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Many important developments have radically changed the oil and gas outlook over the past several weeks.  Prices look likely to stay high, or even rise further.
 
Iraq and Roll
 
The fast and deep advance by the forces of Islamic State of Iraq and Greater Syria or Iraq and the Levant, ISIS or ISIL for short, into Iraq has already made the London based ‘Brent’ world oil price leap up to over $110 per barrel.  To make matters worse, the regime in Baghdad may not be able to hold its own, even with American air power and other international assistance.  
 
In response to ISIS’s actions, President Obama agreed to send a small contingent of special-forces, technical specialists, aerial reconnaissance equipment, and additional armaments.
 
Prior to this year, Iraq had made strong progress toward its goal of producing over nine million barrels of oil per day.  It was approaching four million in real capacity when ISIS attacked late last year, taking the western city of Fallujah with local disgruntled Sunni Muslim insurgent assistance.  
 
Most of Iraqi capacity is in the far south and east, in and around Basra, and the rest is nearly all in the ethnic Kurd region centered in Erbil, and bordered by Kirkuk, which the locally autonomous Kurdish armed forces, called Peshmerga, have taken.  
 
One major refinery in the area, Baiji, is under siege by ISIS, but it is unlikely they would destroy it, as they would want to use its product output, and the revenue it could bring them.  Prized by both the Kurds and the central regime in Baghdad, it is important regionally, but not in a global context.
 
The International Energy Agency, among other bodies and analysts, had made the assumption that Iraqi production could continue its steady progress towards six or more million barrels per day by as soon as next year.  However, the escalating conflict has made this unlikely.  Foreign capital and expertise, both of them essential to increased production, will not be deployed in oil fields due to security issues.  
 
More Political, Security Risk Around the World
 
Aside from Iraq, Libya and Egypt are still not producing at previous levels, and Syria will not return to the markets for a long time.  The nuclear deal the western powers reached with Iran will run out shortly, and that regime has not, according to observers, complied with the full letter of previous agreements.  Potential new sanctions could not only be imposed, but be tightened, taking more oil off world markets.
 
Nigeria’s stability is in question, too.  A major exporter of crude, it is not able to effectively deal with a growing Islamist insurgency in its northern states.  While this has not come close to affecting oil producing areas, yet, it has resulted in a loss of confidence from foreign investors who are working in its oil patch.  Another African oil producing area, South Sudan, is offline, as a civil war rages.
 
Venezuela is descending into chaos, but the regime in Caracas has managed to keep a lid on the violent dissent so far this year.  But the regime has minimal cash flow to reinvest in oil production to forestall an oil production decline. This lack of infrastructure improvement will eventually lead to a reduction in production, and a boost to crude prices.
 
To this point, the reforms to the energy industry in Mexico have only brought one tentative major investor to its Gulf of Mexico fields:  Total of France.  However, it will take years for any substantial improvement to production or reserves.
 
Shocking Reduction in Estimates for Monterey Shale
 
New U.S. federal government assessments of the potential reserves of the promising Monterey Shale formation in central California were a shock.  More than 90% of the potential billions of barrels of oil equivalent gas and liquids of the geologically complex area were determined to be either nonexistent or not commercially viable.  State regulators and politicians were warming to licensing more exploratory drilling and hydraulic fracturing, perhaps even in a major Bakken-level way.  
 
However, the attractiveness of the whole oil province has now radically declined.  On the possible positive side, it could result in the state government becoming more lenient and encouraging in its approach, to entice reluctant companies to take some wildcat bets and try their luck there.  
 
Much Shale ‘Oil’ Not Really Oil at All
 
It turns out, depending on the formation, and the producer, much of the tight oil being produced from shale beds is not, after all, really oil in the normal sense at all.  As much as 40% of this production is highly volatile, light liquids more akin to what has been called ‘Natural Gas Liquids’, or ‘NGLs’, than normal crude oil. 
 
This material cannot be processed easily in most U.S. refineries, which have been configured, over the past several years, to take much heavier grades of oil from Canada, Mexico, and Venezuela.  It has been mixed in with regular crude, used as a diluent to transport Canadian oil sands bitumen, and sent by train cars, but is reaching its limit of demand, causing a discount to develop for shale-produced liquids.  There are some new refinery capacity being built to handle this material, but it will be a catch-up situation; which could cause the discount to widen.
 
Little Known Alaska Gas Pipeline Moving Ahead Fast
 
While there has been a lot of attention paid to pipeline controversies in the Lower 48 and in Canada, but lesser attention has been given to a major pipeline in Alaska, which is currently in the design stage.  This project will bring billions of cubic feet per day of natural gas from the North Slope to tidewater on the Pacific Coast. The natural gas will then be processed for liquefaction into LNG, then exported to East Asian markets.
 
This project will compete with others in Canada and the U.S. in the important, and lucrative, Chinese, Korean, and Japanese markets.  However, it still will take many billions of dollars and several years to complete, while demand in those Asian markets will continue to grow, leaving abundant demand for many suppliers to fill.
 
Canada Supreme Court Ruling Benefits First Nations, LNG, Hurts Oil Sands
 
Last week, Canada’s Supreme Court ruled that aboriginal groups, or ‘First Nations’, which have not already signed treaties with provincial or federal government bodies are assumed to have original ownership rights over their traditional lands.  While they may not have total ownership rights in the normal common law sense, they do have pre-emptive rights over major resource development or disruptive transit initiatives across these lands.
 
This has major implications for the pipeline companies intending to build or expand oil or gas pipelines from Northern Alberta (oil sands oil) and Northeast British Columbia (shale oil and liquids).  First Nations are determinedly set against the heavy-oil-bearing Northern Gateway project, and this ruling will give them the means to fight it in court.  
 
