The unconventional road ahead

1. The Unconventional Road Ahead
Dan Morrison
DMI Consulting
– Actionable, Energy, Insight, and Intelligence
If a conventional road is straight…… then it only stands to reason that an Unconventional Road would
conversely be incredibly non-linear in nature by definition. In exploring the current market dynamics
with this original “line of thought” ……or better yet a …..“Non-linear line of thought”……let’s stroll down
this non-linear road of possibilities that winds through this new world of Unconventional Energy.
The common denominator from the past to the present is that hydrocarbons remain central to our
everyday life. If you don’t agree……..just try going a day without using it, touching it, using it to provide
food or shelter, and/or wearing it. The exercise sounds simple but you will quickly find yourself in the
back yard naked, hungry, and not moving very far….hopefully it is not winter either when you perform
this exercise. To put it into layman terms…..the unconventional road is winding but it generally follows
the direction of the conventional path. These basic drivers of need and demand continue to govern the
new world of “Unconventional Energy” and are especially relevant when examining the ever changing
surface tension between conventional and unconventional domestic supply and demand dynamics.
I once taught a class for a day to a room of graduate business students…..a crash course on the oil
industry in general and how it is intertwined into our history as a country and integrated into our
economy.
I started off the discussion with a set of questions.
When was oil first discovered?
Someone raised their hand and said….”In Titusville Pennsylvania in the late 1800’s.”
“That’s correct”…I replied……The discovery subsequently kicked off the first oil boom and bust cycle.
Next, I asked the class, “What was unusual about this event?”
Someone always gets the answer eventually…a young man in the back responded with a raised
hand….”it was before the car was invented.”
Correct again.
Then I finish the initial lesson off with a closer with more motivation than someone asked to come in
behind Nolan Ryan and finish off the no hitter….
What caused the first boom?
A puzzled look from the mas in the class……

2. ”It put the whaling industry virtually out of
business by providing an alternate source to
heat and light homes instead of using whale
oil. Oil was the original alternative green fuel in
many respects. Strange bead fellows to say the
least given our current age of enlightenment.”
This exercise always paves the way for
reasonable discussion of something very
important.
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Now it is time for Oil to start exiting stage left
and fade away. It is not a lonely exit as old King
Coal is already out of sight for the audience. In
this hydrocarbon game of thrones, oil is slowly relinquishing its throne as the primary source of energy
for the US……conceding its position as the primary go to energy source…….to its cleaner and greener
younger brother…”Natural Gas”.
Like Bob Dylan once
sang…..”The times…..
they are a changing”. If
you need an
example…just look at
how many power plants
were built in the past 10
years to handle the ever
increasing power needs for the US. Amazingly, 75% of the power plants built in the last 1`0 years are
designed to utilize natural gas as the primary fuel of choice. Wind energy was second….and Wind Energy
has been a very ugly second place contender to put it lightly.
The Golden Age of Polyethylene
The current expansion of Polyethylene Production in the US has been on a very steep expansion curve
for the past five years that is a direct function of the low cost natural gas here in the US and substantial
infusion of 20 billion in capital investment in plant expansions here in the US. The math is simple. The
cost of natural gas a feedstock in places like China, Brazil, and Europe is often 4X the cost as that of
natural gas here in the US. As a direct result of this plant expansion, the US has increased production by

3. more than 40% over
the past five
years….which for the
previous 25 years was
nearly a flat growth
rate. The US is on pace
to soon become the
center of critical mass
for global plastic
production as a direct
result of low cost shale
gas. Natural gas prices
continue to stay low
compared to the
global market because it is stranded here in the US unless it is turned into polyethylene or shipped out
as LNG. Despite the substantial and dramatic curtailment in actively drilling rigs…..US Natural Gas
Production continues to supply an abundance of low cost feedstock due to the sheer number of shut in
gas wells in combination with the effect the associated gas content of new liquid shale wells produce
and add to the US supply from new completions.
……..And to add to the mysterious and “non-linearity/unconventional” complexity and nature of the
current “Unconventional Bust Cycle” --- Above ground storage has increased by 100,000,000 bbls in less
than five months. To frame the picture ….that is a SURPLUS of 20% that has been purchased and added
to total storage for some economic reason driving the change in the historic storage trend over the past
30 plus years? Many think the increase is a result of traders practicing a “cash and carry strategy” where
they utilize a Contango method of storing the oil and selling a favorable future contract with a large
spread on the future contract compared to the instantaneous current spot price with an anticipation the
contract will ultimately expire. As the spread collapses back to the historic mean along a pathway that is
defined by economists as the “Normalization Process”, the original incentive for keeping an additional
20% of oil in US storage will evaporate or using a better description word – expire…….and this could
result in a massive dumping of this oil back into the overall spot market. A very dilutive situation to say

