May 29, 2017 § 1 Comment

The Trump administration’s decision to sell half the holdings in the Strategic Petroleum Reserve (SPR) is the right step.  The SPR was created following the Arab Oil Embargo in the early seventies. It is currently near capacity at about 685 million barrels. The intent had been primarily to guard against a disruption of imports.

The President of the US has the authority to add to, or subtract from, the Reserve without Congressional approval.  But the stated reason for this draw down, revenue for the treasury, is debatable, not the least because this is not a piggy bank; withdrawals must serve a strategic purpose.  Also, such a massive draw down is likely not in the spirit of the authority given, so Congressional approval may be prudent.

Not debatable is that the US is increasingly importing less oil and it is progressively traveling shorter distances to get to the US.  Domestic oil is light and sweet.  It is, by and large, not desirable to most of the domestic refineries, which make better profits from discounted heavy oil from Canada, Mexico and Venezuela.  Consequently, imports from these neighbors combined with some export of domestic crude is a benefit to the nation.  Certainly, light oil from the Middle East and Nigeria, is scarcely required.  Our navy does not need to police the Strait of Hormuz, at least not for oil or gas supply reasons (ample shale gas has rendered import of LNG passé).  Supply disruptions are much less likely from the close neighbors.  About the only real risk is Venezuelan unrest.  This combination of reasons justifies a smaller SPR.

But the best reason for a smaller SPR is the rapid response ability of shale oil production.  Conventional offshore wells will produce oil 4 or more years after a decision to drill.  For shale wells, that figure is a few weeks if the lease is on hand.  This nimbleness of shale oil production is a reason why the industry has weathered the saw tooth price behavior of oil.  Furthermore, a threatened shale oil industry, run largely by entrepreneurial independent producers, has responded with innovation to drive down the cost to produce.  These reasons have conspired to defeat the Saudi gambit of leaving oil price down to freeze out shale oil.

In another twist, unique to shale oil, thousands of wells are drilled but not stimulated, known as DUC (drilled and uncompleted) wells.  They wait for better prices.   Around 5000 of these exist today.  A DUC well can be stimulated and produced in a week in response to even short duration shifts in the price of oil.  In fact, their very existence is a bearish influence on commodity traders.  These act as buffers and a surrogate for the SPR.  In fact, given the short time to production of even regular shale oil wells, all of shale oil still in the ground is the SPR.  In my view the SPR could serve its purpose by being only a third of the current 685 million barrels.

I have previously opined that, in the face of the SPR not being needed at current levels, it could be accessed to exert political will or influence.  A friendly, strategic, net importing nation could be provided the necessary technology to create the reserve (usually in salt caverns).  Oil could be supplied from the SPR to fill this country’s new reserve.  India, for example, could be enabled with a strategic reserve of 200 million barrels, more than enough for their purposes.  The US would be paid for this in one form or the other.  At today’s oil price, just north of USD 50, we even net a profit; the average acquisition cost of our SPR is close to USD 30.  We get our treasury funds, and we potentially slow down India/Iran coziness in energy.

Vikram Rao


May 23, 2017 § Leave a comment

In a surprising decision, the US Senate voted to let stand the Obama era regulation curtailing methane related emissions from the oil and gas value chain.  Much of the reaction has related to the political implications of the failure of a Trump supported reversal of an Obama administration action.  My take is that, for once, the Senate acted in bipartisan fashion.  Several senators on either side of the aisle were on the fence.  In the end, Senator McCain’s statement probably best explains the action of the fence sitters.  He released a statement:

“While I am concerned that the BLM rule may be onerous, passage of the resolution would have prevented the federal government, under any administration, from issuing a rule that is ‘similar’”

The key point he was making was that allowing the rule to stand still allowed it to be amended, whereas removing it would prevent any ‘similar’ rule from being attempted in the future.  The current Secretary of the Interior was already on record as willing to encourage voluntary methane reduction by operators.  So, the senator’s direction will very likely be followed.  Besides, as discussed below, much of the mitigation of fugitive methane simply makes economic sense to the operators.

The rule was largely modeled on an existing rule in Colorado, and widely supported by the residents and the oil and gas operators there, who are credited with participating in the details.  The federal action was, at least in part, premised on the fact that other states had not followed suit.  Interestingly, the senator from Colorado ended up voting to remove the rule.  Hmmm.

