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The threat of a wider Middle East war is increasing. Over the past weekend, Iran attacked Israel with missiles and drones in retaliation for Israel’s suspected strike on Iran’s embassy in Syria. This week, our guest, Raoul LeBlanc, Vice President, Energy, S&P Global Commodity Insights, explains why oil prices have increased over the past few months, including the impact of the growing conflict in the Middle East, OPEC+, and US shale oil growth. 

Jackie and Peter also asked Raoul about recent research by Prof. Robert Howarth from Cornell University. The paper, which has not yet been peer-reviewed, concludes that US LNG could be comparable to, or even worse than, coal from a GHG emissions perspective when methane leaking is considered. A BNN article reported that Howarth’s paper influenced President Biden’s pause on LNG approvals.  

Finally, Raoul explains the drivers for US oil and gas producers’ recent mergers and acquisitions (M&A) and if this trend could come to Canada. 

Content referenced in this podcast:  

• How One Scientist Influenced Biden’s Pause on LNG Approvals (BNN Bloomberg, Feb 29, 2024) 
  
• The Greenhouse Gas Footprint of Liquefied Natural Gas (LNG) Exported from the United States by Robert W. Howarth, Department of Ecology & Evolutionary Biology, Cornell University (version is not final and it is currently in a peer review process; original version submitted October 2023, revised version submitted March 2024) 

Please review our disclaimer at: https://www.arcenergyinstitute.com/disclaimer/    

 

Check us out on social media:   

X (Twitter): @arcenergyinst
LinkedIn: @ARC Energy Research Institute   

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Episode 237 transcript

Speaker 1:

The information and opinions presented in this ARC Energy Ideas podcast are provided for informational purposes only and are subject to the disclaimer link in the show notes.

Speaker 2:

This is the ARC Energy Ideas podcast with Peter Tertzakian and Jackie Forrest. Exploring trends that influence the energy business.

Jackie Forrest:

Welcome to the ARC Energy Ideas podcast. I’m Jackie Forrest.

Peter Tertzakian:

And I’m Peter Tertzakian. Welcome back. So, Jackie, we are recording on the eve of the federal budget.

Jackie Forrest:

Yes. So tomorrow, Tuesday, will be the budget 2024. We will talk about that next week.

Peter Tertzakian:

Yeah.

Jackie Forrest:

So next Tuesday, tune in and you’ll get our view on the Canadian budget and especially as it relates to energy.

Peter Tertzakian:

Yeah. And we don’t have any spoiler alerts in terms of knowing what’s going on, so stay tuned for that.

It is also the day after a disturbing weekend, where events in the Middle East have taken a turn for the worst. A swarm of drones and ballistic missiles were launched from Iran against Israel, and that tension escalation was already priced into a barrel of oil. Barrel of oil had gone from $75 to $85 in the span of a handful of weeks in anticipation of these escalating events.

So, the price of oil hasn’t moved, Jackie, and we’re going to talk about that, but I think the event, just in advance of the ballistic missile launches, was this seizing of a cargo ship in the Straits of Hormuz, an Israeli owned ship in the Straits of Hormuz. Prior to this, the seizing of ships has been on the Red Sea side. But the seizing of a ship right at the mouth of the Straits of Hormuz, where 20% of the world’s oil transit, I think is an understated event in terms of its potential implications because if the theater of military action and just tension in general goes over to the Straits of Hormuz, and if, for whatever reason, those Straits are blocked, it will definitely have a major impact on the price of oil. It has major impact on energy security.

I think there’s a whole other podcast where I will reiterate how vulnerable Canada is to such an event because we don’t have an SPR. We’re one of two countries, the other being Norway, in the Western World that chose not to build a Strategic Petroleum Reserve. We are extremely vulnerable, and I want to come back to that. And we’re going to be monitoring this situation very carefully.

But in terms of understanding the implications of what’s going on in the Middle East, this rise in the price of oil, we have brought on an expert, a very special guest. So, Jackie, I’ll leave it to you to introduce someone you’ve worked with.

Jackie Forrest:

Yes, we want to welcome our special guest, Raoul LeBlanc, Vice President Energy, S&P Global Commodity Insights. And I worked with Raoul prior to joining ARC, so I’m excited to have him on. He goes deeper in the analytics than anyone else I’ve met in this business, and I always learn a lot from talking with him. So welcome. And also, when we worked together, you were in Houston and now you’ve moved to Calgary.

Raoul LeBlanc:

I am a Calgarian now. That’s right.

Jackie Forrest:

Yes.

Raoul LeBlanc:

I married a Canadian woman that you also worked with, Jackie. And I’m real happy to be here. I’m loving Calgary.

Peter Tertzakian:

Great, great. Well, maybe tell us a little bit about yourself for the benefit of our audience-

Raoul LeBlanc:

Sure.

Peter Tertzakian:

… and how you came to be so passionate about oil.

Raoul LeBlanc:

It’s really kind of interesting. It was a situation of adaptation to failure maybe, but I was an English major and then I was a teacher. And then I went to graduate school with the full intent of getting into a specific program within the graduate school. And they said, “No.” Well, that’s the reason I’m here.

