Energy

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ENERGY

FINANCIAL TIMES SPECIAL REPORT | Tuesday June 28 2011 www.ft.com/energy­june2011 | twitter.com/ftreports

West takes action on prices and supply A move by consumer nations to release oil from their strategic stocks has helped cool the market down, for now. Sylvia Pfeifer surveys the situation

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t the start of this year, US motorists were grumbling about paying more than $3 for a gallon of petrol. The culprit was the high price of oil, which was trading close to $100 a barrel. Before last Thursday, the price of a barrel of Brent crude had soared close to $120 a barrel – having peaked so far this year at $127.02 a barrel in April – and the price at the pump was touching $4 a gallon The lesson for consumers is inescapable. Energy, from the petrol that drives our cars to the electricity that powers our homes is likely to get ever more expensive. It is a lesson that has already been heeded by western governments, which last Thursday released the biggest amount of oil from their emergency strategic stocks since 1991. The International Energy Agency (IEA), the advisory body for western countries, agreed to release 60m barrels of oil in the coming month to offset the daily production loss of 1.5m barrels of oil from Libya, the north African country engulfed in civil war. The surprise announcement sent Brent crude prices tumbling to $108 a barrel on the day. The move, only the third such in the history of the IEA, which was established in 1974 as a counterbalance to Opec after the Arab oil crisis, underlined how concerned western governments have become about the impact of high crude prices on the economic recovery. The IEA’s twitchiness is understandable. The two events that have dominated the energy world in the past two months, a crisis at a Japanese nuclear plant and the ongoing civil unrest in the Middle East, have driven home the point that energy is becoming more expensive. The events in Japan and the Middle East helped trigger the short-term jump in prices that angered US drivers, and put a question-mark over long-held assumptions about the source and cost of energy supplies. Despite the west’s attempts to curb its appetite for power, there

is no sign of global demand diminishing. If anything, the world is becoming more hungry for power, according to Christof Rühl, chief economist at BP, with global consumption growth last year at its highest since 1973. China accounted for 20.3 per cent, surpassing the US to become the world’s biggest consumer of energy. Bob Dudley, BP chief executive, drove the point home to an audience in London last week, noting that “on current trends, we believe the world will require about 40 per cent more energy in 20 years’ time than it consumes today”. He added: “That’s basically two more United States. Or two more China’s worth of consumption.” The IEA forecasts that global demand will grow 36 per cent by 2035, forcing governments to diversify their energy mix and enhance sourcing security. Questions are also being raised over the viability of some of the alternatives to fossil fuels. The near meltdown at the Fukushima Daiichi nuclear plant in Japan after a devastating earthquake and tsunami has forced governments to re-assess their commitments to nuclear power – and how to plug any supply gaps that might result from changing course. One of the most radical responses to the crisis has been in Germany, where the coalition government of Angela Merkel abandoned a planned extension of the country’s nuclear reactors and reverted to shutting them down by 2022. The decision constitutes one of the biggest bets made by an advanced industrial country on renewable energy. Under the plan, eight reactors, or 8.5GW of capacity and about 8 per cent of Germany’s annual electricity production, will be closed permanently this year. It also commits Europe’s largest economy to doubling its energy from renewable sources to 35 per cent this decade. Most experts believe Germany will be able to meet the energy demands of its citizens but doubt its ability to meet tough domestic climate change targets, to cut carbon emissions by 40 per cent by 2020 compared with 1990. While more power from renewables may be the ambition, in the short to medium term, natural gas is emerging as a winner from countries’ plans to scale back their nuclear power. Analysts at Deutsche Bank, for example, expect emissions by Germany’s power sector to rise

High cost of oil gives boost to services M&A Spare cash and tighter regulation are leading to more consolidation, says Sylvia Pfeifer

In deep again: ExxonMobil this month announced two significant oil discoveries and a gas discovery in the Gulf of Mexico

Inside this issue UK emissions Mixed reviews

Australian LNG Frantic

for coalition sustainability policies – swift progress is required if targets are to be met Page 2

investment is spurred by Asian demand Page 2

US oil recovery Hydraulic fracturing (using fracking fluid, below) and horizontal drilling are expanding supplies Page 2

Renewables policy Solar industry feels chill of UK cuts Page 2

Shale gas in Europe Regulators must balance environmental and energy supply concerns Page 3

China There is no need to be unconventional yet. Conventional assets are still young, productive and capital­efficient Page 3

The Arctic If there is oil, it will be surprising if humanity shows the restraint not to use it Page 4

by 370m tonnes between 2011 and 2020 as a result of the increased use of gas and other fossil fuels. The IEA has cited slower growth in nuclear power after the recent events in Japan as one of the factors behind new estimates suggesting the world could be entering “a golden age of gas”. According to the agency, the use of natural gas could rise by

more than 50 per cent by 2035 from last year. Industry executives have welcomed a more prominent role for natural gas in the energy mix. Malcolm Brinded, executive director of exploration and production at Royal Dutch Shell, the Anglo-Dutch company, told a conference in the Netherlands this year that gas is “abundant, acceptable and affordable”.

