A Look at 2013’s Biggest Energy Stories

In this last issue of The Energy Letter for 2013, I take a look back at the year’s biggest stories in energy. Here are my top 10. They are mostly in no particular order, except I do think my #1 is the top energy-related story of the year.

1. Lac-Mégantic disaster

Lac Megantic disaster photo

Devastation at Lac-Mégantic. Source: CTV News Montreal
On July 6, a train carrying crude from North Dakota’s Bakken oil fields to the Irving Oil Refinery in Saint John, New Brunswick, started to roll downhill after it was parked for the night. The train picked up speed and ultimately derailed in the heart of Lac-Mégantic, Quebec. A wave of burning oil engulfed the town, killing 47. Businesses were destroyed, homes lost, and the center of the town ruined. The rail company involved — the Montreal, Maine and Atlantic (MMA) Railway – declared bankruptcy shortly after the disaster.

This story intersects many of the themes I cover. Growing oil production in new hydrocarbon basins has led to growing rail shipments, while pipeline projects race to catch up. I have written a great deal about this trend, as well as the relative safety of rail transport versus pipeline transport. But what makes this my top energy story of 2013 is the magnitude of the casualties. Any major loss of life that occurs during the procurement of energy is deeply troubling, but the fact that this accident killed so many innocent bystanders puts it at the top of my list.

I have yet to see a top 10 list of energy stories with this one at the top (sometimes it isn’t even listed). I am pretty sure that if this disaster had happened somewhere in New England, it would have gotten a lot more attention. But the fact that it happened in Canada, and in particular in Quebec, meant that we quickly turned our attention toward other things.

But to put this tragedy into perspective, more lives were lost in this disaster than in any accident in the energy industry since the 1988 Piper Alpha disaster in the North Sea that killed 167.

2. US oil production continues to expand

oil barrels illustration
Twenty-thirteen marked the fifth year in a row of increasing US oil production.

After nearly 40 years of intermittent decline, US crude output began to climb in 2009. US crude oil production has now increased from 5.1 million barrels per day (bpd) in early 2009 to 7.3 million bpd in the most recent quarter. Remarkably, the US has become the fastest growing oil producing region in the world, and the International Energy Agency (IEA) is projecting that the US will once again become the world’s largest oil producer by 2015.

The resurgence in US oil production is a result of the fracking revolution, which refers to the marriage of the decades-old techniques of hydraulic fracking and horizontal drilling. Production is being driven primarily by Texas and North Dakota. The Bakken Formation and, below it, the Three Forks Formation, in the Williston Basin that lies underneath North Dakota have driven that state’s oil production from less than 150,000 bpd in 2008 to the current level of nearly 900,000 bpd. In 2012 North Dakota surpassed Alaska to become the country’s second largest oil producer.

Like the Bakken, the Eagle Ford in Texas is a tight oil formation rendered economical by high crude prices and the application of fracking and horizontal drilling. The Eagle Ford stretches across south Texas, and is projected to grow even faster than the Bakken. In the past five years Eagle Ford oil production has grown from essentially zero to 659,000 bpd for the first 10 months of 2013. Projections have production reaching 930,000 bpd this year and well beyond 1 million bpd by mid-2014.

Then there is the Permian Basin in Texas, with more estimated reserves than the Bakken and Eagle Ford combined. The Permian Basin has been producing oil since the 1920s, and is projected to still contain recoverable oil and natural gas resources exceeding what has already been pumped out.

The Permian Basin currently produces some 900,000 bpd of crude, about 12 percent of US oil production. Some analysts expect Permian production to more than double by 2018 to 2 million bpd — a level last reached during the 1970s.

A number of analysts believe that the US fracking revolution will soon fade, but in 2013 production actually accelerated. The increase in 2013 will likely end up as an unprecedented 1 million barrels per day (bpd) increase over 2012 levels, putting US oil production at the highest level in more than 20 years.

