Russia’s invasion of Ukraine dumped a large turnip of uncertainty into the punch bowl of oil and gas market projections, but analysts are keeping an eye on two key factors that will determine how those markets behave over the next few months. They are jet fuel and coal.

Jet fuel, refined from crude oil, has yet to fully spring back to life following the near-grounding of the global commercial air fleet at the start of the COVID-19 pandemic in 2020. Coal demand, on the other hand, has been showing stronger signs of life than suits the comfort level of natural gas producers.

Much of this March’s market madness stems both from the questions of how quickly oil and gas producers can ramp up production, and how quickly they want to ramp up production, given the cash-flow-over-growth strategies that investors favor. Stability may be an elusive quality this year.

Oil and jet fuel

Gasoline, diesel and petrochemical feedstocks all made major recoveries in 2021, said ESAI Energy LLC analysts during a recent webinar. 2022 is jet fuel’s turn.

Global demand for jet fuel will rise 25% to 4.1 million bbl/d this year, estimates Linda Giesecke, manager of global fuels at ESAI. Despite that, demand will still lag pre-pandemic levels by 20%. It’s a sign of a world getting back on the move. Global GDP is expected to grow by 4.4% in 2022. Growth in the U.S. will be particularly strong, she said, and not just in transport fuels. Ethane, used in the manufacture of plastics, will enjoy a rebound.

But who is going to supply all of the oil needed to meet demand? ESAI believes private U.S. E&Ps will drive growth in oil production this year as public producers bow to investor demands for free cash flow generation.

The analysts added that pleas for OPEC to rapidly increase production to lessen European dependence on Russian oil will likely fail. The only members of the cartel with spare capacity are UAE and Saudi Arabia, and the Saudis are already bumping up against their self-imposed strategic limit.

Enough supply

Still, concern over a lack of crude oil may be premature.

“We are cautiously optimistic on crude oil supply,” said Sarah Emerson, ESAI Energy’s managing principal. “We think there’s more supply.”

Emerson acknowledged the dramatic drop in crude stocks and days of throughput in 2021 and 2022 that has led us to very high prices. But she also noted that the five-year global average is 36 days of crude oil in inventory and the present figure is above that, at 39 days. In the U.S., the five-year average is 29.2 days and the average in early March was 27 days.

US days of oil supply
(Source: EIA)

“A day is about 80 million barrels,” Emerson said. “So that’s 240 million barrels. In addition, Iran has close to 150 million barrels stored outside its borders, and crude oil in transit has jumped by more than 100 million barrels since last summer. So we do have inventory to draw down, notwithstanding the tightness in U.S. and European online inventory.”

The Iranian factor

That could change with a resumption of a deal to contain Iran’s nuclear enrichment program in exchange for a lifting of economic sanctions. The Iranians currently export about 1 MMbbl/d, but sold about 2.6 MMbbl/d in early 2017 before the Trump administration reinstated sanctions.

Asian customers, such as China, India, South Korea and Japan, would be the prime beneficiaries of a resurgence in Iranian crude exports, ESAI said, although exports would be hampered by increased domestic consumption in Iran.

Natural gas and coal

At the heart of the natural gas story is sluggish U.S. supply growth tied to sluggish oil production recovery from the pandemic. It wasn’t until December that associated gas production passed pre-pandemic levels, said Samantha Dart, head of natural gas research at Goldman Sachs, at the recent CERAWeek by S&P Global conference.

That led to near-term tightness in the market, Dart said, which might have some staying power.

“I think we’ve heard enough from producers to understand that growth is going to happen at a slower pace and a higher price point,” she said.

Natural gas price and storage
(Source: EIA)

Chad Zamarin, senior vice president for corporate strategic development at The Williams Cos., agreed with Dart on the general shift to capital discipline that is dampening growth, but he also noted that there has been a response to demand as oil prices shot past $100/bbl. The March 17 midday price was $103.40/bbl for WTI and $107.20/bbl for Brent.

“There’s more discipline, but there is a response to price,” Zamarin said. “Part of the reason we’re seeing that in the secondary basins is because they don’t have the same constraints and they’ve got existing capacity that can be brought to use.”

He pointed to the dramatic rise in the Anadarko Basin rig count in the last 12 months. Second-tier basins may not get the attention paid to Haynesville, Appalachia and Permian, but they also boast tremendous resource.

Oklahoma rig count
(Source: Baker Hughes)

The coal story

There is a parallel to oil production on the coal side of the story. Just as oil producers have trimmed growth aspirations to fend off another plunge in prices, mining companies have been reluctant to pump up capex for the same reason, Dart said. As a result, miners increased utilization of existing capacity and inventory of U.S. thermal coal ended 2021 at its lowest level in more than four years.

“This has become not only a tight natural gas story but a tight gas and coal story,” Dart said. “Now we’re at a point where they go together. If production growth is somewhat limited, that substitution away from gas and into coal, we think, remains relevant in balancing the gas market, which means your demand for coal is going to stay high.”

price trend of coal vs. gas
(Source: EIA)

For 2022, the price point for the U.S. gas/coal balance will need to be relatively high, she said,  at close to $4/MMBtu, even if the forward curve is above that. The trend will change to favor gas in future years because higher gas production will allow power plants to substitute a little more into gas and away from coal.

“It’s a key point and, in my mind, one of the main drivers of Henry Hub prices right now,” Dart said.

The cost advantage that the U.S. enjoys over Europe at the moment can be attributed to the coal-to-gas shift not being mandated as policy in this country. In northwest Europe, coal-fired power generation capacity is down 30% in the past five years. As a result, a tight natural gas market sends the price skyrocketing because coal capacity is simply not there to meet demand. (On March 16, the Henry Hub price for April delivery was $4.75/MMBtu. At the Title Transfer Facility in the Netherlands, the price was $33.19/MMBtu.)

Oddly, given the enmity among producers of the fossil fuels, natural gas needs coal to keep power markets sane.

“Think about gas trying to balance with nothing to substitute against,” she said. “If you’re a little oversupplied, you’ve got to shut production down. If you’re a little tight for whatever reasonit doesn’t have to Russia; you get a cold winter, you get a tight LNG yearthen you’ve got to go and destroy industrial demand.”