The Demand Destruction & Future of Energy Pricing with Ed Hirs

Ed Hirs, Energy Fellow at the University of Houston, discusses the various moving parts behind the demand destruction of oil and measures that need to occur in response.
Ed Hirs, Energy Fellow at the University of Houston, discusses the various moving parts behind the demand destruction of oil and measures that need to occur in response. OPEC Plus was not able to stabilize pricing throughout 2019, so when the demand shock of COVID-19 arose, uncertainty and negative trends only further accelerated. Saudi Arabia has since grown tired of bearing the burden of supply cutting, and Russia is in a unique position where high oil prices benefit them financially while low prices benefit them politically in European countries, thus creating a supply war.

The return to domestic supply stability of around 90 million barrels per day is contingent upon the rate of post-COVID re-openings. Air traffic in the United States consumes 2 million barrels per day and has been temporarily removed from the market due to national shelter-in-place impositions. There will also be a mass exodus of firms from the industry due to the current overpopulated and over-leveraged conditions currently facing the energy sector.

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Ryan Morfin:                    Welcome to NON-BETA ALPHA. I’m Ryan Morfin. On today’s episode, we have energy economist, Ed Hirs, from the University of Houston to talk to us about the demand destruction that’s gone on over the last few months, as well as the future of energy prices. This is NON-BETA ALPHA. (Music). Ed, welcome to the show. Thank you for joining us today.

Ed Hirs:                             My pleasure.

Ryan Morfin:                    So, you’re an energy economist and the current landscape, current capital markets trends are really interesting from an academic pursuit, but also from a tactician standpoint. Maybe we can talk a little bit about your view on the energy landscape today, where we are and how did we end up in a place where we had negative pricing in a commodity market? If you could just talk a little bit about what happened, how did we get here?

Ed Hirs:                             I’ll be as brief as possible. Looking at the oil market, through 2019, the oil market was softening because OPEC plus was really not being able to tow the line and keeping the price up and production down. Demand was slowing across the world, led by the global trade war that the US is quite active in. Then we had a very, very warm winter, December, January, January with some warmest on record. OPEC plus met in February, the Russians and the Saudis elected to undertake the price war and things began to go south. We saw capital budgets that were being cut in 2019. They were absolutely slashed heavily in February of 2020, and then COVID hit and everybody stopped fighting and everybody stopped driving. What was a very simple one or two million barrel a day surplus into the market became a 20 to 30 million barrel a day surplus.

                                           The oil companies really wound up with a position that couldn’t push anything more out into the market. I liken it to when you fill up your car with 15 gallons of fuel, the value of that 16th gallon goes to zero in a hurry, and suddenly that happened all across the globe. Everyone had too much oil and because it’s very inelastic, the price just plummeted. We wound up in a negative situation because the asset allocation models, notice that there was a discrepancy. The price of crude as a commodity fell significantly more than the market did, or the prices of other commodities. Naive investors decided it was a good idea to buy crude. So they bought it through the easiest format or instrument, and that was an ETF. The ETFs at the time were concentrating on buying oil in the front month or the contract that’s currently being traded for delivering next month.

                                           A huge amount of money went flowing into the May contracts in April. Suddenly the owners, the ETFs as agents for the investors are stuck with contracts they have to get out of because they’re not set up to take delivery of crude oil. As they ran to the market to get out of it, the market recognized essentially a short squeeze, a short squeeze on storage and the ETFs were just bludgeoned. That’s how we wound up trading in a negative region, negative prices down to minus $37 for a contract of crude oil. This has happened before. Yes, it’s happened. We have negative natural gas prices, especially in the [Permian 00:04:27]. And we have negative electricity prices in many markets across the US, especially at night when demand is very low, the renewable energy bids into the market actually pays the grid operator to take the electricity.

                                           It’s not uncommon in commodities to have somebody have to pay to take it off your hands. I’ll probably have to pay someone to take my car off my hands at some point, but I’m not there yet. That’s what happened. The June contract traded down to $20, $22 a barrel. Currently, everything seems to be in the $30 to $40 range. For the industry, the important crisis surprise at the wellhead, and we’re still seeing very significant haircuts at the wellhead. Up in North Dakota in the backend, crude oil is trading anywhere between five and $15 a barrel at the wellhead. And West Texas, certainly the price is in the $30 range, but there are other grades of crude across Texas that are not receiving that kind of pricing.

Ryan Morfin:                    One of the questions I have is that the demand destruction that has occurred globally as a response to this pandemic, how has that changed your forward looking guidance or the supply demand fundamentals from an economist standpoint? It seems like we’re way supplied globally and will be so for some time. So what are your thoughts on that?

