22/11/2016 - 08:32

Distance cuts both ways for WA gas

22/11/2016 - 08:32

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ANALYSIS: Vienna is a long way from Perth, but what might happen there on November 30 could have a profound effect on the Western Australian economy.

Distance cuts both ways for WA gas
WA’s gas sector is poised to benefit from output decisions made by Opec producers.

ANALYSIS: Vienna is a long way from Perth, but what might happen there on November 30 could have a profound effect on the Western Australian economy.

The Organisation of Petroleum Exporting Countries (Opec) is scheduled to hold a meeting in the Austrian capital at the end of the month to consider a proposal to cut oil production.

If that happens, and if Opec members stick to any cut they might be asked to make, the oil price could rise significantly, delivering a much-needed boost to WA’s second most important export industry.

A lot could go wrong at the Vienna meeting of Opec, as has happened at past meetings, but this time there is a whiff of panic in the air as members of a cartel that has effectively held the Western world to ransom, on and off, for more than 40 years face the reality of becoming irrelevant.

Multiple factors have changed the global energy industry over the past five years, and while WA’s big gas-exporting sector is exposed to the oil price (because it is oil that determines the price of gas), the latest developments in energy favour WA more than its rivals in the Middle East.

One of the biggest advantages held by WA is, ironically, a situation once regarded as a negative – gas-prone geology.

Back in the 1950s and 1960s, when oil and gas were first discovered in the state’s north-west, the high levels of gas and small pools of oil were regarded as a curse because the world wanted oil and WA’s gas was tagged ‘the loneliest gas in the world’.

Loneliness, or the tyranny of distance, which has always added to the cost in doing business in WA, has been largely overcome by the development of technologies to produce liquefied natural gas (LNG), which is lower in heating value than oil but far less polluting when burned.

What was once a negative has morphed into a positive, with oil now under pressure (along with coal) because of its role in producing climate-changing carbon dioxide.

Gas, once difficult to get from remote locations to major population centres except by pipeline, has become the go-to fuel – widely seen as a half-way house between oil and renewables such as solar and wind energy.

The problem for Opec members is that they have become over-reliant on oil exports, while also assuming that the price could never stay low for long due to the belief in ‘peak oil’, the theory that oil production would eventually peak, and then decline sharply.

Today, that theory (like WA’s gas-prone geology) has been flipped. Peak oil is no longer a theory about production peaking, it’s about demand peaking as the world weans itself off an oil-rich diet onto more efficient use of fuels amid the rise of competitive energy sources.

Opec has acknowledged the problem of ‘peak demand’ but its executives believe the day of declining demand is at least 20 years away.

Big oil companies such as Royal Dutch Shell are more confident of peak demand arriving a lot quicker than that, with the turn from growth to shrinkage perhaps just five years away.

Shell is one of the oil majors putting its money where its beliefs are, investing heavily in gasfield development and new gas production technologies as it prepares for the market changeover.

First shifts in the oil market started in the US, with technology developments enabling the extraction of oil from rocks such as shale once regarded as too tightly-packed to release any hydrocarbons – a term that covers oil and gas.

I first encountered shale oil when attending the North Texas Oil and Gas Association annual conference in Wichita Falls 10 years ago. There was talk at that event about evolving technologies, which would enable massive but undeveloped beds of oil-rich shale to be brought into production.

Not many people at the conference took much notice back then of what has become known as the shale oil industry, though one researcher at Houston’s Rice University did, and she produced a devastating document that predicted everything that has happened to the oil industry during the past few years.

Amy Myers Jaffe, a post-graduate researcher at the Rice’s Baker Institute, forecast that shale oil would ‘rock the world’ because it would lead to the development of an entirely new source of oil and gas, which would flood markets and destabilise governments in the Middle East as well as threaten the future of Opec.

Everything Ms Jaffe predicted has come true, with the US reclaiming its role as one of the world’s biggest oil and gas producers, as well as an exporter, while countries in the Middle East have been thrown into turmoil.

The next chapter in this evolving energy-industry picture should become even more favourable for WA thanks to its reputation as a reliable supplier far from the war zones of the Middle East and the instability that could come if oil prices stay low.

Government ministers from Opec-member countries are acutely aware of the crisis brewing in their economies, thanks to the oil price plunge from more than $US100 a barrel just over two years ago to its current $US47/bbl.

Even the world’s biggest oil producer, Saudi Arabia, is feeling a squeeze on its budget with social services being cut back as the government is forced to raise money in debt markets for the first time in decades.

Saudi Arabia needs is an oil price of around $US70/bbl to balance its budget, and a first step towards that price target will be the cutbacks to be considered in Vienna at the end of the month.

Whether Opec members get their higher-price or not, WA’s gas-export industry should be a winner because: either it benefits from a boost to the oil price flowing through into gas prices; or its attraction as a source of energy separate from the Middle East ensures strong long-term demand.

The jury is out on global energy markets as to whether Opec members will agree to production cuts, or perhaps a freeze at current levels of output, to deliver a pre-Christmas boost to the oil price, or a longer-term rise during 2017.

The cash squeeze that is starting to ignite social instability in Opec countries such as Venezuela is the biggest single factor supporting an agreement on production cuts.

But there is also a realisation inside Opec that any cut might have a minimal effect on oil, because mothballed US shale-oil producers will move quickly to restore output as the price rises (with a side issue being that there is a history of OPEC members cheating on promised cuts to sneak a bit of extra revenue).

Those issues arise even before consideration is given to the proxy wars involving Opec members in the Middle East, such as that being fought between Saudi Arabia-backed forces and those with Iranian support in Yemen.

Countries that are effectively at war are unlikely to trust each other with oil production cuts, or even agree on how to measure any cut.

What’s evolving in the energy industry, whether higher oil and gas prices or more Middle East conflict, is working in WA’s favour.

Last year, WA’s oil and gas production (at a time of low prices) was valued at $16.2 billion, eclipsing gold at $10 billion but well short of iron ore at $48.4 billion.

With the Gorgon LNG project steadily expanding output and the Wheatstone LNG project expected to make its first shipments in the middle of next year, it is easy to see WA’s oil and gas industry clearing the $20 billion mark.

Whether that value-of-sales milestone is passed next year, or in 2018, depends on what happens in Vienna the next few days.

 

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