In mid-2008, crude oil shocked energy markets as it reached an all-time High of $147/barrel (Bbl.) on the New York Mercantile Exchange. (See Figure 1 below.) Within four months, prices had sunk to $50 per barrel. How could this happen and what were the factors causing this level of price volatility? We will be exploring these questions in Lesson 2.
At the successful completion of this lesson, students should be able to:
This lesson will take us one week to complete. There are a number of required activities in this module. The chart below provides an overview of the activities for Lesson 2. For assignment details, refer to the location noted.
All assignments will be due Sunday, 11:59 p.m. Eastern Time.
REQUIREMENT | LOCATION | SUBMITTING YOUR WORK |
---|---|---|
Reading Assignment: Oil & Gas Basics Video Viewing Assignment: Understanding the Drilling Process Reading Assignment: Fracturing Operations | Lesson 2 Reading Assignment page | No submission |
Lesson 2 Activity: "Fundamental" Factors exercise | Lesson 2 Activity page | Submitted through the course blog |
Lesson 2 Quiz | Summary and Final tasks page | Submitted through ANGEL. |
Discussion forum participation | Course Blog | Submitted through the course blog |
If you have any questions, please post them to our Questions? discussion forum (not e-mail), located under the Communicate tab in ANGEL. The TA and I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.
Before we begin our discussion of the logistics and value chain for natural gas and crude oil, we need to have at least a cursory understanding of the “upstream” processes for the exploration, drilling, fracturing, and production of these fossil fuels. The following readings and video support this learning.
Video Viewing Assignment: Understanding the Drilling Process
The focus of this course involves the sectors of the oil and gas industry known as “midstream” and “downstream.” These occur after the exploration and production, or “upstream” processes. In this video, you will view this aspect of the energy industry and see how the drilling, completion and production of an oil and/or gas well is accomplished from start to finish. This will give you a cursory understanding of how oil and gas is developed. The midstream and downstream activities start once the oil and gas has risen to the top of the well and is ready to be produced.
Click on YouTube link to see video with closed captioning.
- Hydraulic Fracturing
- Fracturing Fluid
- Proppant
- Environmental Concerns
- Marcellus Shale Regulations
In 2008, most economists in the world recognized that we were truly a global society and all of our economies were intrinsically tied-together. Growth or recession in one region of the world could now have a ripple effect on other regions. China and India were emerging as large-scale industrial countries with vast exports of manufactured goods. Both were consuming new, higher levels of energy, and most specifically, crude oil. News of increasing crude imports by both countries sparked buying of the financial commodity contracts.
The so-called “speculators” were blamed for a lot of the price increase that year, but there was a whole new set of players who greatly influenced the market. Investment funds and private investors, both domestic and international, saw the crude market as a “safe harbor” from the ups-and-downs of the stock market and the US dollar. When the stock market fell, they bought crude oil contracts. And when it rose, they sold those same contracts. The dollar is a little more complicated. When the value of the US dollar falls relative to foreign currency, overseas investors have more “buying power,” that is, they can buy more crude with their currency than those holding US dollars. So to some extent, it is true that “traders” had a major influence on oil prices that year. But the definition of “trader” had changed from the stereotypical “day trader,” who wreaks havoc on markets, to sophisticated investors and real demand from emerging nations.
Today, the economic health of various countries still impacts the volatility in oil prices, and the US dollar and crude prices have a very high but inverse correlation. Concerns over the stability of Portugal, Ireland, Spain, and Greece (not so politely known as the “PIGS”) impact the perception of world demand for oil on a daily basis as the collapse of even one of them could create a “domino effect” across other economies. Various economic reports on growth, manufacturing, etc. are monitored continuously.
The US currently produces about 6.2 million Bbl. per day of crude oil, representing only about 51% of consumption, with the remainder coming in the form of imports. Domestic production is expected to represent 57% of demand by the end of 2012, reducing imports to 43%. The rise in domestic oil production is mostly attributed to the new, “unconventional”, sources found in shale formations. Advances in seismology (“3-D”), directional drilling (“horizontal”) and, fracturing methods (“fracking”), have made this once inaccessible resource common place today. Contrary to some beliefs, the number one source of imported crude oil in the US is not the Middle East but, Canada. Oil from tar sands in their Western Provinces is shipped via pipeline into the US.