Ed Hirs:                             Well, we do have demand destruction, and if we were to just to get back to normal barring the air traffic, that itself is one to two million barrels a day of demand. The price elasticity of crude oil is about minus 0.047. To be very wonky, that means for 1% increase in quantity, the price has got to go down between 20% and 25%. So right now we’re significantly oversupplied and the price is going to stay soft regardless of what the Russians and the Saudis say. We need to have global GDP pickup, and we’re not there yet. To see prices get back to the 40, 50, 60 dollar range, we’re going to have to see demand pickup and the supply overhang dissipate over time.

                                           Now, the global oil market supply generally has a natural decline of three to 5% a year. The US shale place, because the shale wells put out 60% to 70% of lifetime production in the first year, have much more rapid declines. I’m expecting the US production to drop as much as two million barrels between now and this time next year, prices stay at the same level. That actually will remove a huge amount of pressure on the supply side for the global oil market. We were at about a hundred million barrels a day, pre-virus, keep in mind that 10 years ago it was about 80 million barrels a day.

Ryan Morfin:                    What’s going to take that US production off? Is it going to be just the closure of the frackers because the marginal rate is too expensive for them to continue producing? Or is it the loss curves that you had forecast and that we’ve just start to deplete those wells?

Ed Hirs:                             Yeah. It’ll be the decline curves, as these wells play out. Certainly once a well is drilled and completed, that’s quite literally a sunk cost to the operator. So any oil or gas they can get out of it is a contribution to paying down debt, returning capital to shareholders. We’re going to see many of the frackers or the shale patch producers come back online as soon as they can get to market. And at $30 to $40 a barrel, they won’t get to market. Their lifting costs are less than $10 a barrel. That will provide them with a marginal contribution to keep going, but they will not be drilling new wells this year. And because they’re not, they’re going to run off the supplies that they have in the current wells. That’s how we’re going to drop about two million barrels a day. Currently, the pre-virus production from the shale place in the US was about eight million barrels a day. So losing 25% of that over the course of the year is really, I think, a pretty conservative estimate.

Ryan Morfin:                    How has this demand destruction been impacting future supply in Russia and Saudi Arabia? There’s obviously economic hits to both of those economies. Saudi has increased their VAT because there must be some budgetary pressure on their outlook. What can you tell us about what’s the expected international supply looking like in the next year?

Ed Hirs:                             A lot of folks focus upon crude oil and natural gas as the sources of foreign exchange for both Russia and Saudi Arabia. And they’re absolutely right. These are tremendous sources of economic wealth. The Russians have a real easy way of getting around this. They can just devalue the ruble, the economy’s fairly self contained. And frankly for the Russians as a strategic player in the oil markets globally, if the price of oil goes up, that’s great for them because they accumulate more wealth. If the price of oil goes down for them, they accumulate greater influence in Europe because they can sell cheaper oil to our European allies. They achieve greater influence in the middle East because those nations typically become less stable with oil prices. So it’s a very different calculus for Russia than it is for the rest of us.

                                           The Saudis on the other hand have tremendous foreign reserves. They’ve been very unhappy to have to carry the load for all of OPEC, the other 20 odd members by reducing their production. So they’ve been very tired of basically shouldering the burden of seeding market share, not just to other members of OPEC, but to the US shale plays. Especially when they have the low cost oil, they can continue to produce oil at five, 10, 15 dollars a barrel as their high cost field, which is a waterflood. They’re even going into a shale play and using this opportunity, just like they did in 2015, to hire very experienced engineers from the US shale patch to come develop their fields in Saudi Arabia. So they’re beginning to look at this more like a corporate competitor than a national oil company and sole source for a treasury.

Ryan Morfin:                    That’s interesting to me, the Saudi Arabia is getting US engineers. Isn’t a lot of the shale and the fracking technology, isn’t that restricted from [ITAR 00:11:56] and some of the technologies aren’t able to be exported or is that no longer the case?

Ed Hirs:                             None of these things are contained in a bottle. I had an Uber driver, since I’m here in Houston for the audience, my Uber driver works in Saudi Arabia three months on, six weeks off. I was explaining how he’s over there. Frankly, we have Saudi engineers, Saudi companies here, we have Chinese companies here in Houston and all across the oil patch. They’ve been making inroads to learn how to open up their shale place for more than 10 years now. Schlumberger, Halliburton, National Oilwell, Baker Hughes, they all have offices in the major fields, not just in the US but in China and Malaysia and Saudi Arabia. It’s a global market.