And so, I started looking around within the graduate school and it was an international study school, and they just started a program called Energy Environment Science and Technology. So, I was taking courses around, and I took one course on energy, and I was hooked. I was hooked for life. Because really, I’m a generalist, and to me, energy is this giant jigsaw puzzle that has technological, economic, political, social implications. And I loved that and love trying to put it together. And I feel like I dodged a bullet by not getting in the program because I would’ve been pretty unhappy, I think. And I’ve loved my job ever since. I’ve done everything from M&A at an oil company on through to machine learning, but mostly I have been a storyteller. So, trying to put the research together and convey it to very smart people who just haven’t had the time to study like I have. And so, my background as a teacher, I wound up sort of in a similar role.

Peter Tertzakian:

Wow, fantastic.

Jackie Forrest:

Yeah, different background, and that’s why I think you come at things differently. Well, lots going on today in energy, but we want to talk a bit about oil markets. As Peter talked about, oil prices are up about $10 in the past month, and he was quoting WTI Price at around 85 now. Tell us what has caused the price to strengthen. And I’m interested obviously with what’s going on in the Middle East, why didn’t price move and how much was already built into the price because of the Middle East tensions?

Raoul LeBlanc:

Right. So, when I look at the oil market, we studied it very intensely, our view for this year was, wow, the non-OPEC supply, which is quite robust, it was going to overcome a relatively weak year. As it turns out, first of all, demand is actually doing quite well, thank you very much. Okay, so demand is outperforming. And there’s this big sort of narrative out there between the IEA on the one hand and the OPEC on the other side. And it’s turned a little bit into an ideological battle in our minds because both are sort of talking, quote-unquote, “Their book,” with OPEC suggesting a very large growth in demand while the IEA has something significantly lower. And so, it looks like it’s tending toward the OPEC number right now. So, first of all, we’ve had the demand go up.

On the supply side, I think the non-OPEC supply is relatively on track. You had some problems with weather-related events in the first quarter. That took a bunch of barrels out of the market. But you got to say, OPEC, for all its dysfunction, is doing the job on holding a line on this. So, we haven’t had the kind of builds. That’s what markets really look at every week is they look at how much is going into inventories, whether it’s measurements from planes or satellites, or the US number, they look at those numbers. And the builds haven’t shown up. So, they’re doing that.

At the same time, you get a ratcheting up of these Middle East concerns. Our view has been the Israeli-Palestinian conflict, it’s a real problem because it appears intractable, right? There’s no easy solution there. And that’s a terrible thing. From an oil market point of view, it really doesn’t have much impact. And our view has been, we’re looking for a couple of things that would have an impact. Number one is Straits of Hormuz. I’m glad you brought it up, Peter. That is a physical deal that’s big. All of the Yemeni attacks on the shipping, they just rerouted things. Okay, so you take 15 days and now you have 15 days more oil at sea.

Peter Tertzakian:

To go around the Horn of Africa.

Raoul LeBlanc:

To go around the Horn of Africa, but it’s not a real loss of supply. It’s a temporary deal and they’re showing up. So, the other thing we were looking for was an attack on the Saudi loading facilities from some sort of rocket attack. If you saw physical damage there, that would be a big deal.

Peter Tertzakian:

On the Western side, on the Red Sea?

Raoul LeBlanc:

That’s right. On the Western, that’s right. On the way to the Suez Canal. So that was an area that was kind of vulnerable. So, you’re looking at that and saying, “But we haven’t really seen those.” But now this might change of course with the events of the weekend.

The other thing I’ll just point out is one thing we think was important was the Ukrainian attacks against Russian oil infrastructure. Now, so far, they’ve been targeted on refineries. But in effect, because refining capacity is tight and because of the sanctions being moderately impactful, an attack on Russian refining capacity ends up to have a deleterious effect on Russian oil exports. And that’s what people heard about.

Peter Tertzakian:

I heard of something like 700,000 barrels a day, almost. 6, 700. It’s a large number.

Raoul LeBlanc:

It’s getting up there. And the Russians have some ways, but they don’t have a lot of ways in the Russian system to move oil around. It’s not like, “Oh, we get attacked in the Black Sea and we can just shunt everything up to the Baltics.” Everything was kind of operating. There’s not a lot of optionality in that system. They’ve not built a lot of optionality, which showed up in spades of course on the gas side when they stopped selling to Europe and frankly Europe survived. And now they don’t have a place to sell a gas because they don’t have the capacity.

Peter Tertzakian:

Yeah. So, I want to come back to Jackie’s question and understand the premium that is built into a barrel of oil today, the price of a barrel of oil. So, if we contrast, say, I’ll call it world peace scenario, which seems highly unlikely, where the Ukraine situation is resolved, the Middle Eastern situation is resolved, and what the price of oil would be then versus the $85 WTI or even $90 Brent, what is the premium that is built into this geopolitical uncertainty?

Raoul LeBlanc:

Yeah, we would argue there’s not an enormous disruption built in there. It’s not as if the market is assuming that there’s going to be an all-out regional war. If there is an all-out regional war, you’ll see a very significantly higher premium.

Peter Tertzakian:

So, what you’re saying then, the discussion of the Russian situation and other situations is that the rise in the price of oil by $10, which is quite significant, is not just because of the Middle Eastern situation?

Raoul LeBlanc:

That’s right. It’s not. It’s actually due to fundamentals being pretty good. It’s not just the anticipation that something’s going to go wrong and there’s going to be a supply emergency. Because remember what’s interesting about this, and one reason I think that we’re not building in a big political premium is we have an enormous amount of spare capacity. Because of the OPEC, consistent OPEC cuts over the last couple of years, we have a lot of capacity on the sidelines that people feel could come in. Now, will OPEC bring it in? That’s a whole other question. But I think helping to restrain prices.