Two Democrats, Heidi Heitkamp of North Dakota and Joe Manchin III of West Virginia, had considered voting for repeal for similar reasons as Senator McCain, that it was not comfortable as written.  Apparently, they were persuaded that changes would be forthcoming.  The rule applies only to Bureau of Land Management (BLM) lands.  But as a practical matter, if operators are going to act to limit emissions on BLM leases, transferring the technology to other leases would be simple, unless economically onerous.

The Environmental Defense Fund (EDF) is leading an effort on quantifying the nature of the problem and the means to solve it.  The Department of Energy’s ARPA E unit launched the MONITOR program to create better means for detecting fugitive methane economically.  Both these efforts are described in some measure in chapter 2 of my book: Sustainable Shale Oil and Gas: Analytical Chemistry, Geochemistry and Biochemistry Methods.  The chapter also describes the principal findings of an EDF funded effort to quantify the distribution of fugitive emissions along the entire value chain from the well to the city gate and somewhat beyond.  The data are a bit old now, but the takeaways are illustrative, nevertheless.  Over 82% of the losses occur at under 20% of installations.  Mitigation measures are advantaged by this concentration.  They also conclude that 45% of the emissions can be captured with then current technologies in economic fashion.  This could be accomplished by a net additional expenditure of USD 0.01 per thousand cubic feet (mcf) of gas produced.  Even at the currently low natural gas prices in the vicinity of USD 3 per mcf, this is certainly economical.  Of particular note is that they do take into account a credit for the sale of the natural gas captured.  While reasonable, this is not realistic for leaks in the midstream pipeline infrastructure.  Detection is also more problematic in the midstream.  But some of the MONITOR projects do address that area as well.

There is a tendency to confuse methane releases with emissions from the flaring of natural gas. Both represent economic loss, but the first is more harmful to the environment because methane is about 25 times worse than carbon dioxide in the global warming impact.  Many states have regulations covering the various sources of fugitive methane, including coal mining and agriculture. Colorado has a comprehensive one directed to oil and gas production.  North Dakota has regulations requiring flaring to be curtailed.  The vast bulk of flaring is of gas associated with oil production, whereas the majority of methane releases are in the natural gas production and distribution infrastructure.  In the US, gas production is more economically challenged than oil because the market price is lower (gas has regional pricing, unlike oil).  This makes investment in mitigation more challenging.  But, as the numbers quoted above show, much of this is still economical.  Several technologies are in development, some currently available, to attack the problem of flared associated gas.  Some of these are also described in the book referenced above.

Fugitive emissions of methane from various industrial sources, including coal mining and oil and gas production, must be targeted for economic and environmental reasons.  But the regulations must be guided by the economic availability of detection and amelioration schemes.

Vikram Rao


April 11, 2017 § 1 Comment

Here we go again.  Presidents making decisions that are largely symbolic in the face of economic realities.  The latest is a report that President Trump will shortly issue an executive order to promote oil and gas exploration and production in the Arctic and Atlantic.

Arctic truck

I had previously written that President Obama’s 11th hour decision to ban future sales of leases in the Arctic would have no net effect on the industry in the foreseeable future.  His ban on the Atlantic coastal waters was more interesting, in that it stopped at approximately the North Carolina border with Virginia.  Interesting, because previous exploration had shown potential in the North Carolina waters, more so than Virginia.  I think some exploration is likely as a hedge, but actual development will await the sorting out of the true impact of shale oil, as discussed below.

The industry has gone through a secular change.  Predicting oil price has proven even more tenuous than in the past.  When conventional oil (as opposed to the more recent shale oil) was the only product, oil price prediction entailed understanding the development pipeline, usually years in duration, while factoring in political instability in the oil producing nations.  Further assisting the crystal ballers was OPEC, which manipulated prices to remain in the vicinity of USD 100 per barrel.  Since about 2015 all that has gone out of the window.  Shale oil in the US caused a halving and it has been seesawing around USD 45 ever since.  What the future bears depends on the source.  In the past, there had always been the outlier analyst predicting USD 200 or some such.  But the consensus was in the low one hundred region.  Now we have polar opposite predictions regarding supply and demand from the likes of Goldman Sachs and Morgan Stanley.  Sort of the definition of uncertainty.  Not the best climate for long term investment.  More on that below.