                                           I think one thing everyone needs to keep in mind for the oil side of it, US max oil production is about 13 million barrels a day. And I’m not including the light liquids that some folks in the administration count, but that’s 13 million barrels a day out of a pre-virus world of a hundred million barrels. That means 87% of global production is outside the United States. It’s a huge market, it’s a big world, and there are a lot of big fines that are coming online there.

Ryan Morfin:                    So the a hundred million per day pre-virus, what did you say that was going to go down to? How do you look at the next normal supply, demand equilibrium?

Ed Hirs:                             I think what we’re looking at right now is a pandemic level of about 80 million barrels a day of demand. I expect that by the end of the year, we’ll be back to 90 million barrels a day of consumption and perhaps higher. It really depends upon how rapidly the economies open up and how rapidly we return to full transportation activities.

Ryan Morfin:                    Is the energy industry, are they expecting a second wave? Are they expecting another rolling set of, we’ll call them blackouts, shelter in place blackouts across the global economy?

Ed Hirs:                             Well, certainly some of the companies are, but that’s gazing into a crystal ball. And for many of us, the energy economy really hasn’t been hit as badly as say hotels and travel and restaurants. But it’s been very difficult, especially on the oil side. Now, the US natural gas industry has tended to stay pretty firm. In fact, has had a little strengthening, if you will, because the oil players have shut in their wells and thereby shut in their associated natural gas production. Those individual independents who produce predominantly natural gas, they’re dealing with a low natural gas price, but they still have a lot of product falling out.

Ryan Morfin:                    Yeah. What point do you think we get back to a hundred million barrels per day? Is it by the end of 2021, or you think maybe it’ll take longer to repair all this demand structure?

Ed Hirs:                             Well, I think we can get back to it by the end of 2021. It really depends on how well the governments of the G7, G11, G20 continue to manage this recession. The Federal Reserve is doing a great job. Congress has been extremely generous with aid packages. But none of that’s a replacement for getting people back to work.

Ryan Morfin:                    What do you think about the Texas? I guess, was it the Railroad Commission was looking at clamping down on Texas production? I don’t know what came of that, but is that a helpful policy to put in place, or what do you think the market’s going to just dictate how this production quotas here in Texas go?

Ed Hirs:                             Well, it was really a bit of grand standing by a couple of independents and the one commissioner who lost his bid for reelection actually in the primary, nothing the Railroad Commission could do could help this market. That’s simply because Texas produces no more than four and a half million barrels a day pre-virus. If Texas were to shut in all of its production, that would have no impact on the global market. In fact, if the Saudis and the Russians shut in all of their production, that wouldn’t have had any impact on the global market either. It seemed to be a backdoor way for some producers to try and get out of their contractual obligations to landowners, royalty owners and pipeline companies. The Railroad Commission saw through that. And quite frankly, more production was shut in by the time of the hearing. Then the Railroad Commission was asked to shut in. The same thing happened in Oklahoma. In fact, the same thing happened in North Dakota. I provided testimony for Texas and for North Dakota in those hearings.

Ryan Morfin:                    Your testimony was basically saying, Hey, listen, this doesn’t make an impact. So you’re just wasting your time. Yeah, interesting. So we’ve got all this production, over supply of oil available. Typically, lower energy prices is good for recovery. Question for you though, as some of this foreign oil has, I guess, has ceased to be imported in the last few years, there has been talk about putting restrictions on foreign oil coming into the US. Who’s having that discussion, who are the stakeholders and how do you think that plays out?

Ed Hirs:                             Going back to our academic side of things, and I work both sides, I work academic and professionally in the business, we called for an oil import restriction going back to Eisenhower’s quota of 1959 to essentially keep the US from being politically and economically dependent upon foreign producers. And even though some pundits and folks in government have said that we’re energy independent, that’s not the case. The oil that we produce from the shale plays and the lights and NGLs are not suitable for our refineries for the fuels that we need. The US refinery run is about 20 million barrels a day in a pre-virus world. The most oil we produced ever, it was 13 million barrels a day, and that was December, January. It wasn’t a great mix for our refineries. So we’re still importing six to seven million barrels a day from our trading partners.

                                           Certainly, the Canadians do a wonderful job. There’s even talk of Alberta wanting to become our 51st state, but we’re dependent upon Venezuela, to a small extent we’re dependent upon Saudi Arabia, Ghana, Nigeria, other producers to complete the mix that we need to keep our cars and trucks on the road. I don’t think the industry is going to push down the road of wanting restrictions. I don’t think it’s politically acceptable. Before we’ve made the argument on national security, Republicans and Democrats both push back and say, the one it would do is raise the price at the pump. That’s the one thing that makes sure that we are not reelected.