Gas, he added, was a “destination” fuel, not simply a “transition” fuel on the way to a lowcarbon future. For the world’s large integrated oil and gas companies these developments are good news. Shell, for example, will produce more gas than oil from next year. The industry is awash with cash, thanks to high oil prices, with analysts expecting the top five international listed companies to spend $128bn on capital investment this year alone. The one challenge for the industry is growth. The majors continue to struggle to replace their production reserves – success in exploration is vital. In some cases their spending is paying off. ExxonMobil announced this month it had made two significant oil discoveries and a gas discovery in the deep water of the Gulf of Mexico. “We estimate a recoverable resource of more than 700m barrels of oil equivalent combined in our Keathley Canyon blocks,” said Steve Greenlee, president of ExxonMobil Exploration at the time. The likely reliance on fossil fuels in the medium term means targets for the reduction of carbon dioxide emissions will be harder to achieve. The jump in gas usage will help reduce air pollution in many cities, in particular in China, and cut the use

of coal, but it could lead to a global temperature rise of 3.5C, according to the IEA. “While natural gas is the cleanest fossil fuel, it is still a fossil fuel,” says Nobuo Tanaka, chief executive of the IEA. “Its increased use could muscle out low-carbon fuels such as renewables and nuclear, particularly in the wake of the incident at Fukushima . . . An expansion of gas alone is no panacea for climate change,” he adds. Mr Rühl says strong demand and increased use of fossil fuels is “bad news” for carbon dioxide emissions from energy use. Today, renewables account for only a small proportion of supply. According to BP, wind, solar, geothermal and biofuels used for power generation and transport contributed about 1.8 per cent of global primary energy supply last year. China became the largest windpower generator, overtaking the US and accounting for 48 per cent of all new capacity. However, there is room for optimism, as more of the energy coming onstream is from renewables. “Over the past 10 years, their share has almost trebled,” says Mr Rühl. “Over the past five years, their contribution to the growth of primary energy was almost 10 per cent, higher than the growth contribution of petroleum-based products.”

Third pipeline from Canada awaits crucial US decision Oil sands Sheila McNulty on concerns over leaks and the impact on the environment Building a pipeline to the US from Canada to bring fuel from that northern neighbour’s vast tar sands operations should be an easy feat to accomplish. Not only is the US desperate for fuel, but Canada is stable and friendly. Its fuel will be cheaper to import than that of far-off nations and its stability would ensure a steady source of supply. On top of that, two such pipelines from Canada already have been built. Indeed, Jim Vines, partner in the energy environmental practice at King & Spalding, an international law practice, believes it will be tough for the US Department of State to say this third pipeline, Keystone XL, is so different. “Denial of this permit by the US would be vulnerable

to a serious challenge in the World Trade Organisation,” he says. But the Keystone XL pipeline is not only subject to criticism by environmentalists about the import of the high carbon fuel. A series of spills from the first Keystone pipeline led US authorities to suspend its operation temporarily this summer. The timing could not be worse for TransCanada, the pipeline operator, which is waiting for the state department to decide by year-end whether to let it progress with its Keystone XL extension pipeline. “TransCanada needs to ensure the pipeline is safe, secure and can operate without the risk of leaks,” says congressman Edward Markey, the top Democrat on the Natural Resources Committee of the House of Representatives. “These concerns need to be fully addressed, as the administration and state department evaluate the Keystone XL project.” TransCanada was able to obtain approval to restart its Keystone pipeline in a

few days and points out that the last incident, at a pumping station in Kansas, had involved less than 10 barrels of oil. “Almost all the oil releases over the past 12 months on Keystone have been minor – averaging just five to 10 gallons of oil,” says Russ Girling, TransCanada’s president and chief executive.

