What a wild week in the energy world! Crude oil, already in the doldrums, is selling off on renewed fears of oversupply in the market. Natural gas producers can’t give the stuff away. And world leaders just adopted a major agreement on reducing greenhouse gas emissions.
OPEC Tanks the Oil Market
Haven’t we seen this movie before? About a year ago, members of the Organization of Petroleum Exporting Countries agreed to hold production steady, even though surging output in the U.S. had pushed the price of a barrel of crude down to about $70. That decision, though unsurprising to us at the time, sent the price spiraling down as traders came to grips with the reality that the oil cartel was not going to bail out the market by cutting production.
OPEC’s most recent nondecision looks like a rerun. With West Texas Intermediate crude trading between $40 and $45 per barrel, the group again opted not to curb output to prop up prices, even though markets are still oversupplied. Once more, we had expected as much. But the failure to act has again roiled markets, with WTI tumbling to about $35 per barrel — the lowest point since February 2009, in the depths of the Great Recession.
Is this the bottom for crude prices? This is a question that readers often ask. Making predictions about short-term market moves is dicey, but our guarded answer usually boils down to this: “We don’t know. But we wouldn’t bet on it.” With markets so volatile, and with so many factors working against a recovery in oil prices, we’ve warned in recent weeks that a brief but sharp drop below the $40-per-barrel level was a real possibility.
As to where prices go from here, our best guess is the bottom is getting close, if we haven’t hit it already. Despite all the cost cutting and efficiency gains that have been achieved by energy firms working in shale oil fields, we suspect that very few wells are profitable at $35 per barrel. And the shale industry seems to be reaching the same conclusion. The latest data from drilling services giant Baker Hughes show that the number of rigs actively drilling for oil continues to drop. At 524 active rigs, the total is down by two-thirds from this time last year.
U.S. output is gradually falling. Pinning down just how many barrels of oil are produced each day is tough, but the latest weekly data from the Department of Energy peg the figure at a hair less than 9.2 million barrels per day. That compares with the recent peak of almost 9.6 million barrels pumped each day during April. We look for output to continue its slow decline well into next year.
Production outside the U.S. is still robust, and probably will stay that way for now. But we expect the latest price drop to start hurting global output sometime next year. The International Energy Agency reckons that virtually all growth in world oil production is coming from OPEC now, which suggests that the cartel’s strategy of driving higher-cost rivals out of the market is starting to work. But even OPEC members might struggle to keep pumping flat out when oil revenues are down substantially. Political turmoil in Venezuela, Libya or another OPEC nation could lead to output cuts sometime in 2016.
The bottom line: The supply glut isn’t about to clear up. But it doesn’t look likely to worsen substantially next year, unless the global economy experiences a sharp downturn that crimps oil demand. Barring that scenario, the downward pressure on crude prices should lessen in 2016.
El Niño Wallops Natural Gas Prices
Natural gas isn’t faring any better than crude oil these days. After trading mostly between $2.50 and $3 per million British thermal units (MMBtu) for much of this year, the benchmark gas futures contract has tumbled to below $2 per MMBtu on fears that a mild winter will suppress heating demand. Gas stockpiles soared to a record of slightly more than 4 trillion cubic feet earlier this fall, and without some cold weather to burn off some of that bounty, traders figure the gas market will be plagued by oversupply next spring.
We don’t see much relief for gas bulls in the near term. The normally gas-hungry Northeast has been seeing record warmth recently, with no sign of an imminent change in the weather pattern. Winter hasn’t officially started yet, but this season looks to be shaping up as a classic El Niño winter: lots of precipitation hitting the West Coast (good news for the region’s drought) and mild weather across much of the northern tier of the country.
But we see some reasons to believe that gas prices should eventually move higher. For one, gas demand figures to be stronger than the warm weather would suggest. In addition to heating homes, gas also powers many of the nation’s electric plants. And in 2015, electric utilities are ramping up gas consumption as new clean air rules prompt the retirement of many coal-fired power plants. So far this year, the electric sector is burning 18.5% more gas than it did during the same period last year. That trend will probably intensify, no matter what the weather is.
Also, the U.S. is importing less gas and exporting more of it. Most of those added exports are going to Mexico via pipeline, but Cheniere Energy of Texas plans to soon begin shipping cargoes of liquefied natural gas to overseas markets. And gas production is no longer surging the way it was earlier this year. According to the most recent weekly data, gas output actually fell slightly from its level of one year ago. Early in 2015, output was rising at a 10% annual pace. (As with oil, gas drilling activity has slowed sharply.)
Those factors should help whittle down gas stockpiles. If the winter of 2015-2016 ends up being as warm as 2011-2012 (one of the warmest on record), we calculate that the combination of weak demand for space heating and strong demand from power plants will push gas held in storage down to about 2.4 trillion cubic feet. That’s high for the end of winter, but not unprecedentedly high (March of 2012 saw a similar level). We reckon that would dispel fears that the country might run out of storage space next spring, when stockpiles start growing again.
We look for natural gas prices to rebound modestly by winter’s end, to between $2.50 and $3 per MMBtu. Unless, that is, this El Niño winter ends up exceptionally balmy.
Paris Climate Negotiators: D’Accord!
As we predicted a month ago, the UN meeting in Paris on efforts to rein in emissions of greenhouse gases did indeed produce a deal. And environmentalists are celebrating.
But it’s important to note the actual details. Negotiators agreed to try to limit future emissions so that global temperatures rise less than 2 degrees Celsius from preindustrial levels. In fact, they resolved to shoot for limiting the increase to 1.5 degrees if possible.
The goals sound impressive. But the emissions cuts that the signatories committed to won’t reach those targets, assuming that the UN’s projections on greenhouse gas levels and temperature are correct, according to the Netherlands Environmental Assessment Agency. Keeping future temperature increases below 2 degrees (let alone 1.5 degrees) would require dramatic reductions in global emissions. The pledges made in Paris jointly add up to simply slowing the growth in emissions, if they’re implemented as promised.
For environmentalists and anyone else concerned about climate change, Paris will likely be seen as a good start. It certainly won’t be the end.