Ryan Morfin:                    Yeah. There’s a great paper, it’s worth reading for anybody who wants to get deeper into this about crude oil imports national security, it’s online. I think it’s worth a read. It’s a thoughtful piece. I spent a little time with it. I would take away that, it’s interesting, a lot of politicians say we are energy independent, and you’re saying that there really is a seven million barrels per day gap between refining capacity at its max and what we can historically produce internally domestically. So how are they able to say that, how are they getting away with that? Or is it just completely false, fake news from their standpoint? Or what is the thesis behind that comment that a lot of politicians like to say, we’re energy independent today?

Ed Hirs:                             I think that’s a political spin that if you’re hearing rumbling, it’s because we have a tremendous thunderstorm rolling in right now.

Ryan Morfin:                    Yup. Texas storms are famous. So as it relates to this marketplace today, I guess one of the questions I have for you is, the ETFs you mentioned earlier as a capital formation vehicle to invest in the space, the business development company loans in the space, those don’t seem to be the best vehicles to invest in to the energy space. I don’t know if that’s your opinion or not, but can you talk a little bit about what you think the forecast is? There seems to be a lot of bad debt on a lot of these producers in the US domestically. What’s your view about how this is going to play out for an over leveraged industry in the coming year or two?

Ed Hirs:                             Well, in an over leveraged industry with depressed commodities prices, we’re going to see a number of continuing bankruptcies. The Haynes and Boone bankruptcy monitor, which has been running [inaudible 00:22:13] price were first kicked off in 2014 shows just ever increasing flood of public and private companies seeking bankruptcy and reorganization. There’ll be a number of these that are done on the courthouse steps. There’ll be a number of shotgun weddings. There’ll be a number of mergers. Quite frankly, there are 151 private equity backed companies in the Permian Basin, and you don’t need a 151 CEOs and 151 CFOs. In an over leveraged environment that doesn’t make money if oil is less than $30 a barrel at the wellhead. That is very difficult. We’ve seen a lot of capital destruction. In fact, during the Railroad Commission hearings, two producers in the Basin spent a huge amount of time talking about how they destroyed capital in the shale plays.

                                           Again, that’s simply because they’re the high cost plays. I think there’s an opportunity for conventional plays and I’ve seen a couple of companies position this way to come shore up the finances of conventional players to shore up the finances and take advantage of the extremely low service company cost to go out and drill old fashioned conventional wells on the [Friohings 00:23:37]. Things that made Texas what Texas became before everyone decided that the shale plays have less risk, the CFAs and the MBAs all solved that they didn’t need a geologist because they had a shale play and this could work, but not understanding that they would need eight out of eight shale wells to work just to eke out at 10 or 15% rate of return.

                                           Whereas an old style conventional well in Texas or Louisiana, if you drill eight of those, you’re going to hit at least three to four of them. And each one pays off at 10X to 20X at current prices. The risk analysis just seemed to get lost. The risk reward profile was dismissed as everybody looked at the shale plays without keeping mind that easily 88% of the world is non-shale.

Ryan Morfin:                    The bankruptcies, there’s going to be consolidation. Is it going to be the major oil companies that come in that have the balance sheets come soup and collect them all up again? Or do you think some of the banks are going to create a new code just trying to consolidate some of the bad debt, turn the debt into equity?

Ed Hirs:                             I think we’ll see a lot of both. Some companies such as Apache, Apache had to write-off at shale plays. Fortunately, it has a huge fine in Suriname and that’s what’s going to keep the company alive, or at least some of the assets. We’ve seen the incredible implosion of Occidental, the chaste Anadarko and as an illustration, Chevron had the fiscal discipline not to chase Anadarko. Now for example, Chevron could acquire the combined companies for easily one fifth of what was bid on Anadarko. I think we’ll see some opportunistic acquisitions, but first we need to see how these independent shake out in the oil patch. A lot of them carried some form of hedging on their books, not for three years, but on average, say 18 months. When we get to August and we have the new borrowing base redeterminations from the lenders and we get a better picture of how the hedge books have held up over the year, then I think we’re going to see a lot of consolidation if prices don’t recover before then.

Ryan Morfin:                    I don’t know if you do anything in the nuclear or renewable space, but is there any changes to the coffee production mix for the US? Are you seeing more clean coal or more nuclear start to accelerate? What are some of the new technologies that you’re seeing that may be over the horizon that may shift will call production mix to some of these other types of energy production?