Figure 2 illustrates the current mix of domestic/import crude and liquids while Chart 3 shows the mix of import sources. (Based upon the latest completed study by the Energy Information Agency of the US Department of Energy.)
Among the major factors influencing US crude oil prices are:
In contrast to crude oil, natural gas is almost strictly a domestic North American commodity whose price is more influenced by weather and the health of the US economy. Other factors, such as the level of US natural gas inventory, impact prices on a weekly basis. While US economic indicators, such as the stock market, employment figures, housing and, manufacturing indexes, are deemed to be indicative of demand for natural gas, global economies and the US dollar do not have much affect on pricing in this country.
Natural gas is used in more than 50% of US homes for space heating and hot water. In addition, it is the second largest source of energy for electrical generation behind coal (Figure 4) and is widely used in commercial and industrial industries. Figure 5 illustrates the break-down by consuming sector.
The main sources of natural gas supply in the US are domestic production, imports and, Liquefied Natural Gas (LNG). Canada again represents the largest source of imported natural gas, with Mexico contributing a minor amount. Additionally, there are export points into Canada and Mexico. The map in Figure 6 [4] indicates the major import/export and, LNG import points in the US.
Domestic production in the US has grown dramatically in recent years due to the same advanced technologies that have allowed crude oil production to increase: “3-D” seismology, horizontal drilling and new “fracking” methods. All contribute to successful recoveries from hard formations such as the new “shales.” Figure 7 illustrates the growth in production of the currently active shale basins in the US.
Among the major factors influencing US natural gas prices are:
As we explore pricing for crude oil and natural gas in a later lesson, we will consider the major influential factors for each and define their individual impact. We will also have a weekly discussion about the market prices for crude oil and natural gas and the factors we believe affect them.
Note: You may wish to print this page to circle each corresponding decision (bearish, bullish, neutral) as you work through the scenarios.
Read each of the factor examples and scenarios given below for crude oil and then for natural gas. For each scenario, determine whether it could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price. When you are finished with the scenarios, tally the totals to arrive at your decision to buy or sell overall for each commodity.
Crude Oil Factor Examples
Read through these factor examples to help you with the scenarios that follow.
Crude Oil Scenarios
Determine whether each scenario could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price.
Natural Gas Factor Examples
Read through these factor examples to help you with the scenarios that follow.
Natural Gas Scenarios
Determine whether each scenario could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price.
For the next several weeks, you are to find information related to each of the "factors" listed above for crude oil and natural gas. Beside each one, state whether it would lead to higher or, lower, prices. Post your findings on the course blog.
Part I: Create your Blog Entry. Begin a new entry to the EBF 301 course blog.
The blog entry should consist of two paragraphs: one for your trading decision to buy or sell crude oil, and one for your trading decision to buy or sell natural gas. You will need to post your findings in how you arrived at your decision to buy or sell for each commodity.
Part II: Read and comment on other students' blog entries. After Part I has been completed, blog entries from all students will be available. Read through entries by about 5 other students. Pick two of these students and write comments on their entries. Pick students whose entries do not already have a comment on them. If all of the entries already have comments, then pick students whose entries only have one comment on them. Also, pick students whose entries are interesting to you for any reason.
You will be graded on the quality of your participation. See the Blog Discussion Rubric [5] for specifics on how this assignment will be graded.
Now that we have examined production and consumption in the United States as well as the energy “mix,” we will focus on the fuel sources that comprise over 57% of the energy used in this country. Crude oil, with refined products, and natural gas and related natural gas liquids (NGLs) make-up this large sector.
Log onto ANGEL and complete the Lesson 2 Quiz (located in the Quizzes, Surveys, Midterm, and Final Exam folder).
You have reached the end of Lesson 2. Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there before beginning the next lesson. (To access the next lesson, use the link in the "Course Outline" menu at left.)
Links
[1] http://www.petrostrategies.org/Learning_Center/oil_and_gas_basics.htm
[2] http://www.petrostrategies.org/Learning_Center/fracturing_operations.htm
[3] http://www.eia.gov
[4] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/images/lesson02/less02_fig06.jpg
[5] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/EBF301_Discussion_Rubric.docx