Sunday, December 27, 2015

Five energy surprises for 2016: The possible and the improbable

Many energy analysts like to make predictions at the end of the year for the coming year. Instead, I'll point to five possible surprises in energy--surprises because few people expect them to happen. I am not predicting that any of the following will happen, only that there is an outside chance that one or more will occur. Naturally, these surprises would move markets and policy debates in unexpected directions.

1. Crude oil ends 2016 below $30 per barrel. With oil hovering in the mid-$30 range it doesn't seem implausible that at some point in the not-to-distant future, crude oil will dip below $30 per barrel, if only briefly. What would surprise most people is if the crude oil price finished next year below $30 per barrel. The conventional wisdom is that cheap oil is giving a boost to the economy that will lift worldwide economic growth and thus demand for oil. There is also a belief that high-cost producers will simply have to stop drilling new money-losing wells after more than a year of financial Armageddon in the oil markets. This will bring down supply just as economic growth is rising, sending prices much higher as the year progresses.

The alternate view is that oil in the mid-$30 range is a reflection of an economy that has been weakening since the middle of 2014 and foreshadows a worldwide recession which should hit in full force by the end of 2016. In addition, with Iran almost certain to add to the current oversupply as sanctions are lifted and with the continued determination of OPEC to destroy the viability of tight oil deposits in the United States, the oil price could surprise on the downside, even testing $20 per barrel.

2. U.S. natural gas production declines. Despite persistent low U.S. natural gas prices, U.S. production has continued to grow. Most of the growth has been coming from two places: the Marcellus Shale where ample deposits continued to be economical in the range of $3 to $4 per thousand cubic feet (mcf) and Texas where furious fracking for oil locked in deep shale deposits also produced associated natural gas without concern for the price of that gas.

With oil drilling across the United States in precipitous decline because of low oil prices, we won't see nearly as much new natural gas associated with oil drilling as we saw in 2014 and 2015. With natural gas now hovering around $2, even the very sweetest of the sweet spots in the Marcellus are unlikely to be profitable to exploit.

Having said all this, U.S. natural gas production growth has continually defied predictions that it would dip in the face of low prices. Part of this had to do with desperate drillers carrying heavy debt loads who had to produce gas at any price in order to pay interest on that debt.

3. Several approved U.S. liquefied natural gas (LNG) export projects are postponed or abandoned. One of the memes of the so-called shale gas revolution was that the United States would produce far more natural gas than it consumes and that that would open the way for liquefied natural gas exports to other energy-hungry countries. Two things went wrong. First, U.S. production, while growing, has not exceeded U.S. consumption. Despite the highest natural gas production in history, the United States had net imports of natural gas of about 3 percent of its consumption so far this year.

Second, with the price of landed LNG around the world between $6 and $7, LNG exports from the United States are currently uncompetitive. Even with U.S. natural gas at $2, when the cost of liquefying and transporting gas--about $6 per mcf--is added to the American price, landed LNG prices would have to rise to about $8 just for American suppliers to break even. And, of course, just breaking even is not a proposition investors are very much interested in.

Now, some of the export projects have already undoubtedly received commitments from buyers to take U.S. LNG under long-term contracts, usually priced at Henry Hub plus a certain amount for liquefying and transporting the gas (plus something to reward investors, of course). If those contracts are in place, then the builders of the LNG export projects don't care what U.S. prices are. They make money no matter what. And, it doesn't matter whether they export so much LNG that the United States is forced to IMPORT more from Canada via pipelines or possibly in the form on LNG itself.

Whether buyers make out under such an arrangement will all depend on how world spot LNG prices unfold over the next couple of decades. Undoubtedly, many of those with long-term contracts today would be better off buying in the spot market. But, of course, when prices are high, they have no protection.

What we'll find out this year is which projects have contracts from buyers and which do not. The ones that do not yet have such contracts will almost certainly be postponed or abandoned. For those that proceed, investors who are not careful to understand how much of the capacity of the project has been taken up by long-term contracts and how much will be sold on the spot market may be in for rude surprises if they are too exposed to the spot market and that market remains soft.

4. Bipartisan support for climate change measures emerges in the U.S. Congress. You will certainly think I'm reaching here, and it would be a surprise if this does happen. But expectations for the recent climate conference in Paris were extremely low. And yet, world leaders hammered out an agreement that committed the parties to emissions limits with regular reviews. True, there is no enforcement mechanism. But even so, this result was better than most anticipated.

The same could go for a U.S. Congress stalemated on the climate issue. Even though the Republican majority has taken the view that regardless of the science, Republicans are better off opposing any measure to address climate change, not all Republicans have taken this extreme position. If enough of them peel off and join Democrats on even a small measure, it will mark progress--though it will certainly be a surprise coming in an election year.