Ed Hirs:                             Well, nuclear is of course, a decades, multiple decades, long investment process. We have a couple of plants online in South Carolina, I believe, and they will come online. We’re not seeing any other new construction in the United States, and we’re not going to. The political environment is just too hostile. We’re seeing nuclear power expand across China and in some places through the middle East, but I don’t see a big future for nuclear. France is considering retiring its fleet and replacing it with an updated model, but that hasn’t been done yet. In the US, a lot of hope has been put forth on small modular reactors, essentially the same sorts of reactors that power our aircraft carriers and submarines today. These are well contained, would operate on a small footprint and could easily be dropped into place and then removed at the end of service life. But again, the political environment is just too hostile.

                                           We’re seeing an awful lot of renewable coming online, especially in Texas, which leads the nation with a renewable fleet. Land, and now a very rapidly expanding solar farms, solar facilities. Certainly, everything has had a slowdown due to COVID, but the renewable farms, the wind farms, the solar farms will continue, especially as we get past COVID and everybody can actually just get back together in office or out in the field. We’re seeing a lot of expanded interest in offshore wind in Texas and offshore wind along the Atlantic coast.

Ryan Morfin:                    Do you think the unit economics makes sense without the subsidies for a lot of these wind and solar projects, or from your economic analysis, is this really a subsidized policy prescription given that we do have so much coal and maybe clean coal coming globally?

Ed Hirs:                             I’m not so certain that we’ve got a lot of clean coal coming online because that’s really expensive to do. We’re seeing a lot of coal retirements across the United States. The one large clean coal facility that Southern has built in Mississippi has come in at just 4X over estimated costs. I just don’t think there’s a great future for coal, because number one, natural gas produces 54% the amount of CO2 that coal does, and natural gas is a lot easier. You don’t need people actually moving the coal, mining the coal, putting it on rail cars, and then picking up the coal ash and then trying to find some way to basically sequester the coal ash without it damaging the environment. We’ve had coal ash pond breaks in the Tennessee along the TVA and the Tennessee river several years ago. There’s a problem in Alabama right now. We had the pond with Duke power a few years ago.

                                           Coal is going to be around for a while, but eventually it will drop out of the power mix. The wind and solar, even without the subsidies is beginning to make sense because as we retire coal, as the grids become a little less reliable as we take this base load off, this is giving boosting prices for the renewables to come in. They don’t have to pay for the transmission lines in Texas. There’s been a backdoor subsidy for the wind farms out in West Texas because the public utility commission, the legislature, the public utility commission and the grid operator allow transmission companies to build lines that would otherwise be non-economic and push these costs out across every consumer in Texas.

                                           Every consumer in Texas actually is helping pay for the wind farms in West Texas. It’s a great deal. Nobody’s really complaining. At night the price of electricity goes negative for Texas most of the year. I think we’re going to continue to see that happen. The dynamics are in place, the political will is in place, and we’re seeing in different regions of the country, some sort of carbon pricing mechanism put in to place. California, Oregon, Washington, and then Reggie up in the Northeast. And as these carbon pricing cap and trade or carbon tax regimes become more entrenched, that will tilt the table more towards land, solar and of course, battery storage, which is needed to pick up the delivery of electricity when the sun is not shining or when the wind isn’t blowing.

Ryan Morfin:                    Can you talk a little bit about our energy grids today, the ability to store power, battery capacity, or storing the production of energy that we can then disseminate through the grid? And then also, some of the risks that we’re seeing, how unsafe is our national grid infrastructure, critical infrastructure from cybersecurity attacks? What are your thoughts about the cost and how we should raise money to harden those infrastructure needs?

Ed Hirs:                             Right. Well fortunately, the grid is a regulated part of the electricity markets. Generators can be non-regulated, if you will in a competitive area and local distribution companies are typically regulated. The main transmission lines are typically regulated. Every consumer pays a share out of every kilowatt to make sure we can get power from Quebec to New York, from Los Angeles to Arizona and Arizona to Los Angeles. In Texas, of course, ERCOT is an Island unto itself, but we have the transmission lines as well.

                                           The cybersecurity folks that I’ve worked with, that I’ve spoken with know that the transmission facilities are under cyber attack almost every day. Now, to a certain extent we’re insulated by the age of the grid. As I went through one of the nuclear power plants, we asked the question, how safe is this power plant from cyber attacks? And the operator looked us dead in the eye and said, “Guys, this is the best technology 1968 has to offer.” We don’t have any internet [inaudible 00:34:02], but the rest of the grid that this plant feeds into can be destabilized by a cyber attack, which of course would adjust the frequency on the grid. The nuclear plant would pick this up and then trip out.