Now, interestingly enough, just to throw it out there, when it comes to, say, North America, one of the things that also the market is thinking about it..and I believe price formation is really critical. Because we’re all throwing around these numbers and we all have in our brains that, “Well, at this level of fundamentals, the price ought to be X or ought to be Y.” And so, part of that is based on, well, how’s the price set? And from 2013 to about 2020, I would argue the US shale, the Canadian shale to some degree, but mostly the US shale was incredibly responsive, it was elastic, price went up, and these guys went… In fact, at $55, they went, and they flooded the market. Well, we know that has changed.

Peter Tertzakian:

Much tighter market.

Raoul LeBlanc:

Much less responsive. And so, one of the interesting things here is you look at that market and you say, “Well, $85 looks really good.” We had last year when we didn’t even have $85, and the US grew by a million barrels a day. That’s a very significant number. What’s going on there? So, the US is less responsive these days. At any price, it’s going to deliver less than it would’ve in, say, 2013 to 2020 when it was going crazy. So, you have a more moderated system. The Ukraine event came along, and prices were very high. Remember they went up to 100, 110, 120. And if you look at the response of the US shale producers, you saw something really interesting. You saw a huge bifurcation between the publicly listed of companies who really stuck to their guns. And I remember I was at CERAWeek-

Peter Tertzakian:

In other words, they didn’t-

Raoul LeBlanc:

They didn’t take the bait. In their mind, they didn’t-

Peter Tertzakian:

They didn’t send the drilling rigs out?

Raoul LeBlanc:

That’s right. They didn’t send the drilling rigs. They didn’t say, “Okay, bam. We’re going crazy.” And it was really interesting because I was at CERAWeek and the US government was there. And I got to tell you, the US government was hammering these companies, “Why aren’t you doing anything?” And they said behind closed doors, “This is not our problem.”

Peter Tertzakian:

And I’ve seen this movie before.

Raoul LeBlanc:

And I’ve seen this, yes. And so, in public now, they feel like the sober one, they feel like they passed the test in 2021 and 2022 that was my high price test. I did not take the bait. I did not go for this and blow my brains out and do this. Now what is interesting is that the privates did. The privates went for it massively. In fact, if you look at the top 10, the US went from its pre-pandemic level, right? It fell off a cliff and then it worked its way back. If you compare the pre-pandemic, by the time it worked itself back, what you saw was something really interesting. Of the 10 companies that had more production last year than in 2019, so comparing two times, seven of them were private.

Peter Tertzakian:

Right.

Raoul LeBlanc:

And only three companies, only three listed companies were at their pre-pandemic level.

Peter Tertzakian:

Right.

Raoul LeBlanc:

That’s crazy.

Jackie Forrest:

Well, let’s come back to that. There’s a lot of stuff there. The demand is part of what’s helping. But what those helping is almost over two million barrels a day of OPEC plus cuts.

Raoul LeBlanc:

Right.

Jackie Forrest:

Now, OPEC makes those cuts because I think they feel confident that they’re not losing market share. Because back in 2015, and again, right, prior to COVID, OPEC got a little uncertain around that. They didn’t like the US growing too much and they flooded the market. We know even in recent memory that they can change their strategy. Last year was a bit of surprise because the US was actually producing more oil, adding more oil than people thought.

Raoul LeBlanc:

Yeah.

Jackie Forrest:

They grew over a million barrels a day. And this year most analysts expect that they are not going to grow as much, but if they do grow as much, OPEC may start to get a little uncertain about their strategy of cutting their own production only so that the US can grow and take their market share. Are you concerned by that? And I’d just be interested in your view, S&P’s view on growth this year, and why will it be less when you consider last year surprised us?

Raoul LeBlanc:

As I say, knock on wood. We were on the very high-end last year and we got a lot of pushback on our US growth estimates. We started the year saying US was going to grow very significantly. I think we’re at seven or 800 and we turned out to be right. And it was just the math that we did. It said, no, that’s the way it looks. And so, we were maybe less surprised than other people. We saw the privates, we’re able to see their activity, and so we saw that happening. Now, OPEC was waiting for a long time for the US producers to “Get religion and stop taking the bait and going forward and over producing.” And I think they have; the public producers have. I think nobody counted on the role of the privates, which was quite large. Now, one of the interesting things this year is many of those privates, especially some of the biggest ones, have now been purchased. I know we’re going to talk about M&A here later, and that’s important. And so, the question is, will they come?

Peter Tertzakian:

Purchased by public.

Raoul LeBlanc:

Purchased by publics. That’s right. And in general, one plus one is 1.8, okay, when it comes to activity and growth.

Peter Tertzakian:

Right.

Raoul LeBlanc:

I think about that to get to the bottom of things, last year we had an estimate of say seven or 800, turned out to be about a million. This year, our estimate is closer to five to 600.

Peter Tertzakian:

Right.

Raoul LeBlanc:

Now why is that? What’s interesting is, and it is a sort of thing that few people keep track of is the decline rate of the US. Now, the global base has a decline rate. If you don’t drill any new wells or don’t do anything new, most petroleum systems will decline between four and 9%. And with the exception of, of course, the Canadian oil sands, which come and decline almost zero.