5. World oil production declines. In the past world oil production has declined only during recessions or once in the early 1980s following a long period of rising prices and the most severe recession since World War II (that is, until 2008). We've had a long period of price rises from 2000 onward, followed by a severe recession. But production continues to eke out some growth.

According to figures from the U.S Energy Information Administration, worldwide production of crude oil including lease condensate (which is the definition of oil) grew by 15.7 percent in the nine-year period leading up to 2005. In the nine-year period from 2005 to 2014, production grew only 5.3 percent despite record prices and investment.

If worldwide production declines, it will almost surely be because drillers simply lay down even more rigs and companies delay development of tar sands mining projects in Canada to wait for higher prices. This restraint would have to counterbalance additions to world production expected from Iran which will have sanctions lifted in 2016 allowing it to increase its oil production and exports substantially. If peace breaks out in Libya, then the rise in Libyan oil production will probably prevent an overall decline in world production.

Recap of 2015's list of possible surprises

1. U.S. crude oil and natural gas production decline for the first time since 2008 and 2005, respectively. While U.S. crude oil production in 2015 looks like it will exceed total production in 2014, production began to slide in June this year and continues downward. So, there was a surprise for those who thought the so-called shale revolution could go on without high prices. Natural gas production continued to rise so there was no surprise there.

2. World crude oil closes below $30 per barrel. This hasn't happened yet and probably won't with only a few days left in 2015. But a price in the mid-$30 range has certainly surprised a lot of people, especially those who were touting the midyear recovery of prices to around $60 as the beginning a new oil bull market. So, this did come as a surprise, but not quite (yet) the $30-per-barrel variety.

3. Developments in solar thermal energy show that it can solve the storage problem for electricity from renewable energy. Perhaps the biggest obstacle to broader use of electricity generated by renewable energy is the high cost of storing that energy for use when people need it. A Maryland inventor is still trying to put together funding for a prototype of a possibly revolutionary solar thermal capture device that he claims has 90 percent efficiency. There's no prototype yet. Perhaps in the coming year we'll find out whether the claim can be confirmed. So, no surprise here yet.

4. A climate agreement in Paris calls for binding greenhouse gas emissions limits. Okay, the greenhouse gas limits weren't binding. And, of course, that's not a surprise. What surprised me is how unanimous the world's leaders were about the problem of climate change and how specific they were about limits in the agreement.

5. Oil prices reach $100 per barrel before December 31, 2015. This possible surprise was premised on a robust world economy and an OPEC relenting on its war on frackers in America and tar sands in Canada. The OPEC war continues, and the world economy seems weaker at year-end than when it began.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 20, 2015

Who's right, commodities or the Fed?

As the U.S. Federal Reserve Bank raised interest rates last week for the first time in 10 years in response to what it said was strength in the U.S. economy, economically sensitive commodities such as industrial metals and crude oil continued to plumb new cycle lows.

Either these commodities are about the turn the corner as renewed strength in the United States--the biggest buyer of commodities next to China--revives industrial metal and crude oil demand--or the Federal Reserve is misreading the tea leaves and crashing commodity prices signal a world and U.S. economy in distress.

Market analysts like to say that copper is the metal with a Ph.D. in economics. Because of copper's central role in the modern economy, it often reliably forecasts the direction of the economy. Since copper reached its peak at the beginning of 2011 above $4.50 per pound, it has swooned to near $3 in 2011 coinciding with a crisis in Europe, bounced back to near $4 once the crisis passed and then settled above $3 by the middle of 2013 where it essentially traded sideways until this year. After trending down since May copper hit $2.05 a pound last week, only three cents above the low for the year registered on November 23.

And, it wasn't just copper. Nickel started the year above $7 a pound and finished last week at $3.90 a pound. Aluminum began the year above 90 cents a pound and settled last week at 67 cents. Zinc peaked near $1.10 a pound in May and now sells for 66 cents. Iron ore prices, which dropped almost 50 percent last year, this year dropped from $68 per ton to $47 as of last week, another 31 percent decline.

Crude oil, which dropped about 50 percent in the last half of 2014, has dropped another 35 percent so far in 2015.

So, given this picture of the price trends for basic materials which are key to the economy, why has the Fed concluded that now is the time to start raising rates?

A clue comes from the analysis of Doug Noland who has been following what he calls the greatest credit bubble of all time. Noland explains that the swoon of emerging market countries--which include commodity producing economies such as Brazil, Russia, Mexico and other mineral and petroleum exporting nations--has sent money scurrying to what he calls "the core," the United States, Europe and Japan. For a while this flow will buoy these core areas by injecting money into their economies and stock markets.

Eventually, the financial rot in "the periphery," the emerging market countries mentioned above, will reach the core and slow their economies while threatening their financial institutions which hold increasingly shaky debt from periphery countries.

Already indicators show that world trade is slowing as the Baltic Dry Index, which measures shipping costs, crashes to new lows. U.S. manufacturing is now in recession creating "the worst manufacturing climate since March 2009."

