Will La Nina save natural gas?

Oil and natural gas prices remain in the doldrums, and the odds of an immediate turnaround look long indeed. But with these volatile markets, you can never say never. And while unlikely in the short term, there are a couple of wild card factors that could give energy markets a lift later this year.

Natural Gas: La Niña to the Rescue?

The price of benchmark natural gas futures fell to $1.75 per million British thermal units (MMBtu) in December, the lowest level since 1999. (No, that’s not a typo. The last time natural gas was that cheap, Bill Clinton was president and no one had ever heard of a smartphone.) Gas prices have been hammered by the climate phenomenon known as El Niño, a marked warming of the Pacific Ocean that often brings unseasonably mild winter weather to much of the eastern U.S.

El Niño showed up in a big way this season. Christmas Day in the nation’s capital saw temperatures flirting with 70 degrees, for instance. And that meant that demand for natural gas (which heats half of homes in the U.S.) all but disappeared. And now, even with colder weather in place and a crippling snowstorm hitting the Mid-Atlantic, gas prices haven’t rebounded much. Heating demand is up, but not enough to really dent the massive stockpiles of gas that built up during winter’s warm start.

So while we don’t expect gas prices to retest their December lows, we also don’t see much upward momentum yet. At $2.21 per MMBtu now, the benchmark gas price could creep up to about $2.50 if the latter half of the winter turns out to be chilly. That’s still painfully low for gas producers.

To mount a real rally, the gas market is going to need some help from Mother Nature, in the form of heat, not cold. Specifically, a switch from El Niño to La Niña could do the trick.

Why La Niña? The opposite effect of El Niño, La Niña involves a cooling of Pacific waters that can cause warmer-than-average summer temperatures in the U.S. For instance, the last La Niña cycle, which ran from 2010 to 2012, coincided with three consecutive scorching summers. And hot summers mean soaring electricity demand as homes and businesses across the country rev up their air conditioners.

There’s no telling what the weather will be like in six months. But some signs are starting to point toward a switch from El Niño to La Niña. Australia’s Bureau of Meteorology, for instance, says El Niño is already waning, and that there’s a 50-50 chance of La Niña taking hold later this year.

A hot summer would be sure to give gas prices a jolt. Now more than ever, U.S. power generation depends on gas as a fuel. As we’ve noted before, coal’s role in powering the grid is shrinking, and gas is filling the gap. The Department of Energy reports that, since January 1, the electric sector’s gas usage is at an all-time high, rising further from the annual record set in 2015. And unlike in previous winters, when severe cold caused power demand to rise, the temperatures this year have been fairly typical. That means demand is rising for the simple reason that coal-fired power plants are shutting down and gas-fired units are taking their place.

A summer heat wave would cause gas consumption by utilities to soar to even higher records. That would whittle down gas stockpiles and give traders a reason to bet on higher prices. At the same time, demand for U.S. gas will be heating up abroad. The DOE figures that America, long a net importer of gas, will flip to a net exporter by the middle of 2017, thanks to increasing sales to Mexico via pipeline and the beginning of shipments of liquefied gas to markets such as Europe and Asia.

With weather trends, there’s never any certainty. But if you’re looking for a scenario in which natural gas prices finally climb out of the basement, La Niña looks like your best bet.

Oil: The Geopolitical Angle

Perhaps the most remarkable aspect about crude oil’s price tumble is the fact that it took place amid tremendous chaos in the Middle East. Syria’s civil war rages on unabated, as does Libya’s. ISIS continues to control vast swaths of territory. Iran and Saudi Arabia are rattling their sabers at each other across the Persian Gulf. And yet, nothing seems to scare oil markets enough to give prices a lift.

But how long can the lull in geopolitical risk last? Every major oil exporting nation is hurting from the drop in crude prices from nearly $100 per barrel to $30 per barrel. From Russia to Brazil, the economic pain is palpable. Venezuela is facing outright economic collapse, with inflation in triple digits.

So far, OPEC and other big exporters have failed to agree on output cuts needed to bring balance to an oversupplied world oil market. We’ve noted before that such a coordinated response will be very difficult to pull off.

Perhaps the pain is finally getting bad enough to galvanize OPEC to act. The cartel’s secretary-general, Abdalla Salem el-Badri, said recently in a speech in London that the world’s oil exporters need to coordinate a production cut in order to stabilize prices and ensure sufficiently high prices to finance the drilling needed to meet future crude demand.

Ultimately, the group’s de facto leader, Saudi Arabia, would have to approve such a strategy. And the Saudis have been reluctant so far to cut unless other exporters join them. Which is why it’s noteworthy that Leonid Fedun, vice president of Russian oil giant Lukoil, said in comments to news agency Tass that Russia would be open to a coordinated supply cut. Russia is the world’s largest crude producer, so its cooperation in any such strategy would be crucial.

We wouldn’t bet on this scenario just yet. But we might if and when oil prices take their next tumble. A drop from $31 per barrel to, say $25 or $20 would probably focus a lot of minds in Riyadh, Moscow and other petro capitals.