Peter Tertzakian:

Per year, right?

Raoul LeBlanc:

Yeah.

Peter Tertzakian:

Per year.

Raoul LeBlanc:

Exactly.

Peter Tertzakian:

If you’re 100 million barrels a day from, you go to 96.

Raoul LeBlanc:

From January one to December 31st, you’ll be down four to 9%. The shale system, both in Canada and the US, because of these screaming decline of the individual wells, it declines by about 35%.

Peter Tertzakian:

One-third.

Raoul LeBlanc:

It’s crazy.

Peter Tertzakian:

If you’re hundred-

Raoul LeBlanc:

If you’re 100 barrels a day-

Peter Tertzakian:

A day.

Raoul LeBlanc:

You’re coming back-

Peter Tertzakian:

To 67.

Raoul LeBlanc:

Yeah, that’s right.

67 barrels a day. And so what’s interesting about that is of course, that therefore that means that about 90% of your CapEx is just to stay flat.

Peter Tertzakian:

Your investment in drilling.

Raoul LeBlanc:

Yeah.

Peter Tertzakian:

Yeah.

Raoul LeBlanc:

Is you have a massive CapEx requirement.

Peter Tertzakian:

Well, I want to come back to this discipline, this notion of discipline amongst the publics. Is it the discipline really in the hands of the CEOs who say, “Yeah, I’ve seen this movie before. I’m not taking the bait as you called it.” Or is it in the hands of the shareholders of the public companies who are basically saying, “I want half my money back, do not drill anymore. I want cash.”

Raoul LeBlanc:

So, I used to say there’s two reasons not to drill. There’s the super major reason to drill, which is, well, we have done the well economics, and the well economics don’t hold up to our rate of return on capital and we’re not going to drill this. And then there was the traditional reason for the independence was, I’m not drilling because I’m out of money. I checked my wallet and it’s empty. And that was the way he did. You spent everything you could. They’re moving a little bit towards the super major model, but like you point out, the main reason, the main driver is the valuation that the shareholders are giving them.

Peter Tertzakian:

Right.

Raoul LeBlanc:

And what you’re getting is a situation where if you look at the stock market valuation of oil and gas companies, what you see is, you can describe it in a couple of different ways. Some people say no terminal value. Most companies have a long tail of production, and they get value for that. And either investor discounting that or they feel like the risk and the cyclicality deserves a low multiple. Either way, they have incredibly low multiple, okay.

Peter Tertzakian:

Right.

Raoul LeBlanc:

Much lower than most industries. And so, what you have is CEOs engaging in an attempt to build credibility by delivering consistent returns over the cycle because they feel like that’s the problem.

Peter Tertzakian:

Right.

Raoul LeBlanc:

And so, two things. Number one is I’m going to show you that I can deliver you dividends or whatever. The other one is, my valuation is so low that I have an extra dollar that came in the door, and my best use of that dollar is to buy back a share.

Peter Tertzakian:

Mm-hmm.

Raoul LeBlanc:

If you don’t want to buy my shares and you give them a low valuation, that’s okay because I have the money. And that’s interesting to me is they have the money.

Jackie Forrest:

Well, let’s talk about that because US shale has changed a lot between that 2015 and 2020 period, the average price was $50 WTI.

Raoul LeBlanc:

Right.

Jackie Forrest:

And most people believe that that was setting the price of oil, the breakeven price for bringing on new shale oil and it would happen at $50. And obviously we saw growth in those years. But today, what would you consider to be the breakeven price for shale oil? And is that what we consider to be the floor for pricing? Is that still the price setting mechanism?

Raoul LeBlanc:

I do believe it is. Everything else is very long-term. The only entity that can provide or remove short-term barrels is OPEC because the shale can do it. And so, the question is, where will the shale do it? And it’s a great point, and the way I think about this is shale economics are still roughly the same as they were four or five years ago. What’s changed? What’s changed is this business model. The business model now says, you know what, in addition to this well returning my cost of capital, I need to deliver something probably on the order of 30% of this wells cash directly to shareholders. And so, to make my breakeven calculation, I can only use 70% of this wellbore. And so, we’ve done the numbers on that. And the point is A, a breakeven traditionally only is 50 or $52 or even $45, right? When you add that 30% shareholder premium, it turns out it raises the price by about $15. In our mind, 65 to 75 is kind of the zone where people are looking for decent well economics. And so-

Peter Tertzakian:

$65 a barrel.

Raoul LeBlanc:

$65 a barrel WTI. In our minds, if the price were to drop below that and stay there, right, then you would see people pulling back on activity because they don’t want to invest at that rate.

Jackie Forrest:

That could over the long term be the new floor?

Raoul LeBlanc:

Yeah. Exactly.

Jackie Forrest:

Right.

Raoul LeBlanc:

That is, we think there’s a soft floor at 65 where they start pulling back. And then on the upside, we think if you do go above 90, even the very disciplined folks will start to throw on rigs, or at least the margin, you’ll get more barrels. We think that’s the new band where it used to be probably 50 to 65, it’s probably something more like 65 to 90.

Jackie Forrest:

And is there any scenario that we go back to 50? Because you did say that the economics would work.

Raoul LeBlanc:

You can go back. But one of the interesting things about that is, and this is where I think astute investors made a lot of money on the pandemic, was because of this decline rate, because it is so high, it equilibrates quickly on the downside. When we dropped all those rigs, US production plummeted. Can you go back to 50? Absolutely. We could have some sort of watershed event on the economic side, right? We could have a recession and that kills demand. We could have another pandemic, all those things. But my point is that this decline rate means that equilibration happens relatively quickly on the downside.

