3 things to know in energy: Prices, Permian Basin, Canada’s election
INSIGHT ARTICLE |
Authored by RSM Canada
In this week’s energy industry analysis, we look at the crunch caused by surging prices and decreased supply, how shifting assets in the Permian Basin might affect the industry, and what the results of Canada’s federal election might mean for energy policy. Here’s the latest:
1. Energy shortage and soaring prices threaten growth
Natural gas prices are rallying around the world, a stark contrast to the low-cost, abundant supplies of recent years. The Henry Hub natural gas spot price, a benchmark based on a delivery hub in Louisiana, closed at $5.03 per million British thermal units on Sept. 24, a whopping 47% increase from the same date in 2019.
The problem extends beyond the United States. Natural gas prices in Europe and Asia are also surging, not only because of rising recovery-related demand coupled with supply constraints, but also because of unusually cold temperatures last winter that depleted storage.
The crunch has the potential to turn into a crisis if not managed. It has already caused industrial and residential power outages, threatened economic growth and jeopardized climate goals. You can read more about the impacts of the energy crunch on the middle market here.
2. Permian Basin assets changing hands
Last week, Royal Dutch Shell announced the sale of its Permian Basin assets to ConocoPhillips for $9.5 billion cash. The Permian Basin, located in western Texas and southeastern New Mexico, is the largest producing oil field in the United States. If it were a country, it would be the sixth-largest producer globally.
Over the past 10 years, oil production in the Permian has grown from just over a million barrels per day to over 4.7 million barrels per day as of August 2021, securing its position as a critical contributor to global supply.
A lot of this growth was fueled by technological advancements in pad and horizontal drilling and advancements in completions and enhanced oil recovery. But it also resulted from the entrance of the oil majors (and their investment dollars) into the area, which had historically been held by independent producers that generally lack the ability to invest at the same capacity as the larger players.
- September 2012: Shell and Chevron bought Chesapeake’s Permian assets for $3.3 billion
- January 2017: ExxonMobil more than doubled its Permian acreage with a $5.6 billion purchase of Bass family assets
- July 2020: Chevron acquired Noble Energy for $5 billion
- October 2020: ConocoPhillips announced the acquisition of Permian independent producer Concho Resources in an all-stock transaction worth $9.7 billion
- October 2020: Pioneer acquired Parsley for $7.6 billion
- September 2021: ConocoPhillips acquired Shell’s Permian assets for $9.5 billion
Those transactions are only a few that have occurred over the years, but they highlight the scope and scale of operations in the oil fields spanning parts of West Texas and New Mexico.
As management teams seek to operate within free cash flow and move toward achieving climate goals, the fate of their Permian assets hang in the balance.
Shale oil production is capital intensive and requires continued reinvestment to keep up with the steeper production decline curves, and management teams everywhere are evaluating their assets and making decisions on where they will see the largest returns. And, sometimes, that means divesting from the Permian to focus on other more commercial assets because a pure-play independent shale producer can do more with those assets for less.
Additionally, as in the case of Shell, a few of these producers have set aggressive climate goals and are under increasing scrutiny from investors and consumers to shift away from carbon intensive operations into cleaner sources of energy.
It will be interesting to see how management teams respond to rising prices driven in part by a supply crunch. We expect to see more transactions among Permian producers capitalizing on rising asset values.
We also anticipate that some will raise production to secure high prices for produced hydrocarbons. Others have learned from the boom-and-bust cycles and will toe the line, generating slow and steady growth while operating within free cash flow and progressing on climate-related goals.
Watch how the market responds to those decisions, and how supply and demand balance fluctuations result in real impacts to global consumers.
3. Canada’s federal election has consequences
Canadian Prime Minister Justin Trudeau’s Liberal Party was elected for a third term on Sept. 20, its second as a minority government.
Trudeau requested the dissolution of parliament in August for a snap election in an effort to win a majority government, but the Liberal Party won only 159 seats, less than the 170 required for a majority in the House of Commons.
Erin O’Toole’s Conservative Party formed the Official Opposition by winning 119 seats. The Liberal Party gained two seats from the 2019 federal election, despite once again losing the popular vote to the Conservatives and setting a record for the lowest vote share to form government with only 32.6% of the popular vote.
What does this mean for Canadian energy policy?
As a minority government, the Liberal Party will have to rely on support from the New Democratic Party and Bloc Québécois to pass legislation, as it continues to pursue stricter regulations against the oil and gas industry and more aggressive net-zero carbon emissions goals.
The Conservative Party sought to repeal Bill C-48, which banned oil tanker traffic off the north coast of British Columbia, and to amend Bill C-69, which made regulatory approval of major infrastructure projects more difficult by changing the environmental assessment process based on recommendations from a bipartisan senate committee.
The Conservatives also intended to roll back Canada’s Paris Agreement target to the original goal set in 2015—a 30% emissions reduction below 2005 levels by 2030. The Liberals submitted new targets of a 40%-45% emissions reduction in July. Now, the Liberal Party will instead continue to encourage a transition away from oil and gas, including the proposal of a new CA$2 billion ($1.57 billion) federal fund to train workers in the industry for new careers in lower-carbon sectors.
Oil and gas companies will also have to reduce methane emission levels by at least 75% from 2012 levels by 2030, which is an increase from the previous requirement of 50%. Additionally, Trudeau’s new platform includes a commitment to eliminate fossil fuel subsidies by 2023, which is two years ahead of the original G20 target date. However, what constitutes a fossil fuel subsidy is vaguely defined by a 2009 G20 agreement as an “inefficient” subsidy, and both the exact dollar amounts spent to date and what is permissible beyond 2023 remain undetermined.
The federal carbon tax of CA$170 per tonne by 2030 will remain in place, whereas the Conservative Party had stated that this target would only be met if it was matched by the U.S. and Europe. The Biden administration in the U.S. has not made any indication that it intends to implement federal carbon pricing policies, and as Canada’s largest oil and gas trading partner, we expect that Canada’s federal carbon tax will create a competitive imbalance to the detriment of the oil and gas industry in the country.
We also expect that the Canadian federal government will continue to give minimal pushback against the U.S. with regard to differences on cross-border infrastructure projects, and pipeline takeaway capacity in Canada will remain limited for middle market producers under a second Liberal minority government.
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This article was written by Homan Chung and originally appeared on 2021-10-07 RSM Canada, and is available online at https://rsmcanada.com/what-we-do/industries/energy/3-things-to-know-in-energy-surging-prices-permian-basin-shifts-c.html.
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