In this week’s energy industry analysis, we take a look at the recently passed infrastructure bill’s implications for the sector, proposals for carbon capture and storage projects in Canada, and the recent rise in oil prices.
Infrastructure implications
The infrastructure bill passed by the House on Nov. 5 and headed for the president’s signature on Nov. 15, formally named the Bipartisan Infrastructure Deal, carries significant implications for the energy industry including considerable investment to rebuild the electric grid, environmental remediation financing, and outlays for electric vehicle expansion and infrastructure.
Although the current version of the plan is significantly smaller than the original bill President Biden announced in March, it still represents a massive step forward in the administration’s efforts toward net-zero emissions by 2050.
In our view, though, many companies will not experience the true impact of the bill—or the associated increased investment—until the second half of 2022. We expect it will be even longer, perhaps until 2024, until we can truly understand the impact on commodity prices. This anticipated delay is due to the long list of variables in play such as the timeline of pandemic-related restrictions lifting, the return of U.S. shale production, and OPEC increasing output. In a nutshell, by the time the infrastructure bill’s provisions start to affect the energy sector, these other variables will likely have changed significantly, making it difficult to predict the long-term impact on commodity prices.
While specific impacts remain to be seen, these infrastructure investments will undoubtedly change the energy industry on a fundamental level. The deal will further incentivize clean energy, for instance, and support the overall energy transition. As the energy transition matures, companies should consider their existing product portfolios and position them to evolve along with the regulatory environment. Companies should also weigh diversification strategies involving renewable energy and/or cleaner fuel technology investments, given the incentives outlined in the bill.
Organizations should also consider how the bill may affect their human resource needs such as their ability to hire and which skill sets—especially related to advanced technologies—will be in demand. Human capital and required subject matter expertise should be carefully considered alongside strategy to shift toward advanced/digital technologies.
Carbon capture collaboration in Canada
Calgary-based Pembina Pipeline last week requested that two competing carbon capture and storage projects combine with its Alberta Carbon Grid project (which is a joint proposal from Pembina and TC Energy). If these three projects do ultimately combine, the scale of the joint effort would boost the advancement of carbon capture technology and allow for greater energy security as the global energy transition advances.
The Alberta Carbon Grid intends to use existing infrastructure owned by both Pembina and TC Energy to reduce costs by transporting carbon through spare pipelines for sequestration at a reservoir at Fort Saskatchewan. It would compete for government approval, incentives and underground sequestration space against other prominent parties: Royal Dutch Shell’s Polaris carbon capture and storage project, which is planned to be built at its Scotford Complex near Edmonton, and the Oil Sands Pathways alliance’s carbon capture proposal to achieve net zero emissions from oil sands operations.
The Pathways alliance—an entity established by Canada’s major oil sands producers in June—announced last week that is has expanded to include ConocoPhillips Canada as its sixth member. Along with Canadian Natural Resources, Cenovus Energy, Imperial Oil, MEG Energy, and Suncor Energy, the six-member alliance now represents approximately 95% of Canada’s oil sands production.
The oil sands make up a majority of Canada’s oil production, and are on track for record production of 3.5 million barrels per day (bpd) by year-end, surpassing the previous high of 3.25 million bpd set in January, as producers aim to squeeze more production out of existing assets as opposed to starting new capital projects.
Investing in carbon capture technologies will help address Canada’s energy needs and challenges, given the nation’s cold climate and size as the second-largest country by land mass. Also, as the world’s fourth-largest oil producer, prioritizing these technologies is critical to ensuring that the country is able to capitalize on one of its top resources, while supplying the world in a sustainable manner. By reducing emissions, carbon capture benefits many industries beyond fossil fuel producers, such as manufacturers and concrete producers.
Oil prices on the up and up
It’s hard to believe that oil prices have steadily been on the increase and closing in the $80s nearly every day for the last month, given the historic price crash of just 20 months ago. But, when you consider the macro fundamentals, it’s not surprising at all.
The upward price trend is a function of the global supply and demand balance. Repeated downturns over the years, coupled with pandemic-related demand destruction and now capital restraint on the part of producers have resulted in reduced investment in the projects necessary to replace reserves and maintain supplies of produced crude.
At the same time, demand recovery as many nations lift COVID-19 restrictions is underway, which directly impacts prices. As demand outpaces supply, prices trend upward. Market participants and consumers of refined products (most people in developed economies) should watch developments in a few areas in order to stay abreast of the situation:
- OPEC+ production: If OPEC+ heeds President Biden’s request to ramp up the pace of production increases, it would likely result in additional spare supply that would push prices down. However, the organization has repeatedly indicated that it plans to stick to measured increases, citing concerns that spare supplies will outpace demand as early as the first quarter of next year, given the combination of increased supply and seasonal travel demand destruction.
- U.S. Strategic Petroleum Reserve: The reserve contains 612.5 million barrels of oil as of Oct. 29, which could replace U.S. oil imports for over a year. Should Biden elect to release some of those reserves to the market in an effort to reduce prices, we can expect a temporary decrease in prices.
- COVID-19 travel bans: As the United States and other countries lift travel restrictions, the expected increase in demand associated with increased travel will push prices higher if supplies do not increase at the same pace.
- COVID-19 spikes: While case counts are coming down in some countries, they are ticking up in others. Case trends in Europe have historically predated upticks in the United States. Should there be another wave resulting in lockdowns and travel restrictions, we expect some level of demand growth destruction, resulting in lower prices.
While direct consumers of gasoline are most certainly aware that oil prices are up, outcomes of higher prices are not all bad. Excess free cash flow realized with higher commodity prices can be used to fund energy transition efforts, for instance. Additionally, with the stable increasing commodity price outlook, M&A activity has been and continues to be extremely active. Just this week Maersk Drilling and Noble Corp. announced a $3.4 billion dollar merger, and last week, Pioneer Natural Resources sold Permian acreage to Continental Resources for $3.25 billion.
Management teams should consider how the commodity price outlook affects their cost structure (power/electricity/fuel, travel costs, labor costs, etc.) and plan accordingly. Companies interested in M&A need to critically evaluate valuations and cash flow assumptions on the target assets. There are many moving pieces, and the global markets are extremely sensitive to the news cycle and market sentiment. Things can and will change often, but the above noted items are a good place to start.