Peter Tertzakian:

Yeah. If I can summarize and maybe try and unpack it at the same time. What you’re saying is demand is growing, and we’ve got on the supply side, two arms. One is the OPEC organization of petroleum exporting countries plus Russia, and they artificially control the market. It’s one of the most successful long-term cartels ever. On the other side, we have the US shale producers who are just in time delivery of barrels, and they are governed now largely by shareholders who now are imposing a 30% cash return. I won’t call it a tax; I’ll just say it’s almost like a fixed cost that they demand out of the barrel-

Raoul LeBlanc:

In order to give better multiple.

Peter Tertzakian:

Right, right. The vulnerability here seems to be OPEC and what happens if it falls apart. But interestingly, I’m going to sort of back up a segment. We had President Biden make a plea to the American producers, and they basically said, “No, I’m giving money back to shareholders or something like that.”

Raoul LeBlanc:

I am. Yeah.

Peter Tertzakian:

And then on the other side, we have President Biden phoning up OPEC and saying, “Crank it up because we don’t want high gasoline prices.”

Raoul LeBlanc:

Right.

Peter Tertzakian:

And so it doesn’t seem like there’s a lot of political leverage over the situation.

Raoul LeBlanc:

Well, it’s interesting because oil has clearly been repoliticized in the last three or four years.

Peter Tertzakian:

Geopoliticized, I guess.

Raoul LeBlanc:

Geopoliticized. Yeah. And politicized because you have much more direct intervention. Think about the SPR.

Peter Tertzakian:

It’s very low now.

Raoul LeBlanc:

It’s low. Now, what’s interesting about that is the Strategic Petroleum Reserve was created at a time and thought about at a time when imports from the US were dramatic, and they’re not anymore. It never changed with that time. And so, there’s a big question about, well, do we need that amount anymore? Does it make sense to hold that? It’s certainly far more in terms of days of imports than we used to have.

Peter Tertzakian:

Just for clarification for our audience, it was about, was it a year ago or a year and a half ago? The price of oil was high, and the Biden administration decided to unlock the Strategic Petroleum Reserve to keep prices low. Ultimately at the gas pump, which affects voting.

Raoul LeBlanc:

Yeah. They injected oil into the market like another source of supply.

Peter Tertzakian:

Right. And now you can’t do that anymore because you’ve depleted the Strategic Petroleum enough.

Raoul LeBlanc:

And the price is not 120 anymore.

Peter Tertzakian:

Right.

Raoul LeBlanc:

Yeah.

Peter Tertzakian:

Getting back to my point, the price of oil is somewhat hostage to the situation of what OPEC decides to do.

Raoul LeBlanc:

Right. Given the reluctance of US shale producers to produce at the drop of a hat, the balancing factor in the market and the driver of price formation has shifted back, if you will, probably, to OPEC and its effectiveness. And one viewpoint says OPEC’s never been a particularly effective regulator because there’s no supranational enforcement mechanism. If you exceed your quota, what happens to you? On the other hand, it has successfully brought off in the last couple years or particularly last year, like Jackie says, a very significant amount of oil.

Jackie Forrest:

Right. Well, I think history has shown when OPEC’s in the driver’s seat, we generally have higher prices, and it seems like that’s the situation today. As long as we don’t see big outages in OPEC countries, that could change that balance.

Well, that was fascinating. I have lots to talk about, but let’s move on because there’s a few other topics we want to cover today. And I know you’ve done some great work around carbon emissions as it relates, especially to North American production. So, we want to talk a little bit about that and contrast that with Canada. But let’s start out with what is the carbon footprint of US shale. I think many of us in Canada, we think they’re flaring like crazy in the Permian and they’re venting and that we actually are pretty low emissions, or maybe in the case of some of that they could be quite high. What’s the real situation from your work?

Raoul LeBlanc:

Well, it’s a little bit like asking what’s the shoe size of Canada. The deal is it varies a lot. So this is one of those deals where distributions matter. Distributions matter quite significantly. Now if I do talk about the average, because it is helpful to talk about the average, and we’ll talk about the flaw of averages here in a minute, but the US shale is somewhere around 15 to 20 kilograms per barrel. Now you contrast that with the oil sands, which is more like 60, 65-

Jackie Forrest:

On average.

Raoul LeBlanc:

On average.

Jackie Forrest:

And there’s a lot of range to that too.

Raoul LeBlanc:

There’s a lot of range to that too. And you say, okay, so the oil sands clearly are that… and I think if you talk to people in the oil sands, they say there’s some inherent factors in terms of what we have to do to get the oil sands out that make it that. Now it also has some advantages, which we can talk about if you want. But around, of course, the number of sites that actually emit for oil sands is far lower.

Jackie Forrest:

Yeah. And they’re not distributed over such large area.

Raoul LeBlanc:

And they’re not distributed across, in the Permian alone, we have more than 1,000 companies.

Jackie Forrest:

So that gives us the basis that although there may be some outliers, they’re actually pretty low emissions already.

Raoul LeBlanc:

They are.

Jackie Forrest:

Despite the fact they don’t have a carbon price and they don’t have… I mean, they have methane rules that are fairly new, but our methane rules kicked in many years ago and so they’re behind in terms of that, but they’re starting from a better starting point.