4. the least……..and the spreads have been reduced dramatically over the last couple of weeks…..so where
is the incentive for the “Contango Bubble” to stay in storage?
Figure 1 Rig Rate vs Oil Storage
Lions, Bears, and High Gravity Oil…Oh my……
A large portion of the liquids coming from these US shale assets is high API Degree oil…..borderline
condensate….which the refineries across the gulf and throughout the US are currently configured
toward a heavier and broader API spectrum of feedstock and actually have limits on the volume of high
gravity condensate crudes they can utilize with their current configurations. This becomes a very
significant factor when considering how the current export bans impact the development of this
unconventional crude domestically. I like to say Red Apples are Apples and Green Apples are
Apples…but an export ban on Apples doesn’t specify the color of the Apples….Get the point?
As the price of oil dropped below $50….. The industry started laying down rigs….. But to no avail US oil
production continues to rise and has exceeded 9 million BOPD from a low water mark of just 5 million
Largest Inventory Increase since 1982
in just four months???

5. BOPD considered the norm less than six years ago. In fact, there exists today a large backlog of wells
waiting to be fracture stimulated. Some estimates have the number of wells waiting to be completed in
excess of 3200 wells. (A backlog almost equivalent to 100 rigs working constantly for a year….or 1000
rigs working for 30 days…your choice on the visual)
Export Bans, Production Highs, and Super Inventory Levels……Where’s my cheap
gas at the pumps?
Currently, the US has export restrictions in place on oil produced in the US and as a direct result of this
policy….. the Brent/WTI price spread is substantial and without denial from any legitimate analyst limits
the efficient development of domestic US unconventional hydrocarbon reserves relative to global
conventional reserves……..and has generated an uneven playing field for domestic shale companies
against their global competitors. The strategic reasoning for keeping the export ban in place and
maintaining the status quo is that it is a matter of US national security or thought process….let foreign
oil be produced “first” for foreign global energy needs, and only provide the economic impetus for
domestic development of US reserves when the hydrocarbons will be used for domestic use and/or
domestic industrial consumption”. Originally, the policy was very benign in nature…..but who would
have guessed that any new significant refinery for gasoline related products would not be built in the US
for numerous decades’ during the time this policy was initially implemented.
Matter of fact, the refineries that were built….were mostly built elsewhere in the world where the
environmental laws were less restrictive and cheap labor was available. Refineries were simply not built
here in the US due to our domestic social and environmental risk variables (lawyers and activists) that
have impaired domestic investment into increasing and easing the constrained domestic gasoline
refining capacity problem. Personally I think, the US would greatly benefit from lower cost gasoline
…..but how do you achieve that goal when you do not have the infrastructure or functional US energy
policy to create the required nexus of change? What did we end up with in exchange? Higher gas
prices….environmental pollution somewhere beyond our borders and beyond our control and influence,
and human rights abuses following in suit.
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Excerpt: EIA
When was the last refinery built in the United
States?
http://www.eia.gov/tools/faqs/faq.cfm?id=29&t=6
Last updated: June 25, 2014