On the other hand, these same First Nations have been more equivocal, and often positive, on the gas pipelines, which will go to various Pacific ports, mainly Kitimat, in the north.  Environmental groups are opposing most new energy projects, and are fundamentally opposed to all oil sands, hydraulic fracturing, or, indeed, most any hydrocarbon development, production, or consumption.
 
With the pipeline and energy firms now compelled to deal, they could end up simply making straightforward monetary settlements, which could be very lucrative to these mostly un-populous and impoverished communities.  There are few real environmental issues with these projects, unlike with Northern Gateway, or the Kinder Morgan-owned TransMountain expansion to Burnaby from Edmonton (which may end up getting done, as it is an existing route and structure).
 
General Electric on Brink of Drastic Reduction in LNG Liquefaction Costs
 
General Electric’s energy research division is reported to be in the testing stage of a new process for the liquefaction of natural gas, which reduces the costs of making LNG by an order of magnitude, or in the neighborhood of 90%.  
 
While still in the testing stage, this breakthrough, if true, could radically reshape and restructure energy markets worldwide.  Not only will it reduce the cost of shipping LNG to Asia from North America, it could make many more projects viable all over the world.  Right now, producers take a big discount, since liquefaction and shipping can cost over $5 per million BTU, whereas pipeline gas may only get charged $1 or less per thousand miles.
 
It could also mean not just experimental, tentative, pilot-project-like efforts at use of LNG by transport fleets of trains, trucks, buses, and delivery vehicles in North America and elsewhere, but faster and more widespread deployment and demand for LNG and gas in general.  This could mean that the apparent ‘hard floor’ of more than $4 per mBTU in North America could rise.
 
U.S. Government Eases Export Restrictions
 
In a somewhat surprising move, the U.S. federal government gave approval for quantities of lightly processed oil to be exported, relieving pressure on the oversupply of light shale liquids being produced in ever-growing abundance.  These liquids are already close to being usable as-is by customers overseas, so some very simple refining not requiring full refining capacity is apparently enough to qualify for export.
 
This will also relieve some pressure on other, conventional oil and also oil sands oil producers in North America, and on refineries configured to take heavier oil, not the lighter shale liquids.
 
U.S. Federal Government Enacts Restrictions on Coal Use
 
On June 2nd, U.S. President Barack Obama and the Environmental Protection Agency announced that it would require the power sector to reduce carbon emissions by 30% below 2005 levels by 2030.
 
The major effect of this will be to radically reduce U.S. coal consumption and increase use of natural gas as a substitute, and in new power plant capacity.  While the current administration wants to encourage more use of renewable energy, energy storage of most renewables’ intermittent nature means, in practice, that gas will have to take up the supply gap.  
 
Fortunately, there is abundant gas in Canada and the U.S., and energy reforms in Mexico mean that country may eventually start becoming a net exporter rather than an importer of the commodity.
 
Russia-China Deal Impressive, on Surface
 
Russia and China signed a major deal for the export of hundreds of millions of dollars worth of natural gas from Siberian fields to the energy hungry industry in eastern China.  This deal is very important for several reasons, which is why Russia had to take a significant discount to its previous asking price.  
 
Russia is further diversifying its customer array.  Previously, Russia has been mainly dependent on Europe as their primary customer, and now with the sanctions enacted for the subverting of Eastern Ukraine and the takeover of the Crimean peninsula, Russia needed to have another outlet for its main export, and another source of money, should Europe further constrict its commercial arrangements with the Kremlin.
 
As for China, it gains another major source of supply, although it already had one significant pipeline from Russia.  This will enable China to better manage its gas supply, which has been highly dependent on Central Asian and Myanmar gas.  There is, as yet, no North American import gas available, and Qatari and other Mideast sources are expensive.  
 
Moreover, the horrible air pollution in most Chinese cities means that the country can no longer keep adding coal-fired power capacity to feed its growing economy.  The pollution is a major health hazard, and also a cause of increasing public discontent.  Gas use will grow, but only at a price acceptable to Beijing.  There has not been much news on the country’s own shale gas and liquids efforts.  The geological conditions are dissimilar to those in North America, and access to water is an issue, so production growth will be slow.
 
Energy use is expanding rapidly in China, and has, thus far, been mainly in the form of coal or oil.  The shift to gas will tend to keep a floor under prices, especially as demand for gas picks up in major consumers such as India and Indonesia.  As for Indonesia, it is only very slowly reducing price subsidies to domestic consumers of fuels, making it an artificially large importer of oil and gas.
 
Africa Wrangling Keeps Continent on Sidelines
 
Uganda has finally made a deal which will bring its new oil production to export markets via a facility on the coast of Kenya.  However, the contentious nature of the negotiations, which required the producing companies to construct an uneconomic refinery in Uganda, set a poor precedent for further exploration and exploitation in central Africa.  
 
Corruption and poor infrastructure continue to delay development in Mozambique, while logistics, royalty regime uncertainty, and other issues are slowing exploration offshore Tanzania, Namibia, and South Africa.  Production growth in Africa will be important in future, but it will only partly offset declines elsewhere in the world.
 
Conclusion:  Oil and Gas Prices Likely to Stay High
 
Aside from the potential lower costs of gas liquefaction from GE, most other energy news has been neutral or negative regarding the supply for the next several quarters, while demand for both gas and oil continue to rise, not just in North America, particularly for gas, but all around the world.  
 
Therefore, even if there is not any major armed conflict (in addition to all the current ones) in the near future, it seems unlikely that either natural gas or oil prices will decline in the near term.  The former could rise as coal recedes in use, the economy continues to slowly grow, and winter looms with storage levels below the long-term average.  With the U.S. economic expansion already tepid at best, higher energy prices will depress growth even further.
 

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