The plunge in world stock markets certainly grabbed the world’s attention. Why did it occur? What might it mean for energy prices? What should we make of the turmoil?
Two factors are having an outsized impact on energy prices. The first factor is the worldwide action to prevent the spread of COVID-19. Travel restrictions and broad enforcement of social distancing have created considerable uncertainty for economies around the world.
While economic activity in China has slowed, driving lower energy demand, that may change. China seems to be emerging from its COVID-19 outbreak relatively quickly. It’s unclear how it will play out elsewhere. There are fears that global markets may be impacted for some time to come.
The impact of the COVID-19 pandemic is the backdrop to decisions taken by countries in the Organization of Petroleum Exporting Countries (OPEC). OPEC attempted to coordinate production cuts to underpin world oil prices. When Saudi Arabia and Russia failed to reach an agreement, Saudi Arabia announced a production increase in order to maintain or capture new market share during this decline in demand.
In the battle for global market share, oil producers in North America (and everywhere else in the world) will need to adjust to receiving less revenue. This puts North American producers at a decided disadvantage. 63% of American oil production since 2009 has been a result of shale drilling and fracking. 2.8 billion barrels of oil were produced/extracted through fracking in 2019[1].
The cost of shale oil production can range between $40 and $90 per barrel, while countries like Saudi Arabia can produce at under $10 per barrel through conventional drilling[2]. With prices currently hovering around $30/barrel for NYMEX crude, the issue confronting American producers is stark.
Assessing the impacts of an oil price collapse on natural gas and electricity markets will be difficult.
Historically, NYMEX natural gas (American), as well as AECO natural gas (Canadian) markets have been highly associated with NYMEX crude. Since 2008 however, most of the natural gas produced and consumed domestically has been independent of oil production. The widespread use of fracking technologies across North America has facilitated access to plentiful natural gas reserves trapped in porous rock.
More recently however, increases in natural gas supply have been tied to the production of crude in North America, again through fracking. Referred as “associated” or “wet” natural gas, US production increased from 4.3 Bcf/day in 2006 to 15 Bcf/day of production in 2018[3]. This means 16% of all natural gas produced in the US is coming from sources associated with crude oil.
It seems counter intuitive that natural gas prices might rise as a result of an oil price slump.
If the collapse of world oil prices drives down North American shale oil production it may cut back the new natural gas supply associated with it. This could in turn, contribute to some tightness in supply, depending on the longevity of current conditions. North America recently saw record low prices for natural gas following low demand this winter. The news that supply might be tightening has contributed to a strengthening in natural gas prices in the days since oil markets collapsed.
Should natural gas supply tighten in the near future, it is also reasonable to expect resulting higher natural gas prices will put upward pressure on electricity market prices. Look for this in markets where natural gas generation of electricity predominates.
The factors affecting energy markets are fluid at the moment. The length and severity of COVID-19 are not yet known. The competition for oil market share between the Saudis and the Russians may also continue for an indeterminant period of time. Further actions and measures in response to these two major global economic upsets will likely come into play. These are early days of what is undoubtedly an evolving situation.
As always, 360 Energy customers are our first concern. We will continue to actively monitor energy market volatility and to share knowledge of the impact it is having on our customers.
