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Mixed messages from the global energy market

opec logoMix messages from the now globalised energy market dominate the pricing landscape right now.

For every glut in LNG supply as Japan announces its long awaited nuclear restart, there is increasing strangulation of US shale as OPECs oil price strategy continues to escalate, there is also an exit from gas storage limiting supplies.

All in the market’s reaction to such mixed messages is a confused and confusing one.

Japan’s move to restart nuclear generation for the first time since 2013 remains in limbo but has moved another step closer as the crucial opinion of local courts was received in finally approving the restart of two reactors following the Fukushima disaster in 2011.

Japan’s reliance on nuclear energy is well known, as a nation without fossil fuel reserves, it has built its economy on the development of atomic power. Since 2013 then the formerly self-reliant energy economy has had to operate in the global market for their energy sources, most notably LNG.

Now with the reactors being passed fit for operation under new safety standards set by Japan’s Nuclear Regulation Authority, there is potential to see a full restart as early as June this year.

Crucially a nuclear restart will render demand from the East for LNG weak, leaving buoyant Qatar supply amid lower global demand, a positive sign for future downward price pressure.

Ostensibly this negative pressure on prices is being mirrored in the oil market where OPEC’s US shale strangulation strategy continues.

OPEC ‘s strategy to pump oil onto the market even in a period of over supply has had the desired effect, with oil prices predicted to stabilise between $60 and $80 per barrel for the foreseeable future, below the marginal cost of production of much of the non-OPEC producing countries.

Whilst this is short term good news for the price of oil and its influence on the wider energy markets the strategy has a longer end game – to remove a strong competitor in US shale and to return OPEC to a position of market dominance and price making with a return to the highly profitable days of $110+ per barrel of oil.

As part of the strategy, OPEC have already factored in an increase in global demand predicting it will average 29.27m barrels per day (bpd) in 2015, representing an increase of 80,000 bpd from its previous prediction.

The OPEC announcement said:

“Higher global refinery runs, driven by increased seasonal demand, along with the improvement in refinery margins, are likely to increase demand for crude oil over the coming months. Given expectations for lower US crude oil production in the second half of the year, these higher refinery needs will be partially met by crude oil stocks, reducing the current overhang in inventories”

Even more serendipitous for the cartel is their prediction of a lessening contribution from non-OPEC supply whose contribution they forecast will only rise by 680,000 bpd this year, down from its previous forecast of 850,000 bpd.

With an apparent innocent face OPEC explained:

“US tight oil and Canadian oil sands output are expected to see lower growth following the recent strong declines in rig counts”

Their gamble is that the low price period will put US shale so far back in its development that years of OPEC dominance can continue unchallenged in a new era of high prices.

But will OPEC’s gamble pay off?

Well the US aren’t giving in easily and are proving a harder nut to crack than OPEC has expected. Instead it’s the high marginal cost of production of the African drilling projects that have been hit hardest with greater, though not perfect, resilience in North America.

Indeed the US are putting their stall in becoming the final victor in what is expected to be a long term price war.

Atul Arya, from IHS, the market commentator explained:

“There was a strong expectation that the US system would crash. It hasn’t”

Whilst Head of Exxon Mobil Rex Tillerson added:

“The freight train of North American tight oil has just kept on coming. This is a classic price discovery exercise”


“This is going to last for a while”

Although some natural bluster is required on both sides the signs are that indeed the number of operational US ‘rigs’ has collapsed since OPEC’s strategy began – down from 1,608 in October to just 747 today. But output from the remainder has actually risen.

Tillerson promised:

“This is a very resilient industry. I think people will be surprised”

One major fillip to the fracking industry is its very immaturity as the nascent industry naturally searches for and discovers new ways to extract the oil and its very non legacy structure means a new breed of ‘flexi fracking’ jumping from one relatively low cost investment to another wherever the best returns exist, a talent OPEC had apparently not counted upon.

This flexibility is actually lowering the marginal cost of production enabling rig operators to remain pumping even in previously uneconomic pricing environment.

That could prove to be good news for a new era of tight oil, or it could find its natural floor and see OPEC regaining its advantage as second mover advantage starts to erode.

Meanwhile closer to home, an exit from gas storage announced by Centrica, the owner of both British Gas Business and the UK’s biggest gas storage site, Rough, has placed the gas market on alert for increased prices.

Rough, for reasons of supposed ‘integrity’, according to Centrica, needs limits imposed on the pressure in its wells lying beneath the North Sea. The impact is forecast to see storage levels cut by as much as 30% over the coming months.

Centrica, fresh from announcing another disappointing set of financial results, announced euphemistically that it had taken:

“The prudent step to test and verify the operating parameters of the Rough wells”.

The implication of this potential storage cut is amplified by the fact that Rough makes up fully 72% of the UKs total storage capacity.

The reduction caused by its self inflicted capacity constraint therefore means major implications for UK gas prices.

Trevor Sikorski of Energy Aspects, the Energy Consultancy explained:

“Europe is fairly well stocked. It has a lot of gas storage facilities.

“The UK sticks out in that it doesn’t have very much. Historically that’s because we had a lot of North Sea fields, but as UK output has declined that has raised the question of whether you should build more.

“Extreme winter peaks will be met at higher prices”.

However National Grid promised all was under control saying:

‘This reduction in capacity will not be an issue over the coming months, the country has a diverse range of supplies.

“National Grid will factor the reduction into its winter outlook and seek to understand what impact a long-term reduction might have.”

However in total the UK can store the equivalent of just 19 days of normal gas demand whereas its European counterparts have capacity to store an average of 97 days. Another sign of the failure to invest in the UK energy industry in the good times coming to haunt the bad.

The saving grace for price spikes could be the restart of nuclear facilities in Japan, freeing up the market for LNG to come to UK shores, however an unconstrained seller to a desperate market ends in only one winner.

Meanwhile whilst oil continues its benign spell, its limited impact on the UK gas price means any positive impact on domestic prices will be limited.

The global complex of energy might not be currently experiencing a Fukushima style natural disaster but the vagaries of national and commercial policies in energy continue to have wave effects across the globe, not least the UK.