‘The protests are not going to stop tar sands development’ “The vast majority of that oil was confined to our property and in all cases was cleaned up quickly. None of the incidents involved the pipe in the ground – the integrity of Keystone is sound.” But that the first Keystone has suffered 11 spills in its first year is a worry for environmentalists. Susan Casey-Lefkowitz, director of the international programme at the Natural Resources Defense Council,

an environmental group, notes the highly corrosive nature of bitumen, which is what the tar sands are composed of. This is a concern, she says, because Keystone XL is to cross the Ogallala Aquifer, a freshwater source for eight states. The Keystone XL is a 2,673km, 0.9m crude oil pipeline that would start in Alberta and extend southeast through Saskatchewan, Montana, South Dakota and Nebraska. It would incorporate a portion of the Keystone Pipeline that runs through Nebraska and Kansas to serve Oklahoma, before continuing, to serve the Port Arthur market in Texas. Ms Casey-Lefkowitz says the Keystone XL pipeline is redundant, because there are already the first Keystone and the Alberta Clipper pipelines bringing tar sands fuel into the US. “It’s not necessary for energy security,” she says. “Bringing this oil across US heartland, farms and the Ogallala Aquifer is a real danger for communities.”

Line from the sands: Canada is stable and importing from there cheaper

A growing number of environmentalists and local officials also object to the higher carbon content of tar sands fuel. The mayors of 25 towns and cities wrote a letter on March 24, to Hillary Clinton, secretary of state, expressing grave concerns about expanded tar sands oil imports. “Specifically, we are concerned about the impacts of the proposed Keystone XL pipeline that would transport tar sands oil from Alberta to Texas, increasing our dependence on this high carbon fuel for decades to come, at a time when we, as local governments, are working hard to decrease our dependence on oil.”

Nonetheless, some supporters of Keystone XL say the carbon footprint will be less if fuel is exported to the US in a pipeline rather than shipped in a tanker across the ocean to China. Kenneth Medlock, energy expert at Rice University, says there is a project under way to export the fuel to the Pacific Basin. “The protests are not going to stop tar sands development,” Mr Medlock says. “You have to think of the world as one big bathtub. It doesn’t matter which end of the tub you fill from, as long as you are adding supply. The oil is going to flow.” That said, it is uncertain whether that oil will flow

TransCanada

through the planned Enbridge Northern Gateway pipeline system aimed at taking some to alternative markets. That pipeline, which would run 1,170km from Alberta to a new port in Kitimat, on the coast of British Columbia, has also met fierce opposition. Mr Vines focuses his comments on Keystone XL: “In the US, big energy projects tend to go through a lengthy regulatory process and a lengthy litigation process. “If the Canadians have the perseverance to work through these two processes, which I think they do, the pipeline will get built.’’

In December last year, General Electric announced it was buying Wellstream, the world’s second-largest supplier of flexible pipes for the oil and gas industry, for about £800m ($1,300). The deal capped months of pursuit by GE of the UK company during which it was twice rebuffed. For GE, which has identified energy services as a key area for investment, its dogged pursuit was worth it, as Wellstream had two attractions: its technology and a significant presence in Brazil, one of the new frontiers of oil exploration. The acquisition, among a flurry of others in the oil and gas services sector over the past 12 months, signalled not only that there is ample growth in the sector but that, despite BP’s spill in the Gulf of Mexico, deepwater drilling had not suffered a prolonged downturn, as many analysts had feared would happen. The search for resources is taking big oil companies into the deep water in countries such as Brazil, as well as other areas that involve complex drilling. Unconventional drilling techniques are also in focus in the wake of the development of shale gas in North America. The demand for better technology, combined with an industry that is flush with cash because of high oil prices – analysts expect the five largest publicly listed oil companies alone to plough a record $128bn into capital investment this year – means service companies are in demand. Tighter regulation and increased costs after the BP accident are also expected to increase demand for these companies’ services, in particular those with modern fleets of deep-water rigs, such as Pride International of the US and SeaDrill, the Norwegian drilling company, which command higher rates than shallowwater rigs. The new regulations could make it harder for some smaller service companies to compete. Christopher Pilot, managing director, head of EMEA oilfield services coverage at Goldman Sachs says: “As long as the oil price remains above $70-$80 a barrel for Brent crude, service companies should do well – as the price dips below these levels, international oil companies start debating capex versus dividend reductions . . . capex tends to lose out.” The increasing demand and high crude prices are underpinning merger and acquisition activity. In February, Ensco proposed to buy Pride International for $7.3bn in cash and stock to create the world’s second-largest offshore driller after Transocean. The deal followed a string of smaller transactions, including GE’s purchase of Wellstream, Seadrill’s acquisition of Scorpion Offshore and Noble Corporation’s of Frontier Drilling. Mark McComiskey, managing director at First Reserve Corporation, the private equity group that has invested more than $3bn in oilfield services over the past five years, says there is “strong demand for rig businesses and equipment and services businesses”. Last year, First Reserve sold Dresser, a Texas-based maker of gas engines used to power oil and natural gas production, to GE. First Reserve, adds Mr McComiskey, is looking at several areas to invest, including unconventional gas in North America, in particular companies with service expertise that can Continued on Page 4


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