Have the US passed peak shale?

The worm is turning for the crude oil price and American petroleum’s latest reporting season will likely announce a telling maturation of the US shale industry according to Woodside Petroleum chief executive, Peter Coleman. “The market is feeling pretty positive and we think there will be strengthening of crude prices before the end of the year,” Coleman said on Thursday after the release of Woodside’s wholly predictable but encouraging third quarter production numbers. “Oil demand is up this year by 1.6 [million barrels a day] and is expected to be up another 1.4 next year. And the US reporting season is going to be very interesting,” he recommended. “It will signal whether people are still free to chase volumes or capital preservation has started in earnest. Anadarko is first out of the blocks with that buyback. This is going to tell us how far shale has got to go, whether shale is moving from a growth phase to a value phase.”

Anadarko is one of the bigger US shale players and it is routine mentioned in dispatches as a potential bidder for synergistic parts of the onshore US portfolio that BHP Billiton is looking to slice, dice and flog. But late last month it signalled the change of mood that Coleman clearly thinks is now on in the shale business by announcing a $US2.5 billon buyback. That decision arrived only months after management pared $US300 million from this year spending budget.

The US shale revolution over the past decade or so has had a profound effect on US and global energy markets. Balance of power Having sucked up a tidal wave of debt and equity capital, the shale boom has left the US, very suddenly, a net energy importer. And that has seen a change in the balance of power in global oil markets. In late 2014, Saudi Arabia forced OPEC to shift to a volume over value strategy, effectively running up the white flag on attempts to defend the oil price. This strategy was received as an attempt to force discipline on US shale. If Coleman is right, then it could well be argued that Saudi strategy has worked even, given that the cartel, working closely with Russia, has recovered some level of supply-side discipline over the past 18 months.

The reason why the crude market is so important to Coleman and the liquid natural gas producer that he runs is that the oil sets the price for the export gas market. At least, that is the way it works right now. The global and regional LNG market has been a very stable and predictable place for pretty much all of its history. LNG remains a predominantly bi-lateral market that sees customers help finance new supply through funding and the provision of supply-side security through very long-term contracts that carry binding constraints on both the producer and the customer and that, as we said, use crude oil prices as the cornerstone of what is a very complicated pricing matrix. The reason for this is that LNG plants have always been hideously expensive things to build and the customers of the operators of these projects depend on the export gas markets to sustain their energy security. But Woodside’s global, regional and local LNG world is changing, and possibly much more rapidly than some might realise. Understanding and managing this market reformation sits as crucial to Australia’s economic future as it does to Coleman and Woodside.

As early as next year LNG could overtake metallurgical coal as Australia’s second biggest export earner as projects in Queensland, the Northern Territory and Western Australia either enter the system or complete their production ramp-ups. Short-term momentum Australia exported about 38 million tonnes of LNG last year. Export volumes are expected to top 74 million tonnes over FY19 as the east coast coal seam gas exporters and the big-wind projects to the west, like Gorgon, Wheatstone, Icthys and Shell’s novel Prelude development, all start hitting or ramping up to nameplate. By the time that those big four offshore projects hit their straps, Australia’s capacity will hit 88mtpa and, with any sort of pricing tailwinds, LNG might well be outstripping iron ore as our biggest export business.

Just for the record there, back in 2014, Woodside added a 13 per cent share of Wheatstone to its portfolio. So the recent start of production at the Chevron-operated project will increasingly add some short-term momentum to Coleman’s numbers. Woodside’s boss says that so this year the LNG market has soaked up new supply as fast as it can be introduced. “But next year is tough because there is more supply coming in,” he said. “Over the long term, well, again, things are looking pretty good. 2017 looks like being the lowest year for many for new LNG project final investment decisions. We might end up with only one new project sanctioned. So the pressure is building on the supply side. We have talked about this for a while and, right now, all the things we have kinda hoped for, they are starting to work their way through.” Back in late 2014, when oil and gas prices were tanking and a wave of new LNG supply began hitting regional spot markets, one of the clever dudes that reshaped the iron ore market predicted that the same shift to shorter, index-based pricing just had to happen in the LNG market.

Widening gap He predicted that this change would happen a whole lot faster if the then widening gap between contract and spot pricing was sustained. The theory went that if the short market was reliably cheaper than contracted volumes then Japanese utilities would start pushing for new term contracts that offered customer flexibilities and worked top price gas on its own supply and demand dynamics rather than those of the oil market. On Wednesday, Japan and India signed an agreement to co-operate in their so far individual quest to force the pace of the changes they want, which is an end to “destination clauses” that constrain where a contract customer might on-sell its gas and more flexibility in the take-or-pay arrangements. Japan is the world’s biggest LNG customer, while India’s emerging demand base has already seen it become the fourth biggest national consumer in the marketplace. And their push for change comes just months after the Japanese anti-monopoly regulator determined that destination clauses and other restrictions on shipment diversions were likely breaches of Japan’s competition laws. Now, for his part, Coleman says he sits ready to listen to any clarion call for change that results in export gas markets becoming more liquid, efficient and transparent. “But there are two sides to this street,” he said. “On destination clauses, you know, I am happy to discuss destination clauses if they are happy to discuss source clauses. I am not seeing a lot of Japanese utilities running to negotiate on the source clauses in existing contracts. This cannot be a one-way conversation.” The sourcing clauses serve to prevent contracted producers from sensible supply side flexibility. While they might vary, there effect is to prevent, say, Woodside from swapping shipment of Pluto gas with a shipment sourced from another of its production sources or from the increasing liquid spot market. While the reform train is coming, Coleman seems comfortable that progress is steady and largely anticipated by pretty much anyone in the market.