Energy Capacity Paradox

September 15, 2022

Lewis Fry Richardson was born in the UK in 1881, he was a mathematician and scientist who spent his career studying natural phenomenon. Richardson primarily focused on weather forecasting using mathematics. 

Lewis was also a devout Quaker and pacifist. He was a conscientious objector to the first World War and this stance disqualified him from working in academics during this period. Over his career the pacifist belief system had a great influence on the topics of his research.

Richardson wanted to use mathematics to calculate the probability that two countries would go to war based on the length of their shared borders. However, when conducting research for his work he noticed there was considerable variability in the measurement of borders.

The reason for this variability was coined “The Coastline Paradox.” Take for example if you used a ruler that was 200km in length and measured the coast of Great Britain. You would get a length of ~2400km. Now take a ruler of 100km and the length is 2800km.

Keep shrinking the ruler size and the coastline continues to grow. In mathematics this phenomenon is known as fractals. A never-ending pattern that keeps repeating itself at smaller and smaller scales by using a relatively simple process over and over.

In the energy industry we see a similar pattern when looking at infrastructure constraints and the capacity to move molecules and electrons to market. “What is the capacity” is probably the most loaded question in energy. The answer is always, it depends.

Take for example brining a new natural gas well to sales. Pull up a pipeline map of the U.S. and at first glance you’ll see there are pipelines everywhere. For the uninitiated they might say there is plenty of capacity. Zooming in and the answer is much different.

Moving natural gas requires a combination of capacity factors. What is the size of pipe? What is the pipe made of (poly or steel)? What is the maximum operating pressure? Is there compression available to move the product? Does it need treating?

Are there NGLs that need to be extracted to meet pipeline specifications? Is there takeaway at the downstream residue pipes? Is there fractionation capacity for the NGLs? Is the market injecting or withdrawing from storage? And so on…

Luckily for the producers of natural gas in most of the plays in the U.S. there is existing infrastructure capacity available to move the product. It may take some time and some planning, but with enough of both, you can typically move the product to market.

During the start of the shale revolution this was not the case in many of the areas where new reserves were unlocked. Tens of billions of dollars in investment capex by spent over two decades has made accessing capacity much easier today than it was in the mid 2000s. 

The question of “What is the capacity” for renewables is a harder and more nebulous one to answer than for physical molecules. As is obvious to even casual observers, the sun only shines, and the wind only blows, during certain periods of the day.

The nameplate capacity for wind and solar can be a very large (and misleading) number that is often publicized with great zeal from green energy advocates. “The capacity factor” is how much energy is produced over time vs what could be produced.

For solar and wind the capacity factor is the lowest of any energy source, typically between 10%-25%. Versus nuclear energy, which has the highest capacity factor of any energy source at close to 90%.

If there was an energy storage solution for electricity as cost effective and easy as there is for say natural gas or coal, then the issues around capacity for renewables would be significantly reduced.

Given that we have had decades of investment in battery technology, and little progress to show for it, it is unlikely that we are close to solving this problem anytime soon. Physics is master over the world of energy, you can’t cheat it.

Tesla’s new Megapack battery system is an example of how the problems facing grid scale battery solutions are continuing to mount.

Last year Tesla listed the price on the new Megapack for 10 units at $9,999,290 ($327.87 per kWh). One year later and Tesla has increased the price of these units to $16,048,230 ($412, 37 per kWh). That’s a 60% increase in price!

It is not just battery storage issues that impact the “capacity” of renewables. The lag in transmission buildout is a problem that has no easy near term solutions in sight.

Unlike the free market solutions that solved many of the shale revolution’s capacity takeaway issues, the ultra-regulated electrical grid has been struggling to keep up with the rapid increase in renewable power generation plants.

When moving molecules there is typically stable supply source that needs to be moved from point A to point B. When moving electricity generated from renewable power sources to demand centers, this problem multiplies in complexity because of the intermittent nature of the energy supply.

Compounding this issue is the continued opposition from environmental groups that are working to block many of the needed transmission projects. Capital investment in transmission projects increased by $17.7 billion in 2013 to $22.4 billion in 2019, but miles of transmission completed actually decreased during that same period.

So next time you hear someone use the word “capacity” when discussing energy, just know that the topic is more complex than it sounds. Like in the coastline paradox, the smaller and more detailed unit of measurement used, will give a longer and more complicated answer to the question.

Market Update

Crude Oil

The prompt month contract is off ~$3.34 so far on the day to $85.00, giving back all of yesterday’s rally and then some as a U.S. rail union reached a tentative agreement with its workers, avoiding a potentially disastrous rail strike.          

Permian crude is expected to set a new production record in October of 5.4 mm bbls per day.  Texas also reported a 25% increase in tax revenue for 2022 while O&G tax revenue was up 80% compared to the prior year. 