6. There were 142 operable petroleum refineries in the United States as of January 1, 2014.
The "newest" refinery in the United States began operating in 2008 in Douglas, Wyoming with
an initial capacity of 3,000 barrels per calendar day (bbl/cd). As of January 1, 2014, the facility
has 3,800 bbl/cd of capacity. However, the newest complex refinery with significant downstream
unit capacity began operating in 1977 in Garyville, Louisiana. That facility came online in 1977
with an initial atmospheric distillation unit capacity of 200,000 bbl/cd and as of January 1, 2014
had capacity of 522,000 bbl/cd.
Ground was broken in March 2013 for construction of a new refinery in Dickinson, North
Dakota. The 20,000 barrel per stream day (bbl/sd) Dakota Prairie facility is scheduled to open in
December 2014. Kinder Morgan plans to start up a 50,000 bbl/sd condensate processing facility
on the Houston ship channel by the end of 2014.
Capacity has also been added to existing refineries through upgrades or new construction. The
most recent examples include
 In 2012, Motiva upgraded its refinery in Port Arthur, Texas, making it the largest refinery
in the United States with a capacity of 600,250 bbl/cd.
 In 2009, Marathon upgraded its Garyville, Louisiana refinery. As of January 1, 2014, the
capacity (bbl/cd) is more than double its original 1977 capacity.
The newest refineries currently operating in the United States are as follow
Year
Built
First
Operated
Location
Original
Owner
Original Capacity
Bbl/cd
Current Owner
2014 Capacity
Bbl/cd
Type
2008 2008 Douglas, WY
Interline
Resources
3,000
Antelope
Refining
3,800 Simple
1998 1998 Atmore, AL Goodway 4,100 Goodway 4,100 Simple
1993 1993 Valdez, AK Petro Star 26,300 Petro Star 55,000 Simple
1991 1992 Ely, NV Petro Source 7,000 Foreland 2,000 Simple
1986 1987 North Pole, AK Petro Star 6,700 Petro Star 19,700 Simple
1985 1986
Prudhoe Bay,
AK
ARCO 12,000 ConocoPhillips 15,000 Simple
1981 1982 Thomas, OK OK Refining 10,700 Ventura 12,000 Simple
1979 1980 Wilmington, CA Huntway 5,400 Valero 6,300 Simple
1978 1979 Vicksburg, MS Ergon 10,000 Ergon 23,000 Simple
1978 1979 North Slope, AK ARCO 13,000 BP Exp AK 10,500 Simple
1978 1978 North Pole, AK
Earth
Resources
22,600 Flint Hills 126,535 Simple
1977 1978
Lake Charles,
LA
Calcasieu 6,500 Calcasieu 78,000 Simple
1976 1977 Garyville, LA Marathon 200,000 Marathon 522,000 Complex
1976 1977
Krotz Springs,
LA
Gold King 5,000 Alon 80,000 Complex
1975 1975
Corpus Christi,
TX
Saber 15,000 Valero 200,000 Complex

7. ---------------------------------------------------------------------------------------------------------
My humble suggestion is…… Either level the playing field by removing our internal tariff or apply the
tariff equally to those sending their crude into the refineries here in the US. The reality is that the US is
part of a global economy….something that was in its infancy when the policy was enacted…..and should
be taken into account given that the world economy has a more globally integrated architecture. In the
light of not having any real visible of functional energy policy….the US Congress needs to take a strong
look at updating the policy……at a bare minimum.
It is very unfortunate for JOE Average American who could really benefit from $1.75 gasoline at the
pump or for the small Mom and Pop Company whose margins thrive on lower cost gasoline and diesel
costs at the pumps. In my opinion gasoline prices will not start falling unless the following occurs:
1. Someone jumps up and starts building refineries which is not going to happen without the
appropriate economic incentives…or
2. The US allows themselves to achieve the same goal by exporting low gravity oil internationally
to other refineries internationally and allowing true global supply/demand dynamics help lower
gasoline prices, or as I think…..
3. There will soon be an emergence of micro gasoline refining technologies here domestically.
“I love capitalism. It’s like water…if it finds a pathway….it will carve a canyon. If it is beneficial in
nature….it will be a grand canyon.” – D. Morrison
Capitalism and free markets always find a solution. I think of what might emerge is the “Micro-Brewery
Era” of gasoline refining…..don’t laugh…it is very feasible and economically viable given the current
gasoline production bottlenecks, global energy spreads, regional price fluctuations and an abundance of
high gravity API crude discounted on a global BTU parity/mobility basis for feedstock. A very non-linear
future that happens to have…… not just a silver lining for the US…….but a golden lining for the US…..and
Joe Average American….and Mom and Pop to boot.
In summary, as oil prices
retreated from the $100 realm
last year and fell to the lower 40’s
this winter, starting around
October there was a massive
reduction of 50% in the rig count
that has continues to this very
day, but miraculously US
production continues to increase
from everything like lower rig
rates, work overs, and non frac’d
well back-log……..Production in
the US has never ceased
increasing since the original crisis?

8. In fact…..surface inventory has surged to historic “All time-- high water marks” …In the oil storage tanks
in Cushing, Oklahoma….all in just the past few months. I’m not saying we increased storage by 20% over
the past five years……..I’m saying storage in the US increased by 20% (100 million barrels) in just four
months. Staggering.
One would immediately think “FUTURE CORRECTION in the making”….higher supply….higher
inventory….slightly increasing demand…. A Non-linear and Unconventional market response to say the
least and a very real potential impact on oil prices over the next 5 months depending on how fast this
excess storage of 100 million barrels is discharged back into the spot markets. Therefore, I think we are
headed for a significant correction in oil prices. A few dark days on this complex road…..but it will
establish a platform for reform and change that is needed.
Figure 2. Maybe this is the New Normal? I doubt it.