3. The year in coal

US coal consumption chart

The US coal industry has been in decline for several years. The primary factors behind the decline are competition from cheaper and cleaner natural gas, and increasingly stringent government regulations. This year the EPA published draft regulations for new coal-fired power plants that will likely be economically impossible to meet.

For years the coal industry has suggested that carbon capture and storage technologies would come along to save the day. But this year the Norwegian government abandoned support for a project that was supposed to demonstrate carbon capture and storage on commercial scale. Thus, coal in the US appears to be on the way out.

US coal producers have been battered as a result. Leading suppliers Peabody Energy (NYSE: BTU) and Arch Coal (NYSE: ACI) saw their share prices decline by another 30 percent and 40 percent, respectively, in 2013. This was on top of steep declines in 2011 and 2012, so that the total market capitalization of BTU and ACI has declined by 71 percent and 87 percent over the last three years.

No country in the world has decreased coal consumption as much in recent years as has the US. This explains the declining fortunes of coal companies with significant operations in the US. But no country has increased coal consumption as much as China. In fact, were it not for China, global consumption of coal would have decreased over the past five years. Instead, the world continues to set new records for coal consumption.

The US has the world’s largest coal reserves — 28 percent of the world’s total coal reserves. Given declining US consumption, US coal producers have stepped up exports, and are seeking to expand coal export capacity from the Pacific Northwest to tap into Asia’s growing consumption. However, there are many obstacles in place, both domestically and internationally. Domestically, environmentalists will pull out all the stops in trying to prevent this coal from being exported. Internationally, Southeast Asia is a very competitive market given the proximity of major coal exporters Australia and Indonesia. Australia is the world’s top coal exporter, with nearly 90 percent of its total exports destined for Japan, China or South Korea.

4. The Keystone XL Pipeline decision drags on

Keystone XL protest photo

In what has become an annual ritual, once more the Obama Administration postponed a decision regarding the controversial Keystone XL Pipeline that would deliver oil from Canada’s Athabasca oil sands deposits to refineries in the US. The US State Department issued a largely positive review of the Keystone XL pipeline extension, while influential science journal Nature wrote that the Keystone XL pipeline’s environmental impact is exaggerated. Nevertheless, a high-profile campaign by environmentalists has paralyzed the Administration into inaction, even though President Obama himself “has privately expressed skepticism toward environmentalists’ claims about the pipeline.”

In the meantime, potential customers have started to lose interest, finding other ways of getting their oil to market. Harold Hamm, the CEO of Continental Resources (NYSE: CLR) who had signed on to use the Keystone XL, recently said that shipping crude by rail has been “a very effective way” of getting Continental’s oil to market, and that his interest in Keystone XL is waning as a result.

Canada has also responded with potential new routes of getting the oil sands to its east and west coasts. TransCanada’s Energy East pipeline would be a 4,500-kilometer pipeline carrying 1.1 million barrels of crude oil per day from Alberta and Saskatchewan to refineries in eastern Canada.  To the west, Kinder Morgan Energy Partners (NYSE: KMP) has filed an application with Canadian regulators that would greatly increase the current capacity of the 300,000 bpd Trans Mountain pipeline, currently the only pipeline running from Alberta’s oil sands to Canada’s Pacific coast. The project would nearly triple the existing pipeline capacity to 890,000 bpd, and would terminate in Burnaby, British Columbia.

There are also rail projects on the drawing board would push the oil sand rail takeaway capacity from the current 224,000 bpd up to over 900,000 bpd. For more detail on the projects for getting oil sands production to market, see my article There’s No Stopping the Oil Sands Train.

5. Opening the Arctic

Twenty-thirteen opened with one of Royal Dutch Shell’s (NYSE: RDS-A) two Arctic drilling rigs breaking free from a tow ship and running aground off the coast of Alaska. Shell sent the two Arctic drilling rigs to Asia for extensive repairs. The accident prompted more calls for restrictions on oil exploration in the Arctic. Shell wants to try again in 2014, but Senate Democrats are asking for a delay in further Arctic oil exploration.