But I wanted to talk a little bit. There’s been media reports that this research by Robert Howarth from Cornell University apparently influenced the Biden administration in their recent announcement that they wanted to stop new LNG export permit approvals. His research is not final, it’s still under peer review, but the current draft concludes that when methane leaking is accounted for, that US LNG is comparable to coal from a greenhouse gas emissions perspective if you were to use it in a power plant. Because when you consider all that methane leaking into the atmosphere, which has a bigger impact than CO2, then the overall impact from drilling it at the well all the way to consuming it is worse.

Any thoughts on these results? This is obviously not great for the story that LNG is a clean fuel, if that is the case.

Raoul LeBlanc:

Yeah. Now it’s interesting, I’ve been doing a lot of work on this methane issue and there’s a few things that we ought to talk about. But let me just say overall our view is that it does not look as if this is comparable to coal. It is significantly better than coal. Now, I think that argument rests on this whole notion of methane leakage. And just to point out, methane leakage is a big problem in certain areas of the US infrastructure, it’s significantly less so I think in Canada, they’ve had a bit of a head start. I also feel like the oil sands have a sort of a maybe hidden gem there because methane leakage is almost no problem in the oil sands.

And when you look around the world, if you went to the COP conference parties back in November, you’d see that methane, methane, methane, this is the year of methane, methane leakage is the big issue. Why? Frankly, because it’s amenable. The most interesting thing about the methane is that we are moving from the period of… well, in general on cleaning up oil and gas emissions we’re moving in a couple of directions that are very important. A couple of transitions going on. One is moving from promises to action, we’re now deploying things. The second one is moving from estimation to measurement, and nowhere is that more important than methane.

And so, what you have is, for those of you that have better things to do with your time than study the US EPA regulations, methane generally has been estimated and reported by all the companies by using emissions factors where it says, “Okay, you have a pneumatic device out there. Well, that pneumatic device, we don’t really know how much it leaked, but we’re going to go ahead and use a particular number of assumptions, four kilograms per hour.” And so that’s what you report. And there are a lot of emissions factors and a lot of estimation. Those estimations from our analysis are probably quite low compared to the actual. But the actual is also coming down pretty fast here. And we’ve seen a lot of companies make good numbers.

So, the thing I would say, and this relates to Howarth and the whole LNG thing is, nobody knows that is the truth. The truth is, still we do not have very good numbers, rock-solid numbers on what the methane emissions are.

Jackie Forrest:

So, I think the takeaway is we don’t know because up until today there’s a lot of factors being used in estimates. But I understand with the EPA over the next several years there’s a requirement to actually move to real data and we will have the numbers to absolutely answer this question. Is that right?

Raoul LeBlanc:

That’s right. So, the EPA, the new regulations would kick in a few weeks, at least they allow for and to some degree mandate measurement and much finer granularity. The EPA data from the public point of view has been largely, in my mind, not usable because it gives… for example, for a giant company like Pioneer, it’s all in the Permian, and they basically give you three numbers. When really what we’d like to see are thousands of numbers that allow us to understand the details because the devil is in those details.

Peter Tertzakian:

So, what’s going to happen when we get this greater differentiation through true measurement of the wells and the identification of the methane leakers? Let’s start with the United States, are they going to crack down regulations?

Raoul LeBlanc

So, yeah. As you may or may not know, the EPA also has a methane fee now. It’s mattered to some degree on the economic front, but for the first time there’s going to be a penalty associated with it, assuming it comes.

Peter Tertzakian:

Methane fee is a polite term for a carbon tax, is that what it is?

Raoul LeBlanc:

Yes. I would say it’s a pollution tax, and pretty significant.

Jackie Forrest:

Yeah, so you have to pay for each ton that you release that’s methane, right?

Raoul LeBlanc:

That’s right. It starts at $900 a ton and then moves up over a three-year period to $1,500 a ton, which is somewhere between 20 and $30 per MCF. It’s quite a significant number. So if you’re paying 20 bucks per MCF for everyone that you’re leaking, that’s going to wipe out 19 that you’re not leaking if you’re only getting two bucks.

Peter Tertzakian:

If you’re only getting two bucks to begin with and you got a 20-buck tax.

Raoul LeBlanc:

That’s right. It’s very significant. And what’s interesting is our discussions suggest that the big companies are not really concerned about this because for the last two or three years they’ve been starting to measure, they have a pretty good understanding of what their emissions are. And it’s nice because the big companies are doing more about this and they’re thinking, I got this under control, I can understand the size of it. They are very worried, and a lot of little companies are very worried. People don’t realize that. But these little companies and there’re, like I say, well, in the US, there are roughly 15,000, let’s call it, operators. And a lot of them, they own three wells, and the whole deal makes $3,000 a month. If you tell me now that I got to go get a new storage tank because it’s leaking like a sieve, I’m just going to go out of business maybe. And so, there’s a lot of concern about how do we help those people to clean up and continue to run their family business, and we’ll see how that happens. But that’s where a lot of the focus is when we talk to policymakers even and to companies.

