who have gone through the trials and tribulations of the Clean Air Act (CAA) and the emissions markets the government created in order to create an “optimal” path to emissions reductions – it is very similar.   Very similar to SO2 and NOx markets, the government assigns a target of volume and produces a certification for each unit of volume.   The only difference this time is rather than wanting the volume to be reduced, they want the volumes to grow.   Instead of assigning an emission credit, they assign a production credit.  As a producer of gasoline or diesel, you are required to obtain a set amount of RIN for each volume produced.   One can do this by physical blending and/or purchasing a RIN.  Another difference is instead of assigning a multi-year level of commitment ahead of time as they did in the CAA, the EPA is supposed to assign it each year in the spring.   The market does have a general idea given the RFS does state targets, but as a fuel producer you don’t know your specific requirements.   The brilliance of this design, and at the same time the most confusing, is the banking system which is very similar to the CAA construct.

The RFS includes the magical banking system.   They have learned from the initial CAA markets and have adopted the banking restriction similar to the NOx markets, but actually slightly easier to follow as they limited the banking system to 20% of the total RVO for each year.  There is no decline in values on vintage basis.   The vintages from each bank can be carried into future years. The banking system is the greatest invention since slice bread for those into Operations Research and Game Theory – my two favorite subjects.   I have spent much time in the analysis of emissions banking and game theory, and I presented to AEP management the relationship between the CAA emission markets and the Nash Equilibriums which can be generated.   Funny enough Dr. Nash grew up near one of AEP power plants, which I believed is pictured in the movie – Brilliant Mind.   There are fixed outcomes for these types of systems.   They are equilibrium points when all market participants achieve a certain goal.

I was the lead proponent in AEP to sell the emissions credit heading into the newly created NOx market in 2005.   The NOx market once introduced and, upon an extreme winter, decided to go crazy.   The prices of NOx went over $5500/ton.  This far exceeded any of the equilibrium points.    The other nuance you need to realize in markets which turn in a credit on a fixed date is the cost of a credit in a given time is somewhat irrelevant since the only real value of a credit is when you turn it in.   If you want to make money on a system like this you had better spend time on the end market vs. what the market is now.   Starting the NOX season with a huge rise in price was pointless, and one could run 50+ simulations and show even the hottest summer could not generate a demand level of NOX that would necessitate the price above the highest market equilibrium point.   In the end, after a few years, the market achieved one of the lowest equilibrium points – variable cost of running the control equipment.

The other unique aspect of the RFS is the three levels of targets – Conventional, Biodiesel, and Advance.   In theory, and so far in practice, this is the order of greater complexity and cost.   The order also represents the highest volume targets to the lowest.   The rules do allow one to use a credit from the more complex target into the simpler target not vice versa e.g. Biodiesel RIN can be used for Conventional RIN.

RIN Future

With the lower oil prices and the market structure with banking, I don’t see how one anticipates the modification of RFS with lower goals.   The main argument of “blend wall” will succumb to greater oil demand as consumers not only drive more, but consume more.   The US will not likely save more given the design of our system and culture.   The very act of consuming more whether food or services increases petroleum demand.  The banking ability of 20% gives much room to buffer the changing weather from crop issues to the changing economy from driving.

The low oil prices will impact the economics of many ethanol plants, particularly those that have not been built.   On a sunk cost analysis, the economics should allow them to continue to produce ethanol.   This situation only leads to even greater value for RIN.   The trading and risk mitigation of RIN need serious consideration for those producing transportation petroleum for the US or for those making the RIN.  At All Energy Consulting, we can take our knowledge in the emissions and petroleum market to help you weather the storms of the RIN market.

Other topics to come due to the drop in crude oil prices – Condensate Value …Octane Value…..

Your Energy Analyst Thinking Beyond the Obvious for Your Success,

David

David K. Bellman
Founder/Principal
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”
614-356-0484
dkb@allenergyconsulting.com
@AECDKB

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