Nevertheless, oil companies rushed north to explore for oil. Norway awarded 24 oil and gas exploration licences to 29 companies, mostly in the Arctic Barents Sea. The licenses were scooped up by international majors like Shell, BP (NYSE: BP), ConocoPhillips (NYSE: COP), Total (NYSE: TOT) and Statoil (NYSE: STO), in hopes of reviving Norway’s falling oil production.

Other Arctic nations are also pushing forward with plans for oil exploration in the Arctic. Russia has aggressively defended its interests there, seizing a Greenpeace ship and detaining its crew after the group attempted to interfere with Russia’s Arctic drilling.

6. In a win for refiners, the EPA rolls back the RFS2

In 1978 the US Environmental Protection Agency (EPA) issued a gasohol waiver that set the maximum legal limit of ethanol in motor gasoline at 10 percent denatured anhydrous ethanol.

27 years later, the Energy Policy Act of 2005 created a Renewable Fuel Standard (RFS) requiring 7.5 billion gallons of renewable fuel — primarily corn ethanol — to be blended into the fuel supply by 2012. The Energy Independence and Security Act (EISA) of 2007 created a new Renewable Fuel Standard — the RFS2 — accelerating the renewable fuel adoption schedule. Instead of the RFS requirement of 7.5 billion gallons by 2012, the RFS2 required 9 billion gallons by 2008, soaring to 36 billion gallons by 2022.

But the structure of the RFS2 set up some future problems. If gasoline blenders failed to comply with the mandated volumes (based on the volume of gasoline they sell in the US) they were required to buy credits called Renewable Identification Numbers (RINs) to make up the shortfall. But Americans are burning less gasoline than we used to, so meeting the EPA’s ethanol mandate would require a higher ethanol content than the current allowable maximum of 10 percent in regular unleaded.

This created a so-called “blend wall” that forces refiners to blend volumes of ethanol that would only be feasible if the 10 percent limit were exceeded. After expanding the required volumes every year since the RFS was initially implemented, in 2013 the EPA indicated “that it will propose to use flexibilities in the RFS statute to reduce both the advanced biofuel and total renewable volumes in the forthcoming 2014 RFS volume requirement proposal.” Finally, in November the EPA proposed to reduce the 2014 requirement to 15.21 billion gallons of ethanol in the nation’s fuel supply, down from 16.55 billion gallons for 2013. The ethanol industry, long accustomed to getting what it wants from the federal government, declared the action illegal and threatened to sue.

The EPA also recognized that too little cellulosic ethanol is being produced to meet that renewables sub-category’s special mandated volume, and it slashed the mandated cellulosic blending volume from 14 million gallons to 6 million gallons. (The original RFS2 called for a whopping 1 billion gallons of cellulosic ethanol to be blended into the fuel supply in 2013, but this amount had been reduced previously.) The EPA further extended the compliance date for the total 2013 ethanol mandate of 13.8 billion gallons by four months, to June 30, 2014.

The US Court of Appeals for the District of Columbia also struck down the EPA’s cellulosic ethanol mandate, saying it was based on “wishful thinking.”

7. Mexico reforms its oil industry

Following nearly 10 years of declining oil production, the Mexican government changed three articles of the nation’s constitution to allow foreign investment and production-sharing agreements in energy.

Mexico’s oil industry had been nationalized in 1938, and Mexican state oil company Pemex had been prohibited from entering into production-sharing agreements with foreign companies. As a result. some of the more expensive and challenging techniques for producing oil had not been adopted in Mexico. For example, despite having deep water reserves, PEMEX presently produces no oil from the deep water Gulf of Mexico because of the cost and risk of such projects.