Jackie Forrest:

Well, for the first time, Americans are actually having to pay for pollution when it comes to this. So, it would be interesting to see when they get the great measurements, and there’s a cost of that significance. I think, we’ve seen it here in Canada. We don’t even have a price for methane for the last five years, it’s just been regulatory requirements and it’s already made a big difference. Alberta, I think, is down over 40% in the methane emissions over the last several years. So, because this stuff is-

Raoul LeBlanc:

We have certain companies telling us they’re down, yeah, 40, 56, sometimes even 70%.

Jackie Forrest:

In the US?

Raoul LeBlanc:

In the US.

Jackie Forrest:

Already. So that’s been all voluntary.

Raoul LeBlanc

That’s right. Yeah, that is. That’s a voluntary… And it’s generally the bigger companies who have been able to afford it, they have taken action, if you will. So anyway, we’ll see how that goes.

If I can throw out some numbers that might be interesting for your listeners. So Permian Basin, and the numbers I’m going to give you are for 2022 and for the upstream only, there’s some model numbers in there, but they’re primarily measured numbers. And gets to your point about how do you even calculate these things. But we flew over the basin. We did a data partnership, and so we have the data on flying over the basin multiple times and detecting leaks.

Jackie Forrest:

This is S&P, did this work?

Raoul LeBlanc:

Yeah, S&P. S&P did this work with a partner, Insight M. So here are the three numbers that are there, kind of interesting. Number one is if I look at the amount of methane released, well, the amount of methane released is 155 BCF, 155 billion cubic feet from the Permian-

Peter Tertzakian:

Per year.

Jackie Forrest:

In the venting.

Raoul LeBlanc:

In the venting from 2022. Which sounds like, because it’s an enormous number. Now, if I look at it in terms of basin wide gas production… it’s 2%, 2.01%. And then what’s interesting is that’s a metric that people like to throw around. It’s handy because it’s the gas that leaked versus the gas I produced. But if you use that metric, what about the oil? You’re assuming that none of that methane gets attributed to the oil. So, the second way to do it is of course energy on a BOE basis-

Peter Tertzakian:

Because gas and oil are commingled.

Raoul LeBlanc:

Oh, absolutely. And a lot of, frankly, what drives the gas production is just the oil production, right?

Peter Tertzakian:

Right.

Raoul LeBlanc:

So, if we do that, it turns to .92. So now I’m below 1% of the energy produced that I leak in terms of venting.

Then the interesting thing is everybody says, well, this is a huge revenue opportunity, 155 BCF. And if you do that math, it seems like a lot of money, but it’s .42%.

Jackie Forrest:

Of the total revenue.

Raoul LeBlanc:

Of the total revenue, yeah. So, it’s not as if, I mean, frankly, the gas price moving up by 15 cents is going to do more for you. Since gas-

Jackie Forrest:

Well, especially as gas isn’t worth too much these days.

Raoul LeBlanc:

Clearly. But those are the handy numbers, and they’re all true and they’re all the same number.

Jackie Forrest:

Yeah. Well, that 2% I think is quite a bit lower than some of the numbers that go into these reports that say that LND is-

Raoul LeBlanc:

Well, here’s what’s interesting. If I can take a little diversion. This is where it really gets weird. If I take the 2% and then I add on the midstream, it roughly doubles, so now I’m at 4%. The way that these numbers are calculated, by the way, is that the duration of the leak… if you went out on January 1st and ran a survey and you found no leaks, you went out on February 1st and you found a leak, and then you went back on March 1st and the leak had been fixed. For the EPA purposes to calculate the duration of the leak, you have to start at January 2nd. Assume the leak start January 2nd, continued all the way until February 28th. So, it’s a conservative principle, you assume that.

If you use the midpoint, which we’re doing, it obviously cuts that in half. And my point is that if you take our number at 2%, you add the midstream and then you use the conservative method for the calculation, you actually get to eight or 9%, which is 10 times the 0.9% if you do it on a BOE basis. So, the same number can be scoped and calculated in a way that even if we all agreed on that number, it would be from 0.9 to nine. It’s in order of magnitude.

Jackie Forrest:

And 0.9 would be no big deal. 9% leaking would mean-

Raoul LeBlanc:

Would be catastrophic assuming. Yeah.

Jackie Forrest:

… that this is not a great fuel.

Raoul LeBlanc:

No. Exactly, right.

Peter Tertzakian:

So clearly the thing to do is to get it to zero, then you can multiply it by anything.

Jackie Forrest:

There you go.

Raoul LeBlanc:

Actually, that’s a good point, every little bit … You’re absolutely right, Peter, it does … That’s the key, get it down.

Peter Tertzakian:

That’s the key. Well, I’m delighted to hear that the measurements going in and we actually get numbers and differentiation and identification.

Raoul LeBlanc:

That’s the key.

Jackie Forrest:

Well, it’s good to hear that we’re getting new data. We needed it yesterday.

Raoul LeBlanc:

We did.

Jackie Forrest:

But I think the gas industry and the oil industry are now recognizing that this data is really part of the social license.

Raoul LeBlanc:

They’ve actually been piloting all the new technologies because there are lots of competing technologies. None of them is perfect. They’ve been piloting those new technologies for two, three, four years, now they’re deploying them.

Jackie Forrest:

So, Raoul, you talked about the fact you were working for an oil company in M&A, so we want your opinions. The US upstream oil and gas producers have really had a robust year so far for M&A. Data from Tudor, Pickering & Holt shows that about $50 billion of deals in upstream oil and gas have been done in the United States so far this year.

In Canada, not the same situation. Very weak market, I think only about a half billion so far this year. What’s driving that M&A in the US?

