We hosted a call with Dr. Leonardo Maugeri , former executive of Eni S.p.A., Italy's largest energy company. Dr. Maugeri is currently an associate with the Geopolitics of Energy Project and the Environment and Natural Resources Program at the Harvard Kennedy School's Belfer Center for Science and International Affairs. He is also executive director of the board of Vitale&Associati, an Italian investment bank, and chairman of Ironbark Investments, a U.S. based investment fund.
On a high level, Leonardo covered two major topics which are broadly misunderstood yet heated topics in the energy space currently:
- The underestimated technological advancement in oil and gas extraction from shale resources and its impact on the marginal cost of tight oil and shale gas production
- The opportunities and obstacles for U.S. participation in global LNG trade
1. Technological Advancement of Extraction From Shale Resources
- Most analysis has underestimated technological advancement in production and recovery efficiency
- Model-driven analysis in this space anchors on old information, holding rapidly changing variables static, rather than leaning on real-time, data-driven facts
The biggest mistake in consensus analysis is that it does not accurately weigh each production area within a formation. It uses a gross average for each area within a formation with each area equally weighted.
At the end of the day the lowest cost areas are by far the largest producers. For example McKenzie County, ND in Bakken makes up almost 1/3rd of the formation's production and is by far the lowest cost area with a break-even price in the $20-$30 per barrel range.
Current break-even costs (full-cycle) calculated as capital cost + operating cost + 10% hurdle rate (IRR) yielded the following breakeven prices:
- Lowest cost plays in Bakken (46% of total) have a break-even cost of less than $29/barrel
- 80% of Bakken plays have a break-even below $42/barrel
- Just 7% have a break-even price higher than $70/barrel
2. U.S. Position in Global LNG Trade
- There are many LNG projects underway globally that will bring an excess of supply online
- LNG additions that are expected to materialize have assumed much higher global LNG prices at the onset of the projects
- Australian, Canadian, and Mozambique production costs range between $15-$18/MMbtu, and this is higher than the market prices for LNG in Japan and China which are the highest priced regions in the world ($14-$16/MMbtu on average)
- The only LNG export additions that will contribute to the liquidity in the LNG global trade arena will be in the United States
- U.S. plays are the lowest cost opportunities. However, current new projects even seem uneconomical at current European and domestic prices:
- For example, the marginal cost of the Cheniere Energy LNG export terminal (first one to be approved) is approximately $3.5/MBTU
- Russia and Nigeria are still more economic and they will be able to wage a price war on the U.S., hindering our ability to tap traditional European markets.
What is OPEC’s likely reaction in the near future?
In short, formal production cuts from OPEC and/or individual production cuts from OPEC members next month at the November 27th meeting (or prior) are highly unlikely.
- OPEC countries at large underestimate the technological advancement and longevity of the non-traditional, North American plays (which would relieve incremental stress for a production cut near-term).
- The issue of overcapacity both currently and moving forward in a global slowdown has at least sparked the conversation of production cuts within OPEC negotiations, but collective agreement near-term (and at these non-threatening price levels) among member countries as to who will cut production.