China extended the Covid lockdown in Chengdu.  The lockdown led to a sharp selloff of crude oil futures and the uncertainty has the market on edge.  China is the largest crude importer in the world and has the ability to swing the oil markets with a sharp decline of demand.

Europe is expected to ban Russian crude oil imports starting in December.  However, Europe has continue to increase the amount of crude imports month over month.  The first half of September, Europe imported to 1.2 mm bbls per day from Russia, which is 200,000 per day higher than the August average.   The short term increase in imports is concerning and makes the December deadline seem unattainable.   

The EIA Petroleum Status Report for the week ending September 9th, 2022 was released on Wednesday, and showed another crude build (+2.4mm bbls), adding to the +8.9 mm bbls from the previous week.  Cushing storage showed a slight decrease again, down 0.2mm bbls to 24.6mm bbls, which is more than half of what it was two years ago (54.3mm bbls) during the heart of the pandemic.  Refinery run rates ticked up to 91.5% utilization and crude production kept flat at 12.1mm bpd.  Crude imports dropped 1.0mm bpd compared to same period last week. 

www.eia.gov/petroleum/supply/weekly 

Rig Count Update:

The U.S. O&G rig count increased three on the week to 871, as did the Permian Basin (347). Overall oil rigs dropped four to 662 with Nat Gas rigs picking up seven for a total of 209. For the other major basins, the SCOOP+STACK, Marcellus, Haynesville, and Utica all picked up a single rig, with the Eagle Ford and Bakken dropping two and one rig, respectively. The DJ Basin kept flat on the week.

Natural Gas

After opening the week just over $8.00, Natural Gas prices shot over the $9 mark by mid-week as talks of a railroad strike added more volatility to the market. This morning’s early trading has prices still hovering just above $9 as the railroad strike looks to be averted for the time being. While a strike would put heavy demand on Natural Gas, look for it to be monitored closely in the coming days. Keep an eye on two tropical storms that could make their way into the Atlantic. Germany looks to be filling storage at a higher pace as tensions continue over the threat of Russian supply cuts and crude price caps. Look for winter weather to drive the impact on prices as early winter weather could drive European dependency on Russia. October prices look to continue the bullish structure as railroad negotiations, tropical weather and Russian threats will be monitored closely.     

Prices in the Midcon have rallied this week. With a $.30 climb at Henry Hub, the biggest movements were seen in the Midcon producing region with Southern Star increasing over $.50. Overall demand looks to decrease in the next few days before forecasted volumes show an increase to 14.6 Bcf by late next week according to S&P Global Commodity Insights. Midcon regional pricing has ANR-OK coming in $.78 off Henry Hub at $7.91 while NGPL-Midcon is $.84 back at $7.85. The winter strip (Nov 22-Mar 23) for Chicago city-gates is holding strong at a 40-cent premium over the Henry Hub strip.

The EIA released storage numbers this morning, coming in at 2,771 Bcf, representing a net +77 Bcf increase from the previous week. This increase was slightly above marketplace expectations of +70 Stocks were 223 Bcf higher this time last year, however, this week’s levels are still within the 5 yr. historical range of 3,125 Bcf.

Natural Gas Liquids (NGLs)

Mont Belvieu and Conway products were mixed Wednesday compared to the same time last week – Propane in both markets was flat, N. Gasolines were up 6% and 4%, respectively, and all other products were lower by a range of 2-7%, with Conway Ethane the biggest loser at 7%.  Given the rebound in crude prices compared to last week, all products as a % of WTI were lower on the week.  Propane prices have held ground on the week, despite a surprisingly large build in inventories.  The EIA had released a forecast of 1.5-2.5mm bbl build, well short of the 3.76mm bbl increase reported.      

Talk Energy Podcast

This episode we had two guests on, Calvin Froedge the founder of Marhelm, a shipping analytics company, and Kumar aka @datatrade on Twitter.

Both guys consistently put out insightful takes on the markets and I highly I recommend giving them a follow on Twitter if you’re on the platform.

This episode we discuss the global economy and what Calvin is seeing going on in the world of shipping. His Marhelm platform gives his clients a unique view into the lifeblood of the global economy by analyzing the shipping trends around the world.

We also get Kumar’s unique perspective on marco trends in energy, technology and culture. Kumar is an engineer but also has strong background in tactical marketing.

We dive into energy topics, the global macro economy, Bitcoin, and various other topical trends. You don’t want to miss this one.

Hope you enjoy the show!

ANCOVA DISCLAIMER: The opinions expressed in this report are based on information which Ancova believes is reliable; however, Ancova does not represent or warrant its accuracy. These opinions represent the views of Ancova as of the date of this report. These opinions may be subject to change without notice and Ancova will not be responsible for any consequences associated with reliance on any statement or opinion contained in this report. This report should not be considered as an offer or solicitation to buy or sell any securities.