Sustained low prices decimated the ranks of the shale oil producers, resulting in 100 bankruptcies and default on USD 70 bln in debt.  But a new force has emerged.  Major oil players with deep pockets, such as ExxonMobil and Royal Dutch Shell, have taken large positions.  More importantly, those two plus Chevron are committing to USD 7 bln investment in 2017 (some estimates are up to 10 bln.) in shale plays, primarily in the Permian Basin.  This is a giant leap from before, when the emphasis was on offshore development.  This comes shortly after the Shell announcement of withdrawal from the Arctic “for the foreseeable future”.  This withdrawal is from continued development of existing leases.  That would appear to indicate a disinterest in any more leases in auctions, enabled by the reported President Trump order.  In fairness, that does not necessarily follow.  Even if they are backing off on development offshore, new leases will still be bought as hedges.  This is evident from the recent robust lease sales in the Gulf of Mexico. This is in the relatively benign environment of the Outer Continental Shelf (OCS).  But an Alaska lease is a horse of a different color.  The costs and environmental risks are much higher and the time to first oil (forget gas; that is even more in the doldrums of price than oil) is double that in the OCS.

Uncertainty, with concomitant higher discount rates, particularly hurts long term plays. By contrast, shale oil plays are short term in the extreme. Due to the steep decline rates, new wells must be drilled to keep up the production.  These wells take a couple of weeks, not years.  When the prices drop, drilling can be curtailed and then picked up at the drop of the proverbial hat.  This flexibility is a key to the resilience that shale oil has shown to saw tooth prices.  Furthermore, breakeven costs have dropped dramatically.  At first these were due to steep service company discounts, which in turn caused bankruptcies among the smaller players.  The big boys will inevitably raise prices, especially now with the reduced competition.  But the industry is seeing genuine technology advances dropping costs even in the face of the upcoming service price increases.  These advances will continue.  A Shell spokesman recently stated that they were profitable in the Permian at USD 40 and that “newer wells” were profitable at USD 20.  There is little doubt the industry is “high grading” their prospects: mostly just the most productive areas are being exploited.  I think that is sustainable until additional technology driven cost reductions bring the lesser prospects back into play in roughly the three to five-year time frame.

The foregoing arguments underline the point that with oil companies likely struggling to pay their dividends in a low-price scenario, shale oil is a good bet.  Expensive forays into the Arctic with long term payouts will be off the table in the foreseeable future.  Presidential actions on leasing are mere tempests in the Arctic teapot.

Vikram Rao


April 8, 2017 § Leave a comment

Fair warning.  This is nothing to do with energy.  It is also an ode to UNC, basketball and Michael Jordan, in no particular order.  Would I have penned one had Duke taken one to the bank and Christian Laettner (he of The Shot in the NCAA’s) had said something equally mysterious as did Michael Jordan, who knows?  I suspect a lot would have depended on whether what he said was open to generous interpretation; the ordinary gets few key strokes.

Ceiling is roof

Michael Jordan, speaking to a UNC crowd during a recent basketball game half time, in exhorting the football team (yes, I know that does not appear to compute, but that is the way it came down) to greater heights, famously uttered the phrase: “The ceiling is the roof”.  Coach Williams’ response is quintessentially him: ‘He’s Michael Jordan, anything he dadgum wants to say is OK with me.’  So carefully calculated Hillbilly, so mountains of western North Carolina, and so much a part of Williams’ ‘aw shucks I just roll the ball out’ persona.  That might have caused him to be underestimated in the early years, but three national championships later, any underestimate is perilous (OK, we are talking boys playing a game here, so peril may be a bit over the top; like the alleged death threats by Kentucky fans against the referee of their elite 8 game loss).  I have always thought that Arnold Schwarzenegger’s Austrian accent was more pronounced after he started running for office.