Ryan Morfin:                    Well, similar to France retiring their nuclear fleece, how much longer do we have left in the useful life of the current grid, and when are we going to have to bite the bullet and make strategic investments back into next gen grid infrastructure?

Ed Hirs:                             We’re doing that now. We just absolutely have to. The great thing is copper doesn’t deteriorate very much. Aluminum is fine. Not to be facetious, but with every natural disaster, with every hurricane, with every forest fire, with every earthquake, there is an opportunity right there to rebuild part of the grid and the utilities are doing that. The great challenge with a regulated industry is the only way the CEOs can pick up more money is if they cut costs. This is an intrinsic arbitrage opportunity that runs counter to what the shareholders would like, runs counter to what the consumers would need. A couple of prime examples are Northeast utilities in the nineties, the operators of the millstone nuclear power plants cut costs so dramatically that it became unsafe to operate those three nuclear plants.

                                           Finally, it reached the point where the Nuclear Regulatory Commission closed some down. The company pled guilty to 27 felonies and paID the $25 million fine, but then spent one and a half billion dollars rebuilding millstone two and three. Millstone One was too hot to bring back into service. So it’s been retired. PG&E has always under spent on maintenance and capital. This has shown up with the San Bruno pipeline explosion that killed consumers and citizens because the pipe had just not been inspected for years. Then we’ve got the problem of the Canyon fire where the [arcing 00:36:30] lines came in contact with the trees that hadn’t been cut away and that sparked an incredible fire. I think more than 80 fatalities and a huge economic loss.

                                           Oroville Dam, which is the largest dam in the US with pump storage, hydroelectric all green, no one had actually taken a look at the spillway over the years and noticed that it had become weakened because the geologic foundation of the rock base was just wrong. The US is facing the challenge with infrastructure spending, not just with the grid, but with highways, with bridges. At some point we’re going to have to bite the bullet, as you said, and fix things.

Ryan Morfin:                    Well, one question I had for you is, so given the energy prices are low strategically, we have this a thing called the strategic petroleum reserve. Is it more active today, and should we be getting more active to build out more production or more storage capacity? What are your thoughts on that?

Ed Hirs:                             Well, the strategic petroleum reserve is essentially full. I think it’s maybe got 50 or 60 million barrels of capacity that we could add to. There’s an infrastructure issue with it. It needs to be updated. The reason that it sold down from the top was to take some of the capital that could be generated and spend that on renovating the pipelines, the manifolds, the headers that are required to get the oil to market in the event of an emergency. Yeah, the SPR is there as an economic reserve, it’s there as a strategic reserve for national defense. It’s really not anything more than that. It’s a passbook savings account that is locked away that maybe our great grandkids will use someday.

Ryan Morfin:                    Does China have a version of the strategic petroleum reserve? Are they stocking up in storing long-term stockpiles of energy oil?

Ed Hirs:                             Yes they are. In fact, they’ve kept up their purchases through the COVID-19. They saw an opportunity to keep buying the oil, especially these depressed prices. They pushed away a couple of cargoes that dropped the price down dramatically, but they have been doing everything they can to acquire as much oil through this downturn to fill their reserves. President Xi, a couple of weeks ago, actually said that they were looking to the future and potential military conflicts. They’re looking to build the largest blue water Navy across the globe. The only way they can project that is with a stable insecure fuel oil supply. That’s one of the reasons that they have been building their reserves.

                                           Domestically, China produces about four million barrels a day, but consumes about 14 million barrels a day in a pre-virus market. So China’s the biggest buyer in the world market today to the extent that they can top off reserves and try and find a way to increase domestic production. That’s what they’re spending their money on. They have, with the four million barrels a day, that’s essentially the same level of production that they had in 1995. They’ve not been very efficient or effective in bringing new production online.

Ryan Morfin:                    Is that strategic? Are they just saying, you know what, let’s just buy oil externally and save our reserves for later when it becomes more expensive?

Ed Hirs:                             No, that’s not. I think they’ve just been very disappointed at their abilities to bring in their natural reserves. They’ve partnered with Shell, they partnered with Exxon, they partnered with Total, Schlumberger, all of the Western oil companies to try and bring their reserves to market. They’ve just not been very successful today.

Ryan Morfin:                    Maybe you can talk a little bit about current trends and, we’ll call pipeline politics. Are there any emerging trends that we should be aware of about new pipelines or distribution flows in the coming year or two that could disrupt energy markets?