Mexico’s Department of Energy estimates that foreign investment in oil and gas production will rise by 50 percent by 2018, to $10 billion, and optimistically projects that oil production will reverse the past decade’s decline, rising to 3 million barrels a day by 2018 and 3.5 million by 2025.

8. Iran makes a deal

Iran reached an agreement with world leaders to limit its nuclear program in exchange for lighter economic sanctions. The deal freezes or reverses progress at Iran’s major nuclear facilities, halts the installation of new centrifuges used to enrich uranium, and caps the amount and type of enriched uranium that Iran is allowed to produce. In return, Iran will get back $4.2 billion in frozen overseas assets, and benefit from an easing of trade sanctions thought to be worth about $1.5 billion. The White House reported that $4.2 billion from new crude oil sales “will be allowed to be transferred in installments if, and as, Iran fulfills its commitments.”

In the wake of this deal, some pundits speculated that Iran’s nuclear deal could push oil prices down and threaten the US shale oil boom. But the oil markets don’t operate in a vacuum. What Iran does will affect what Saudi Arabia does, and as each of those OPEC members makes its moves the developing world will continue to increase its demand for oil. Thus, while this deal will increase the amount of available exports, there are supply and demand factors (e.g., OPEC cuts and increasing demand in developing countries) that can easily offset the amount of oil Iran can add to the market. Saudi Arabia will ensure that those supplies aren’t a net addition to the market. Rather, any signals that Iran is ready to cooperate with the world community may take some of the fear premium out of the price of oil.

9. US carbon emissions plummet

The Energy Information Administration (EIA) confirmed what the BP Statistical Review first noted, that US carbon dioxide emissions fell by nearly 4 percent in 2012. The IEA reported that US carbon dioxide emissions fell to the lowest level since 1990, even as global carbon dioxide emissions hit a new high in 2012. The US EPA released a report stating that US carbon dioxide emissions are down 7% since 2005. The primary reason for the decline has been utilities switching from coal to natural gas, which produces fewer carbon dioxide emissions per unit of energy produced. However, there are signs that some utilities are switching back with the recovery in natural gas prices, and many believe that the ongoing drop in US carbon emissions will soon reverse direction.

10. A (Mostly) Bad Year for Cleantech VCs

Over the past few years venture capitalists (VCs) have made some very aggressive bets on cleantech. Many of these VCs had made fortunes in the Silicon Valley computer industry, and were confident that a combination of Silicon Valley genius and Moore’s Law quickly lowering cost curves would be the key to their success. Firms like Kleiner Perkins and Khosla Ventures bet big that cleantech would be the next huge wave.

The problem with that is the computer industry and the energy industry are apples and oranges. A VC may be able to fund 50 guys working out of a garage for less money than it takes to build one advanced biofuel demonstration plant. As Vinod Khosla is fond of saying, VC has lots of misses and a few big hits. But when you are dealing with the energy business, those misses can add up to hundreds of millions or even billions of dollars, and sooner or later you start to run out of other people’s money.

The decision to invest in cleantech has been cited as the reason behind Kleiner Perkins’ well-documented fall from grace. While the losses suffered by Kleiner Perkins aren’t public record to my knowledge, some of Vinod Khosla’s are because they involve companies that he took public.

In 2011, Khosla took public Amyris (Nasdaq: AMRS), Gevo (Nasdaq: GEVO), and KiOR (Nasdaq: KIOR). Each of these stocks started out trading up from the IPO price, with Amyris gaining more than 90 percent at one point. But the challenges of producing fuels from biomass began to mount, and investors realized that this business is capital-intensive. Enthusiasm for these companies dissipated as they fell short of production expectations. Since their respective IPOs Amyris, Gevo, and KiOR are down 70 percent, 92 percent, and 88 percent.