The best basketball player ever out of Carolina, and possibly anywhere, has rights.  These rights include well intentioned malapropism.  But was it that, really?  Many, including the aforementioned Coach Williams, have opined that this was a garbled version of “the sky is the limit”.  A keen observer will note the absence of either of the words sky or limit in the original quote.  I think even Mrs. Malaprop (“The Rivals” 1775) would posthumously agree that her trademark foible required at least a reasonable facsimile of the emasculated word to be present.  So, I think we can safely discount malapropism.  The problem with interpretations of utterances is that one is compelled to consider the source.  Henry Higgins (just saw a rollicking version of My Fair Lady at Playmakers on UNC campus), the eminent linguist of Bernard Shaw creation, would no doubt have been credited with an esoteric, and even possibly a “loverly” *, interpretation.  But we will attempt a less fanciful explanation.

Had this been said by star quarterback Andrew Luck, he of the 3.48 GPA in Architectural Design from Stanford, how would we have interpreted it?  That is what I have set out to do.  Begin with the notion that in a room, the ceiling is the high point.  The roof is above that.  Clearly, the roof is a physically higher level of attainment than the ceiling.  In a multistory building, it gets better. The roof could be hundreds of feet above a given ceiling.  Thus, “the ceiling is the roof” is a metaphor for not settling for the most visible high point.  Is this what MJ meant?  I, for one, am prepared to give him the benefit of the doubt.

Vikram Rao

*Wouldn’t it be loverly in My Fair Lady (1957), written by A. J. Lerner and F. Lowe



March 6, 2017 § 1 Comment

A scant ten years ago this would not have been a discussion item.  Import of liquefied natural gas (LNG) was a sure thing.  A number of plants were sanctioned, and some constructed, and then the shale gale swept them away.  A number of these are being reincarnated into LNG export plants.  How many ought to be sanctioned by the federal government, and how soon, is part of the debate.  This debate is brought on now because the Trump administration is seen as fossil fuel friendly and so a loosening of LNG export is anticipated by some.

lng tanker

Gas is a regional commodity.  LNG is the only means of long distance oceanic transport.  Within a continent, pipelines are the mode.  Consequently, export from the US would entail gas in pipelines to Canada and Mexico, and LNG to other countries.  The former is not contentious, especially if NAFTA survives.  Mexico, in particular, is anxious to obtain low cost gas from the US, while developing their oil resources to offset the steep drop in the production of their giant Cantrell field.  The shale gas producers in Texas are happy to oblige.

The argument against export is that it could cause prices to rise.  The price in the US is artificially low due to supply consistently outstripping demand.  Weather causes fluctuations, but the price is remarkably stable when compared to the pre-shale-gas years.  Stability is friendly to capital investment.  Furthermore, US prices continue to be half that in Europe and a third of that in Asia.  This gives US industry, especially in the petrochemicals sector, an advantage.  However, modest rises (under fifty percent or so) in price would not affect this advantage, especially if oil prices stabilize above USD 50 per barrel.  The connection to oil is somewhat artificial (the markets are quite different) in that LNG is pegged to the price of oil, and LNG price is largely deterministic of gas price in the respective continent, in part because it is the marginal cubic foot.

Natural gas production in the US was 78.6 billion cubic feet per day (bcfd) in 2015.  It somewhat exceeded demand, causing the price to remain depressed, under USD 3.  An LNG facility consumes around 1.5 to 2.0 bcfd.  Today only one, owned by Cheniere, is actually exporting.  The Cheniere CEO was removed last year because he was considered too aggressive in expansion plans to build LNG export facilities.

Is LNG a profitable business?

A profitable LNG export business needs accurate prediction of raw material cost and delivered LNG price, over long periods.  The latter, as noted earlier, requires prediction of the world oil price.  With shale oil driven impotence of the OPEC, that is harder to predict.  For the former, what one needs is long term supply contracts.  Right now is a great climate for that.  Most natural gas being produced today is known as wet gas: methane with high concentrations of natural gas liquids (NGL’s) such as propane and butane.  This trend is due to the fact that on a calorific basis the NGL’s have higher value than methane and so there is more profit in wet gas.  NGL pricing is pegged to some degree to oil price, so some of that advantage is less now than it was in 2014.  Nevertheless, it is there.  As a result, dry gas (little or no NGL’s) properties lie fallow.  A very large and prolific field with this characteristic is the Haynesville.  It is close to the ports of the Gulf of Mexico.  An LNG facility in or near Lake Charles, LA, will have little difficulty in obtaining a long term supply of dry gas on very favorable terms.  Keep in mind that LNG requires dry gas.  It has no use for the bigger molecules.  Dry gas wells currently shut in will likely agree to long term low pricing just to get going.  In other words, the climate is decent for an LNG exporter to grow.  There is still the uncertainty of oil price, but at least the raw material cost could be controlled.