Coal: It’s the pits for 2016

The gloomy headlines about sinking oil prices never seem to end. But crude oil isn’t the only fossil fuel caught up in a bear market these days. Coal prices have also been sinking. And the long-term outlook for coal arguably looks a lot worse than that of oil.

More Financial Pain in Coal Country

Monday brought the latest news of a U.S. coal mining company filing for bankruptcy protection: Arch Coal, a longtime giant of the industry. Arch is looking to follow the path recently taken by other coal producers, such as Walter Energy and Alpha Natural Resources, all of whom have been hurt by the roughly 50% drop in U.S. thermal coal prices that began in 2011.

The reason for the industry’s downturn is simple: Falling demand. Long the mainstay of the U.S. electric grid, coal has seen its dominance upended by a combination of tough new federal regulations on air quality and carbon dioxide emissions as well as fierce competition from cheap and abundant natural gas. Up until the Great Recession, the U.S. consistently burned about 1.1 billion tons of coal annually. And as recently as 2005, coal fueled about half of America’s electricity.

Coal’s woes snowballed in 2012. Demand dipped in 2009 as the overall economy suffered, but then staged a small rebound as GDP growth picked up and power demand recovered. It was only in 2012 that coal consumption nose-dived, with demand slumping to a bit less than 900 million tons. Utilities were gobbling up cheap natural gas and contemplating the Obama administration’s looming regulatory crackdown on power plant pollutants such as mercury. Since gas was both inexpensive and burns cleaner than coal, the shift made both economic and legal sense. (Continued below.)

Fast-forward to 2015, which will go down as coal’s worst year in about three decades. Government statistics on usage for the full year aren’t in yet. But through the first nine months of 2015, coal consumption fell by 10% from the same period of 2014. That puts 2015 on track to see the lowest level of coal use since about 1985. Ouch.

Things won’t get better for coal in 2016. Odds are they’ll get worse. Why? Utilities are still decommissioning older, coal-fired power plants as they prepare for implementation of the Environmental Protection Agency’s Clean Power Plan, which seeks to reduce carbon dioxide emissions. States, which are responsible for meeting emissions reduction targets set for them by the EPA, will have a number of options for doing so. One major strategy figures to be shifting away from coal-fired electricity because burning coal emits more carbon dioxide per unit of power produced than burning natural gas does.

Don’t count on overseas demand to bail out U.S. coal miners. Though many countries continue to depend heavily on coal for power generation, it’s not clear that their consumption will grow enough to make shipping more of America’s coal abroad cost-effective. China, the biggest coal consumer by a long shot, raises particular concerns about future coal demand. Its economy is clearly slowing (though by how much no one seems to know), and the air pollution in China’s big cities is well documented. A cooling industrial sector means less need for coal-fired power. And cleaning up the dirty skies in Beijing and elsewhere probably means burning less coal in the long run.

Indeed, the International Energy Agency has turned notably pessimistic about the outlook for coal consumption. In its 2015 global coal market report, published last month, the energy watchdog projects that total demand will edge up by an anemic 0.8% annually in coming years. The IEA even considers it possible that Chinese coal usage has already peaked and will fall over the next several years, which would cause global consumption to actually shrink slightly. Just one year ago, the IEA was predicting strong demand growth, both globally and in China.

U.S. coal exports are already skidding. We see no reason to bet on a turnaround. Through the first half of 2015, America exported 20% less coal than during the same period of 2014. And that was before Chinese financial markets started signaling a worrisome slowdown there in August. Again: Ouch.

The bottom line: Coal’s long-term future looks increasingly bleak. The oil markets are in turmoil right now, but at least global demand for oil is still growing at a modest pace. Unlike oil, which is the dominant fuel for powering all manner of vehicles, coal faces mounting competition in its chief role of generating electricity. Utilities now derive as much electricity from natural gas as they do from coal in the U.S. And it’s not hard to imagine a future where renewable power becomes more competitive with coal, both here and abroad.

A Note on Fuel Cells

An alert reader recently queried us as to why Congress opted not to extend the 30% federal tax credit for hydrogen fuel cells when lawmakers acted to extend tax breaks for solar power. We sought an answer from the Fuel Cell and Hydrogen Energy Association.

FCHEA President Morry Markowitz called the omission of fuel cells in the year-end deal an “inadvertent error,” one that his group is pushing lawmakers to rectify early in Congress’s new session. Extending the expiration of the 30% tax credit from the end of this year to the end of 2019 “will get done sooner rather than later,” he predicts.

There’s no way to know for sure what lawmakers will do. But assuming the fuel cell industry belatedly gets the same treatment that solar power did, that would be a real boost for hydrogen-based power. Of the top 100 firms that make up the Fortune 500 list, 23 use fuel cells in some capacity, for either backup or primary power generation. That’s a number we expect to see climb, especially if Congress locks in the federal tax credit for fuel cells for a few more years.