Energy Alert update for Aug. 26, 2015

The price of oil has taken a beating in recent weeks, dashing hopes of a quick recovery from the swoon that hit crude last autumn. Plenty of factors are pushing prices down now, but where does the market go in the longer term?

Was it really just one year ago that West Texas Intermediate crude oil was selling for about $95 per barrel? Twelve months later, we’re closer to $40 per barrel, thanks to a flood of new oil coming from U.S. shale producers and certain OPEC nations, not to mention a stronger dollar and a weaker Chinese economy that suddenly seems to need less oil and other raw materials.

The short-term outlook doesn’t hold much comfort for oil bulls. Oil demand in the U.S. is running strong now, but with the summer travel season nearly over, gasoline use is probably about to trend lower, meaning less need for crude. Soon, refineries that are currently working overtime churning out fuel to meet high demand will dial back, and crude oil will probably start piling up in storage. Those factors could push WTI down close to $30 per barrel, says Stephen Schork, editor of the Schork Report, a daily publication that specializes in energy markets. “We are certainly geared to lower prices” as seasonal demand downshifts, he argues.

Drivers won’t be complaining about oil’s woes. The national average price of regular unleaded gas crept up recently because of a refinery outage in the Midwest, to about $2.70 per gallon. But that increase has already reversed, and the national average will soon be well below $2.50 per gallon. In fact, don’t be surprised if gas nears the low it reached last winter — roughly $2 per gallon — in late autumn. (Certain markets, such as California, will continue to buck the trend because of refinery issues, but even the Golden State should get some relief in coming months.)

Truckers also stand to gain. Diesel should edge down, though probably not as dramatically as gasoline. The national average price of diesel should decline from its recent high of about $2.90 per gallon in late spring to around $2.50 per gallon early this fall. But from there, diesel should start to tick back up as seasonal demand for chemically similar heating oil grows. (How much diesel rises depends on the severity of the winter in the Northeast, home to most heating oil customers.)

Low Prices: The New Normal?

What about 2016? Does oil’s sharp tumble this year point to a sharp rebound next year?

The odds don’t look good. The exact price will depend on economic and geopolitical factors that can’t yet be known in detail, but we see no reason at this point to expect a significant upturn in prices. This oil price slide looks different from the last one, which saw crude fall from about $140 per barrel in the summer of 2008 to about $34 per barrel in February of 2009. That drop resulted from oil demand disappearing amid the worst economic recession in decades. This time around, prices have fallen largely because of a flood of new supply.

Low prices are probably here to stay. It might be tempting to believe that such a sharp decline sets the stage for a strong rebound. But worldwide oil production looks to keep growing, says Michael Lynch, president and director of global petroleum service at Strategic Energy and Economic Research (SEER) and a longtime oil market analyst. Output from U.S. shale fields might falter a bit because of the price slump, but with drilling costs falling, that should prove temporary, he says. Meanwhile, Saudi Arabia is keeping production high to maintain market share, output in Iraq is growing, and Iran could soon be exporting more oil. Given the bullish supply scenario, “I don’t think this is an interlude” before high prices return, Lynch says.

Next year figures to see a muted recovery, at best, in oil prices. Markets will no doubt remain volatile, meaning the price of crude could range considerably over the course of 2016. But for the year as a whole, we think WTI will average somewhere between $45 and $55 per barrel. That allows for the likelihood that some producers will dial back output a bit because of the ongoing price slump, but not enough to meaningfully boost prices. Saudi Arabia, long the swing supplier in the global market that adjusted its mammoth production to keep a floor under prices, shows no desire to play that role again anytime soon.

Living in a Cheap-Oil World

Trying to pin down the price of oil a year from now is fraught with peril, of course. Our forecast could be thrown off by any number of events: a worse-than-expected global economy; a financial crisis somewhere in the world; further instability in the Middle East; a big move in the value of the dollar; and much more. But assuming our expected price is in the ballpark, what does that mean for the economy?

Gasoline will stay relatively cheap, compared with prices from a few years ago. We figure gas prices will average between $2.30 and $2.50 per gallon (national average for regular unleaded), with diesel perhaps a dime per gallon more.

Cheaper gas will keep truck sales humming. That bodes well for the Big Three U.S. automakers, which rack up big profits by selling expensive pickup trucks. Compact cars, hybrids and electrics, by contrast, will continue to struggle as consumers feel less need to save on gas.

U.S. shale drillers will face some challenging times. But the industry will still flourish. Drilling costs, which once made shale oil economically feasible to produce only when oil was nearly $100 per barrel, have dropped dramatically as drillers struggle to cope with oil at $40 or $50 per barrel. Those cost improvements should continue, allowing many companies to profit even in a low-price environment.

Successful drillers will focus their efforts on wells with the biggest production potential, particularly in areas such as Texas’s Permian Basin, says SEER’s Lynch. And many small firms that are weighed down with debt now will become attractive acquisition targets for better-capitalized rivals. So 2016 figures to be a year of consolidation in the oil patch, which should leave the industry as a whole on a sounder footing. As is always the case during a price slump, savvy buyers with cash to spend will know how to take advantage.

Energy Alert for August 12, 2015

President Barack Obama’s long-awaited and just-released rules limiting greenhouse gas emissions from power plants have set off a political firestorm, with some states and businesses already rushing to sue Uncle Sam to halt what they see as a costly and unjustified regulation. Meanwhile, the practical effects of the rules and how they might, or might not, play out are getting overlooked.

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