The national imperative

The LNG supporters say there is plenty of gas, go for it.  The detractors point out that the increased consumption will cause a rise in prices, thus hurting the citizenry.  The truth, as always, is likely in between.  Strictly by the numbers today, seven LNG facilities would add around 12 bcfd to the consumption.  That is close to 15% of production today.  Would that move the needle on price, possibly some, but not a lot.  But to the extent that the smart money would contract with shut in dry gas producers, the actual impact on price would be small indeed.  There is the matter of gas reserves.  Do we have enough for a long time?  There is a truism in the oil and gas business:  proven reserves in any new prospect area, and shale gas certainly qualifies, always rise with increased development.  Part of the reason is that proven reserves cannot be posted unless are they economically recoverable.  Field development increases the probability of economic recovery.  Accordingly, any reserves numbers today for shale gas are almost certainly underestimated.

An interesting twist comes from the oil sector.  Shale oil, because it is very light (smaller molecules on average), has significant associated gas.  In 2015 the associated gas was estimated at about 4 bcfd.  With some recovery in the price of oil, one would expect this to be higher going forward.  In other words, oil production alone will add significant gas to the production figures.  This, taken together with a potential revitalization of the dry gas economy, can likely support an LNG export business in the vicinity of 15 bcfd without impacting the price of gas to the point of damaging the economy.

Vikram Rao

Tempest in the Arctic Teapot

January 10, 2017 § 2 Comments

President Obama’s recent action to “permanently” ban new oil and gas leases in the US Arctic is being painted as heroic by the left and dastardly by the right.  In its actual effect, it is neither.  In the face of alternatives, investment in Arctic development is not advisable.  Royal Dutch Shell stubbed its toes badly in the Chukchi Sea, notably through operational missteps.  But that sort of thing is the nature of the game in the Arctic.  The risk/reward ratio is just too great, even counting just financial risk.  Environmental risk simply adds another dimension, especially to companies with serious sustainability goals.  Shell has announced a withdrawal from the Arctic, for the “foreseeable future”, after reportedly spending $7 billion.


Certainly, an outgoing President doing anything “permanent” raises hackles.  But the rhetoric does not comport with the facts.  A statement was attributed to the industry: “…. today’s unilateral mandate could put America back on a path of energy dependence for decades to come, said Dan Naatz of the Independent Petroleum Association of America”.  A nationwide ban on hydraulic fracturing would do what he says.  But not banning Arctic drilling.  Shale gas has made the US chemical industry dominant because of access to the lowest cost natural gas in the world.  More than half of the $150 billion capital investment in chemicals production is from abroad.  Shale gas made us an exporter of liquefied natural gas (LNG) instead of an importer.  Shale oil has made OPEC essentially irrelevant to controlling the world price.  The US is now the (unwitting) swing producer.  The Saudi gambit to kill US shale oil, if in fact there was one, has failed.  So, yes, a ban on hydraulic fracturing could “put America back on a path of energy dependency”.  But not banning Arctic drilling.  They are not going to do it, even if allowed, because there are better pickings.

All offshore drilling in the US is down.  The number of rigs drilling is currently in the teens; these are the lowest numbers since 1990.  Offshore drilling, especially in deep water, requires long term assurance of oil pricing.  No oil will be saleable for at least 7 years.  Multiply that by two, at least, for the Arctic.  Shale oil, and the resultant inability of OPEC to control price, has made price forecasting extremely uncertain.  This is not the best investment climate for long horizon prospects such as the Arctic.  Add to that the environmental risk, and the likelihood of pursuit is slim.