Peter Tertzakian:

So, the mergers and acquisitions, which really leads to the consolidation of all the little players into big players.

Raoul LeBlanc:

Yeah, so it’s kind of interesting. I have a two-part answer here. The one is that the two mega mergers that we saw, which were Exxon buying Pioneer and Chevron buying Hess, that together was 100 billion bucks back last year, at the end of last year.

In my mind, I don’t have insider information obviously, but in my mind, those are easy calls and I think of them as CFO acquisitions. Why? Because if you look at the trading multiple of ExxonMobil versus Pioneer, or the trading multiple of Chevron versus Hess, even though Hess and Pioneer were premier companies, the multiple was so much higher that this thing is instantly accretive on day one. “I’m going to take your cash flows and get my multiple. That’s a win for my shareholders.”

Peter Tertzakian:

For the share price.

Raoul LeBlanc:

For the share price. And I get good quality inventory. I get more growth potential in a place that’s really important to me.

In the Permian Basin, look, Pioneer is the biggest player in terms of the land position. So now Exxon, frankly, I wasn’t sure that Exxon had the inventory to meet its lofty goals for the Permian. And Chevron, obviously they’re trying to get into the Guyana play, I think that’s very smart. And the Bakken position is quite nice. It’s a little bit of a giant ATM right now because I don’t know that there’s very deep inventory left. So those are CFO.

The other deals have tended to target the bigger privates, whether it’s OXY buying CrownRock, or Diamondback working with Endeavor. Those are big deals. Those are some of the people that, like I pointed out, those privates, that have been taken out. Most of the privates that have core acreage were purchased a while ago. There was a couple of big ones left. And so to me, this is about inventory management and getting a few more economies of scale.

Peter Tertzakian:

To bring cost down.

Raoul LeBlanc:

To bring cost down.

Jackie Forrest:

Or to create more well locations in the future.

Raoul LeBlanc:

You create more well locations and beef up my inventory, high grade, all the typical things that you hear.

Peter Tertzakian:

So, tell us, is this trend coming to Canada?

Raoul LeBlanc:

Well, I would argue in the oil sense that it’s already happened. You had serious consolidation. You have a handful of very large efficient players with good inventory and good operations. So in some ways, Canada’s already there. Now in the shale-

Peter Tertzakian:

Conventional

Raoul LeBlanc:

… in the conventional, and the other ones, I don’t know. Canada has a great track record of generating new companies, and then they bring them up and they get sold off. And there’s been some consolidation in there, in that patch. I don’t know that there’s going to be a whole lot more, I don’t know if there’s a big driver. You have some big players out there, they might snap up some of the other ones.

But I don’t think there’s quite the same impetus particularly in terms of inventory management. Because I got to tell you, some of the US shale plays are not in decline. They’re not the Barnett, but they also … It’s quite clear where those edges are. And all the companies have what I call the shrinking box problem, which is the number of new locations stopped growing a couple years ago. We figured out what the inventory looked like and how to do it, and now every day the company just takes one of those out and brings it on production, and then they have one less.

So, they’re in this situation where they’re removing things from the inventory box by putting them on production. At the same time, they are not putting new things in the box. And that’s a little scary for these companies. And I think generally they view themselves as, “We should have a medium-term solution. I don’t know what the very long term is like, but we’re going to be here in five to seven years, and we’ll be relevant. And so, I need to take care of inventory.” And there aren’t a whole lot of good options left.

Jackie Forrest:

Well, in Canada I think we have deeper inventory. But I want to ask you one follow-up question.

Raoul LeBlanc:

Exactly.

Jackie Forrest:

So, you said there’s two motivations. One is the buying company has a much higher multiple than the other one, and the other one has inventory that they need. Why wouldn’t American companies come to Canada? Because our multiples are even lower-

Raoul LeBlanc:

Lower.

Jackie Forrest:

… than the American company that’s equivalent. And on top of that, we have very deep inventory. Do you think that’s a potential? Now, we’ve actually seen the opposite over the last several years of American companies leaving Canada, so that would be quite a reversal in trends.

Raoul LeBlanc:

It’s interesting. I’ll just point out two viewpoints. I have one investor that I regularly talk to in the US, and he says, “I have never lost money in Canada. It’s fantastic.” On the other hand, when I worked at Anadarko and I worked in M&A, we had an acquisition in Canada and we entitled the presentation Bob’s Dead Body, because at that point, Bob Allison, the CEO, said, “We’ll go back into Canada over my dead body.”

So, there’s a little bit of a history of people getting into Canada and feeling like it’s a difficult place to do business as an American company and, it’s hard for me to make money. And so I think both those things can be true. I think there are obviously select places that you go, select investments that could be quite good. I don’t expect people to wholesale come up into Canada. As an American who’s living in Canada, I think sometimes people feel like when an American company goes into Canada has to be quite careful because often the Canadians are the only winners.

Peter Tertzakian:

Well, thank you, Raoul. I mean, this is a fascinating conversation, we could go on for another hour. But Raoul LeBlanc, Vice President of Energy, S&P Global Commodity Insights, thanks so much for joining us.

Raoul LeBlanc:

Thanks, it’s been fantastic.

Jackie Forrest:

Yeah, thanks, Raoul. And thank you to our listeners. If you like this podcast, please rate us on the app that you listen to and tell someone else about us.

Speaker 2:

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