Ed Hirs:                             Well, I think we’ve got a couple going on in Europe. One is Nard Stream 2, which the US has put sanctions against European countries. Russia has now picked up the task of funding and financing the final completion to bring this line into Europe. There’s also the trans Adriatic line that’s coming from Azerbaijan through Turkey that will bring natural gas into the Southern portion of the European grid. Israel and Egypt are looking to get natural gas through the Cyprus and up into Europe as well. LNG exports across the Mediterranean are proceeding ahead. In the United States, we’ve had a lot of opposition to pipelines, Keystone XL of course, being the primary talisman of the anti-pipeline movement. Dakota access pipeline was eventually permitted and approved and it’s an operation. Keystone XL may be approved. I know the Biden campaign has said that they would stop the construction, at least at this point is still underway.

                                           Canada is looking at exporting crude to the West with a line across the Rockies, but that’s also met with opposition with Vancouver, British Columbia. Some of those dynamics are at work and just mucking up pipelines. Here in the United States, we’ve seen the cancellation of the constitution pipeline, which would’ve taken natural gas from the Marcellus in Utica into new England. New York, I think, has really just directed a law and banned fracking. I think there are seven oil wells in the entire state of New York, but as recently as several weeks ago was celebrating the fact that they had blocked the pipeline at New Jersey, and it would not get into New York.

                                           This means of course, that the folks in New York, Connecticut, and then through the rest of the Northeast are going to still be reliant upon LNG imports, and they’re going to be reliant upon dirty fuel oil to heat their homes over the winter. We’ve got two more pipelines underway, the Mountain Valley project, which would bring natural gas from West Virginia down into Virginia, and then the Atlantic coast pipeline, which is pending a Supreme Court case right now on whether or not it can cross the trail. If it can, then this pipeline will go into construction starting in the late fall of this year. It’s an eight billion dollar project, and it would bring natural gas to Virginia, the Carolinas, and eventually down to Georgia into LNG exports. But we have to wait to see what comes out of the Supreme Court hearing.

                                           Finally, there’s been an appeals court decision that has stayed a blanket permit that the Army Corps of Engineers has given to all pipeline companies, anybody transporting essentially fuel, natural gas, electricity. Anytime you cross a stream in the United States, you need a permit from the Corps of Engineers to do so. Typically, the footprint of this is not very much, I mean, it’s less than a bridge crossing the road. However, several groups have challenged the Corps of Engineers permit on a global basis. The Corps lost most recently at the appellate level. So, subsequently stopped construction on more than 1700 projects across the United States. This is a very challenging environment right now.

Ryan Morfin:                    Can you talk a little bit about some new oil fines briefly? I’ve heard that Syria has a lot of oil that has recently been discovered. The US pulled the troops back to protect the oil fields. What’s going on there, what’s going on under the ground? Why would the US pull back, leave some Fort operating basis to the Russians and Syrians, but move to protect the oil field?

Ed Hirs:                             Well, I think the US has been very cognizant of the fact that the oil fields in Syria were used by ISIS. That was a great resource for them. Armies travel on their bellies. You need some money to buy food. You need fuel and you need foreign exchange. Those oil fields we’re actually providing that to ISIS. This was a strategic issue and it was one the Obama administration had not addressed, but it’s one that the French government addressed after the attacks in France. I think at this point, we know there’s plenty of oil in Syria. We know there are huge reserves in Saudi Arabia, around Iraq, throughout the middle East. So providing some political stability and knowing who the heck is getting the proceeds from the oil sales is I think our real strategic interest in the middle East at this point.

Ryan Morfin:                    Then there’s also pipeline politics in Syria. If you stabilize it, you can build a pipeline out of Iraq and Iran straight across to the Mediterranean?

Ed Hirs:                             That’s absolutely true. That goes with everybody in the region. Azerbaijan, Kazakhstan, Turkmenistan, they’re all trying to get their resources to markets and pipes of course, are the cheapest way to do it.

Ryan Morfin:                    Another area that I’ve heard a lot about recently from just geopolitical conversations has been the Arctic. Can you talk a little bit about your view of, how far are we from drilling up there in the Arctic and why is it becoming such a contentious important issue in the Arctic from an energy policy standpoint?

Ed Hirs:                             Well, I think we’ve pretty well dropped out of doing anything with [inaudible 00:47:34] for the time being. We’ve seen the majors abandoned Alaska, Hilcorp is completing the acquisition of BP’s position in Alaska. At this point, Arctic exploration is very expensive. We know there’s oil there. We know that it’s there in large quantities. The challenge we’ve got is, is it going to still be economic to produce in 10, 20, 30, 40 years? As the world looks ahead and attempts to move towards a less carbon intensive environment, it may not make sense to undertake the risk and undertake the financial risk to go drill in the Arctic regions. That’s why we’ve seen many of the US majors or international majors really just draw back. Everybody has mappings, they have seismic, they have test wells, they have all the data required, but at $40 a barrel, it just doesn’t make sense to try to develop it.