By the time the Arctic promise, such as it may be (some estimates have 30% of world  resources to be in that area), is realized, oil substitution will be in full swing.  A small sampling comprises electric vehicles, diesel substitution by LNG, CNG or dimethyl ether (this last led by Volvo), gasoline supplemented with methanol (led by the Chinese), more efficient internal combustion engines; the list is long and certain, at least in principle.  In addition to this, innovation will drive down shale oil breakeven cost to under $30 per barrel, with the ability to weather any oil price tribulation.  This will happen to a moderate scale within 3 years. Shale oil does have environment risks, but in the opinion of this author, they are tractable, and on a vastly different scale than those from Arctic mishaps.  Shale oil will be the investment of choice.  Look no further than the explosion of drilling rigs in the Permian (shale oil) as rig counts deteriorate in deep water.

In the same release, the President also shut down lease sales in the Atlantic.  But, interestingly, the ban stops at roughly the Virginia border with North Carolina.  To my knowledge the early exploratory success had been off the coast of North Carolina.  No reasons were given, but this may well be a nod to industry.  My personal opinion is that, on a national basis, emphasis on shale oil makes more sense; catastrophic risks are lower and the jobs are more distributed.

The President took a step that to some degree cements his environmental legacy.  But the actual effect is likely minor because the risk/reward economics of Arctic development, especially when compared to alternative investments, make them unlikely to be pursued even if permitted.

Vikram Rao




September 12, 2016 § Leave a comment

The September 3 issue of the Economist has a lead story entitled Uberworld.  The piece dwells on the fortunes of Uber to an inordinate degree, but underlines some important trends in transportation.  All of these, provided they materialize, point to a world with drastically reduced car ownership.


The first trend, private cars for hire in competition with taxis, is credited to Uber.  In fact, the first company to accomplish that was Sidecar, a San Francisco startup.  The Sidecar model was a peer to peer concept.  The app allowed riders to search for a driver heading in the direction they sought to go.  All financial transactions were only through the app.  Drivers were vetted by Sidecar and rated by riders.  A rider could reject a driver.  Sound familiar?  Sure, exactly the way Uber operates, at least on those points.  Sidecar’s misfortune was to come into being just a year ahead of competition, with no real barrier to entry.  No, not Uber, Lyft, which preceded Uber.  These two refined the business model to where the drivers were not on their way to anywhere at all; they were waiting to be called.  Not exactly peer to peer.

Today, Sidecar is gone, Lyft has 20% share and Uber has 80%.  What happened?  I have in other writings remarked that innovation in business models may be as (or more) important as technical innovation.  This one is a poster child for that sentiment.  Sidecar reputedly spent their investor money on technical innovation.  Lyft and Uber on market share expansion.  Uber came in a bit later and has swamped Lyft to date.  The price paid, of course, is negative profits on a USD 70 billion valuation.   Think Amazon, whose quarterly profit has been small to negative over the last 20 years since inception.

Aside from expansion, Uber has continued to innovate on offerings.  The latest is ride sharing for a price in the vicinity of half that of the conventional hire.  Starting to sound more like Sidecar.  This last may be the tip of the proverbial iceberg of improved asset utilization.  Especially with this twist, there is the promise of a cost per mile well below that of car ownership.  This increasingly begs the question: why own?

The second big trend, still at the toddler stage, if not infancy, is autonomous vehicles.  The promise is of a high degree of safety (the Tesla mortal crash notwithstanding).  But unlike the alternative taxi model of Uber and others, this one may run into problems with local regulations.  Furthermore, one of the hallmarks of the Uber business model has been the asset light concept.  Self-driving cars may require asset ownership, by some entity, if not Uber or Lyft.  But eschewing this avenue would not be wise.  Remember, there is no real barrier to entry other than sheer size and name recognition, which certainly count, especially the last.  Uber has almost become a verb, as did Google and Xerox.  But autonomous vehicles will be lower cost per mile, so Uber and wannabe’s cannot ignore it.  But the folks threatened by improved asset utilization (that shudder you feel: auto manufacturers) have taken notice.  GM has a USD 500 million investment in Lyft and hired the CTO and twenty employees of Sidecar.  An OECD study of Lisbon found that with large scale uptake of shared autonomous vehicles, the total number of cars required would drop by 80%.  But overall car-miles would increase by 6%.  The number of parking lots would fall drastically.  These may well become green space.  Sort of the reverse of the Joni Mitchell lyric from 1970: They paved paradise and put up a parking lot.  Autonomous vehicles are not yet here, and yet multiple players are jostling for pole position in secondary markets such as ride sharing.  Can you spell disruptive?

Vikram Rao