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This Week In Energy: Oil Markets Reaching a Bottom? Shell Points the Way

The major news of the week was the mega-merger between Royal Dutch Shell (NYSE: RDS.A) and BG Group (LON: BG). The $70 billion price tag of BG Group made the purchase the largest in over a decade. Why did Shell decide to pay such a steep price for BG? The deal will make the combined company the largest producer of liquefied natural gas (LNG) in the world. The move is a shot across the bow for the other oil majors as Shell is going all-in on the future of LNG as a vital source of energy, particularly for the fast growing economies in Asia. The purchase of BG is also a reminder that the oil majors are really oil and natural gas majors. BG will give Shell major LNG positions in Australia, and to a lesser extent in East Africa. By 2018, Shell will have twice the liquefaction capacity as ExxonMobil.

The momentum around the world to reduce greenhouse gas emissions makes LNG particularly attractive. Since it burns much cleaner than coal, it has the potential to significantly reduce smog in the bustling cities of China, Korea, and elsewhere. Although LNG trade has been growing relatively quickly in recent years, it has still been quite small compared to the amount of oil and coal that moves around the world. The prospect that LNG would become one of the most important global fuel sources might have seemed silly until recently. But China actually reduced its coal consumption in 2014 and its Herculean effort to rein in smog puts Shell’s purchase in perspective: coal is on its way out, and natural gas could become the second largest source of energy in the world. Efforts to reduce greenhouse gases will only increase in the coming years, further bolstering the push towards LNG. Related: Many Big Guns Still Betting On Oil Comeback In 2015

Still, the deal can also be viewed through the lens of growth. The oil majors have struggled in recent years to make big new discoveries and book new oil and gas reserves. Despite high levels of capital spending, there have been precious few giant discoveries. The path towards growth, then, for many of the largest firms is to grow through consolidation. Shell will be able to expand its oil and gas reserves by 25% from the BG deal. Nevertheless, the deal is not done yet, and Shell must overcome uncertainties from investors plus scrutiny from antitrust regulators in multiple countries.

While Shell’s LNG push will give coal executives headaches, the Sierra Club and former New York City Mayor Michael Bloomberg are posing a much more immediate threat to Big Coal’s prospects in the United States. Bloomberg announced this week a second installment of funding to Sierra Club’s “Beyond Coal” campaign, a crusade to shutter as many coal plants as possible across the country. Following the $30 million donation (which comes after a $50 million donation a few years ago), the Sierra Club announced a new goal of forcing the closure of half of U.S. coal-fired power plants by 2017, from a 2010 baseline of 523 plants. The Club had originally targeted just one-third of coal plants by 2020. The campaign underscores the increasing inhospitable environment for coal in the U.S., where the dying industry is finding it harder and harder to be heard. Related: Why The Oil Price Collapse Is U.S. Shale’s Fault

Again, to underscore the point, Shell’s big splash and Bloomberg’s donation highlight the massive opportunity for natural gas producers as they can seize market share from coal.

Meanwhile, Shell was not only newsmaker out of Europe this week. In the UK, an estimated 100 billion barrels of oil were discovered near Gatwick Airport, which services London. UK Oil & Gas Investments claims that within 15 years, the so-called Weald Basin could fuel one-third of Britain’s oil demand. If true, that would be a godsend for a country that is watching its once prolific oil fields in the North Sea rapidly run dry. The estimated 100 billion barrels would also be worth an obscene 3.7 trillion British pounds at current prices. Still there is quite a bit of skepticism about how much oil can be realistically produced from the Weald Basin. Some analysts said that only a small fraction of the reserves could be produced. Others say that the reserves in place are also overly optimistic. UK Oil & Gas saw its share price skyrocket on April 9.

Iran’s Supreme Leader threw a bit of cold water on the breakthrough deal with the P5+1 nations. Ayatollah Ali Khamenei demanded the absolute removal of sanctions immediately after a deal is agreed to, which goes against the U.S. position of a phased withdrawal. On top of that, he said that Iran would not permit foreign inspectors at Iranian military sites. “It must absolutely not be allowed for them to infiltrate into the country’s defense and security domain under the pretext of inspections,” Khamenei said, referring to inspectors from the International Atomic Energy Agency. Blocking access to key facilities for IAEA inspectors would probably be a deal breaker for the West. Related: Off-Grid Solar Threatens Utilites In The Next Decade

In his first comments since the framework agreement was reached last week, Khamenei raised significant doubts over whether or not he would allow the gap between Iran and the West to be bridged. On the other hand, an optimistic way of reading the comments would be that Khamenei was merely engaging in political theater for a domestic audience, just as the Obama administration has trumpeted the upside of the deal while downplaying the concessions it made to Iran. Khamenei may still yet allow his negotiators to sign on to a final deal, but his comments were not exactly a positive indication about his intentions.

Finally, oil prices were all over the map this week. After showing some of the strongest gains in weeks on Monday and Tuesday, WTI and Brent fell back on Wednesday after fresh data from the EIA showed a 10.9 million barrel increase to crude inventories for the week ending on April 3. That leaves crude storage at the highest level in over 80 years. The inventory build was dramatically higher than expected and crude prices crashed by nearly 7 percent. Saudi Arabia also announced that it was producing oil at a much higher rate than the markets expected. Now pumping at a record 10.3 million barrels per day, Saudi Arabia has decided to keep the pressure up on shale producers and will continue to fight for market share. Still, despite the bearish news for oil prices, U.S. production is flattening out as rigs continue to decline. Put together, oil prices will remain volatile but will probably remain within a $45-$55 range for WTI, and a $50-$60 range for Brent, at least for the next few weeks.

By Evan Kelly Of Oilprice.com

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