KiOR’s steepest declines took place this year after the company failed to meet production forecasts, with the stock falling 72 percent in 2013 and the company warning of possible insolvency if it fails to obtain additional funding. Investors in just these three companies have seen the combined market capitalizations fall by more than $3 billion since 2011. With a large ownership stake in each company, Vinod Khosla, Khosla Ventures, and his associated funds have undoubtedly suffered enormous losses on their advanced biofuel holdings.

There were a few bright spots in the sector. Notably, Tesla Motors (Nasdaq: TSLA) saw its share price rise by 470 percent between January and October, before recently pulling back to a year-to-date gain of 324 percent. The company’s Model S sedan received a five-star rating for safety overall and in every subcategory from the National Highway Traffic Safety Administration (NHTSA). That’s the highest score the NHTSA awards. Tesla also beat Wall Street expectations in recording two profitable quarters, aided by the sale of zero emission vehicle tax credits. Finally, the company paid back government loans earlier, silencing many naysayers who expected it to default as fellow electric car maker Fisker Automotive had done.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Bolting Out of the Gate

Normally, we wouldn’t be updating so soon buy recommendations made within the last month or so. Then again, we normally wouldn’t expect a decent year’s worth of gains in a month, so a look-around definitely seems in order.

Marcellus and Utica driller Antero Resources (NYSE: AR) is up 13 percent (as of Dec. 27) since we added it to The Energy Strategist’s Growth Portfolio on Nov. 26, extending a rally that has made it one of the year’s most successful initial public offerings.

There have been no company-specific news in the last months, but the prices of natural gas and, crucially, the natural gas liquids that will account for the bulk of Antero’s future profits, have moved significantly higher.

The NGL rally has been driven by propane, the second most voluminous component of the typical NGL barrel, and one increasingly in short supply thanks to rising domestic demand and increased exports. The most common NGL, ethane, remains down in the dumps for now, but that should change as chemical plants spring up to convert the ethane glut into valuable petrochemicals.

Though we didn’t expect Antero to reach our price target so quickly, we’d certainly consider raising it at an opportune time. For now, continue to buy AR on any dips below $62.

Eagle Ford crude driller Carrizo Oil & Gas (Nasdaq: CRZO) is up nearly 14 percent since we added it to the Aggressive Portfolio on Dec. 11, and here too there was no company-specific news. Rather, Carrizo appears to have benefited from the end in mid-December of the sharp autumn correction in drillers’ share prices.

Carrizo’s CFO took advantage of the rally to unload shares worth nearly $1.5 million last week, representing a hefty 31 percent of his ownership stake prior to the sale. Meanwhile, Iberia Capital initiated coverage of Carrizo Friday with a rating of Outperform and a $55 price target. Our buy below target remains at $46, making Carrizo a buy at current levels. Despite the rapid rebound of the last two weeks, the stock retains significant upside it can realize simply by meeting internal expectations for growth in the Eagle Ford and the Utica.

Gastar Exploration (NYSE: GST) is another Aggressive Portfolio pick made on Dec. 11, and so far it has rallied quite aggressively, producing a three-week capital gain of 26 percent. It helped here too to catch the very bottom of the recent correction, but Gastar has continued to report strong test well results from the Hunton Limestone play it’s pioneering in Oklahoma.

On Dec. 17, Gastar reported that the newest test well drilled by its joint venture partner, the Mid-Con 7H, delivered a peak IP (initial production) rate of 906 barrels of oil equivalent (BOE) per day, and averaged 782 BOE a day over the next 17 days. It did so without the benefit of gas lift, which helped the venture’s prior Hunton well, the Mid-Con 6H, to a peak IP rate of 1,442 BOE/day and a 26-day post-peak average of 1,300 BOE/day. The fact that the 7H was still flowing 17 days after peak IP without gas lift is very encouraging, and it comes as Gastar begins drilling its own wells in the Hunton.

The share price has shot well past our initial $5.75 buy below target, and we will consider revising that higher if the Hunton keeps delivering good news.   

— Igor Greenwald