Ryan Morfin:                    What barrel price do you think it does make sense?

Ed Hirs:                             I think we’d have to be back over a hundred dollars a barrel to go forward. And quite honestly, the world has got plenty of supply at prices less than a hundred dollars a barrel. No one really knows how much oil is available East of the euros in Russia. It’s a massive, massive nation that really has not been fully explored and certainly not fully exploited.

Ryan Morfin:                    Interesting. Well, can you give us maybe one or two trends that our viewers should watch out for in the energy markets in 2020?

Ed Hirs:                             Yes. Globally, we’ve got to look for return to GDP activity in a pre-virus world. Then we have to take a look at how this is going to be field going forward. There are anywhere between one to three billion people in the world who live with energy poverty. In other words, they don’t have fuel to cook with. They don’t have electricity and the cheap fuel, the cheap renewable energy, cheap solar, cheap [inaudible 00:49:54], and cheap oil is going to bring these villages and these populations into the 21st century. Sometimes in a matter of weeks, when you run an electrical cable to a village, economic prosperity follows, health follows. That’s going to lead to a population explosion of about another three billion people according to most estimates. That’s where the market’s going to grow.

                                           In the developed world, the United States, Europe, we’re going to be pushing towards a carbon less environment. That’s going to mean more focus upon renewable energy, more focused on grid management, blocking and tackling. There’ll be returns made there, but not great spectacular returns. In the US, I think we’re going to see continued drilling, continued oil and gas exploration, but I would look more for conventional resources with low costs. If you’re going to be in a commodity market, you want to be in the low cost provider part of that market so that you’re not spending a hundred dollars a barrel to get oil out of the ground as some producers have been in the shale plays. And of course, those guys aren’t any longer active. Fiscal discipline, the energy market is not like the tech market. You’re not going to see 100X, 200X, you’re going to have to see five, 10, 20 percent rates of return year on year, and that would be outstanding.

Ryan Morfin:                    What are some of the called silver linings you see in the US economy right now?

Ed Hirs:                             Well, certainly the fact that unemployment is 40 million and roughly 25%, it’s bad, it’s awful, but the economy, and I think generally the attitude of the country is really quite positive. There is a resilience. The George Floyd killing has been very, very challenging. It’s challenging everything about our social network. It’s challenging everything about our economic disparities. That’s an extremely good discussion, an extremely good topic to have, especially as we go into this election year. I think the campaign is going to be very robust and we pretty well see how the sides are going to play out.

Ryan Morfin:                    Real quick then, who do you think is going to win the November election?

Ed Hirs:                             I’m not going to make [inaudible 00:52:57] on that.

Ryan Morfin:                    Okay. Any good books that you’re reading right now that you’d want to recommend to our viewers?

Ed Hirs:                             Well, typically what I’ve done in my COVID time is I’ve gone back and re-read a couple of old classics. So Peachy Wood House is one. I’ve re-read key Largo with Hemingway. I’ve started about three or four others that I really haven’t been able to get into. I have two new books on the counter here, but frankly, I’ve forgotten what they are, what they’re about and why I need to read them simply because of the turmoil in the energy markets.

Ryan Morfin:                    Well, Ed, I appreciate you joining us. We’d love to invite you back in the months ahead, come back and reconnect with us as I’m sure the volatility in the dynamic pricing market that we’re in for commodities and energy is going to be a very timely discussion going forward. So, thank you so much for joining us.

Ed Hirs:                             My pleasure, Ryan. Thank you.

Ryan Morfin:                    Be well, take care. Thanks for watching NON-BETA ALPHA. Before we go, please remember to subscribe and leave us a review on our Apple podcast or YouTube channel. This is NON-BETA ALPHA, now you know. (Music).

Speaker 3:                        All price references and market forecasts correspond to the date of this recording. This podcast should not be copied, distributed, published, or reproduced in whole or in part. The information contained in this podcast does not constitute research or recommendation from NON-BETA ALPHA Inc., Wentworth Management Services, LLC, or any of their affiliates to the listener. Neither NON-BETA ALPHA Inc., Wentworth Management Services, LLC, nor any of their affiliates make any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefore, including in respect of direct, indirect or consequential loss or damage is expressly disclaimed. The views expressed in this podcast are not necessarily those of NON-BETA ALPHA Inc. or Wentworth Management Services, LLC, and NON-BETA ALPHA Inc. and Wentworth Management Services, LLC, are not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast.

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