It is always darkest before the dawn, the saying goes. When referring to his own worst investment decisions, legendary fund manager Peter Lynch loved to parody that saying with this rewrite: It is always darkest before it goes pitch black.

In February, I suggested that the already significant decline in commodities was signaling a weak world economy. Since then commodity prices have weakened again and dramatically so. And yet, the stock markets and economies in the "core," the United States, Europe and Japan, seem to be defying the trend in commodities just as the Fed pronounces the U.S. economy healthy enough for a rise in interest rates.

Either commodities are correctly forecasting the direction of the overall world economy or the world's "core" economies are about to lead the world economy back toward faster growth. The outcome will determine the fate of trillions of dollars of investments premised on the idea that one of these indicators is right.

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For my take on last week's repeal of the U.S. oil export ban, see my piece from September entitled, "Truth takes a hit in battle over U.S. oil export ban." The ban was lifted as part of a huge federal spending bill in which supporters of renewable energy got renewed tax credits for solar and wind power in exchange for accepting repeal of the ban.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 13, 2015

The zombie apocalypse in oil: Why it's a bad sign for all of us

The dramatic drop in oil prices has created what are called "zombie" companies, oil companies which can still afford to pay interest on huge debts, but little else. If oil prices stay low, the problem is likely to spread and become an economic zombie apocalypse for much of the industry and the communities and countries that depend on it.

Meanwhile, consumers have rejoiced as cheap oil prices have led to cheap gasoline, diesel, heating oil and jet fuel. Both households and businesses are finally getting their revenge on the oil companies after a decade of high and rising prices.

But should those consumers be so sanguine? Can the low prices we are experiencing today be extrapolated far into the future? The conventional wisdom says yes. It claims that the American fracking boom of recent years has unleashed a flood of oil that will keep prices down for many years to come. Combine that with an undisciplined OPEC that pumps flat out and you get not a temporary dip in prices, but a new era of low-cost oil and oil products.

But the same facts can be interpreted as leading to serious future supply constraints and high prices, provided the world economy does not fall into a prolonged slump that would reduce oil demand.

Cheap financing fed the fracking boom. And, even though borrowed funds are still cheap, struggling oil companies are finding their bank lines of credit reduced and a bond market that is shunning their high-yield debt. With additional funds hard to raise, many independent companies are finding it difficult to drill new wells needed to make up for declining production from existing ones, around 40 per cent per year in the two largest tight oil formations--the Eagle-Ford in Texas and the Bakken in North Dakota--where fracking is the primary technology for extracting oil.

The U.S. oil rig count stands at 524 for the week ending December 11. A year ago it was 1,546. U.S. oil production (crude oil including lease condensate) is estimated to be down about 450,000 barrels per day from the peak in early June of 9.6 million barrels per day, according to the U.S. Energy Information Administration.

While some say that a rising oil price would quickly reverse the current downward trend in drilling activity in U.S. tight oil fields, the key will be whether investors will provide the capital needed to do so. So, it's important to understand that the OPEC war on American drillers also extends to those who finance them. If the thumping investors have taken so far as result of the long, deep slide in oil prices makes them reluctant to fund new drilling in the United States when prices rise, the presumed fast ramp-up in U.S. drilling won't take place. The necessary cheap and ready credit won't be available as it has been in the past.

This may be what OPEC is counting on, that investor sentiment will be so damaged by the current price war that when world supply does finally come into balance with demand, U.S. drillers won't be back very quickly or in numbers seen at the height of the boom. Moreover, investors won't be easily fooled a second time by an industry that even at the peak of the boom saw most companies experience persistent negative cash flow.

But there is another problem. With OPEC and particularly Saudi Arabia pumping all out, there is little spare capacity to respond to shocks such as disruptions in Libya or Iraq that might reduce production. With little spare capacity, mere growth in world demand might outpace the ability to meet it. One analyst believes oil prices could be in triple digits again by 2017 for this and other reasons.

There is another scenario that is suitably apocalyptic in line with the zombie apocalypse taking place in the oil industry. In this scenario the world economy plunges into a lengthy depression brought on by years of previously high oil prices (which have sapped the strength of the world economy), bursting stock market bubbles, and a merciless debt deflation ignited in part by cascading oil industry defaults.

This scenario would keep oil prices low. But it would also prevent investment in most remaining prospects--prospects that are increasingly expensive to exploit such as tar sands, arctic and deepwater deposits. This implies that oil prices would rise even in a depressed economy, but not sufficiently to make these high-cost resources viable. Relatively high oil prices would put pressure on an already slumping economy and possibly lead to an even deeper slump.

Few people currently anticipate such a vicious circle. But the evidence suggests that none of us should be complacent as long as zombies roam the world's oil fields.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 06, 2015

Taking a short break--no post this week

I'm taking a short break and expect to post again on Sunday, December 13.