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The next month or two figure to be an extremely bumpy period for the oil market. Predicting what the price of crude will do any given day will be even harder than usual. The only thing you can count on is plenty of volatility. Traders are digesting worries about real or potential shutdowns of oil production on four continents, even as the global economy shows signs of slowing, which could dent oil demand. But when the dust clears, we suspect the price of a barrel of oil this summer won’t be radically different from today’s level.
Wildfires, Terror Attacks and More
Looking for an explanation of the recent rally in oil prices? Where to begin? First, there’s the massive wildfire in Canada’s oil-rich Alberta province, which spurred the evacuation of an entire city. No damage has been reported at the region’s sprawling oil sands mining operations, but many firms slowed or shut down work as a precaution and to provide shelter for nearby residents displaced by the fires. Up to a million barrels of daily crude production is now off line.
In Nigeria, attacks by militant groups have hit pipelines and offshore oil platforms, shuttering a substantial portion of that country’s daily output. Civil war in Libya has further reduced what little production had been on line during a shaky truce between two rival governing factions. In Venezuela, the cratering economy is sparking fears that the regime of President Nicolás Maduro could lose the ability to keep exports flowing. And Saudi Arabia recently muddied the picture by dismissing its long-time oil minister, Ali al-Naimi, in what some analysts saw as a sign of a policy change in the world’s largest oil producer.
It all adds up to a critical question for oil markets: Is the world about to shift from oversupplied to undersupplied? After all, the price of crude started tumbling late in 2014 when OPEC announced that it wouldn’t curb its production in the face of rising output from America’s prolific shale fields. Stockpiles of oil held in storage soared as production outran consumption. West Texas Intermediate, the U.S. oil benchmark, plunged from about $100 per barrel in the summer of 2014 to just $26 per barrel in February 2016. Firms working in the shale oil deposits of North Dakota and Texas started going bankrupt.
Going from glut to shortfall in the span of weeks has sent oil prices spiraling higher. From that low of $26 per barrel in February, WTI has rebounded to $48, and oil bulls are betting the rally has further to run. But after such a torrid rally, it probably pays to be skeptical.
For one thing, the market still looks oversupplied. Although Canadian production took a huge hit from the Alberta fire, and U.S. output continues to dwindle as operators shut down drilling rigs, production is ramping up in other parts of the world. Iran continues to boost its exports now that Western sanctions on its oil industry have been lifted. In April, OPEC reported that its combined output rose by almost 200,000 barrels per day (despite the problems of OPEC members Libya and Nigeria). OPEC also expects Russia to boost its prodigious output by 100,000 barrels per day in 2016, compared with 2015 levels.
And global petroleum stockpiles are bulging, a legacy of the recent gap between supply and demand. The International Energy Agency reports that total stockpiles held by economically advanced countries exceeded 3 billion barrels in February, well above the average level over the last five years.
Some savvy oil market analysts aren’t buying the rally, either. Stephen Schork, editor of energy investing newsletter The Schork Report, says the various trouble spots around the world are a legitimate concern for the oil market. But unless output losses turn more severe somewhere, he expects oil prices to decline fairly soon. This is “not a fundamentally sound rally,” he says. What’s more, “producers are selling into this rally,” by which he means energy firms are rushing to lock in present crude prices in contracts to sell their future output. That’s not exactly a vote of confidence from companies with the most incentive to predict where prices are going.
The shake-up in Saudi Arabia’s oil ministry could also be bearish for prices. Some news reports greeted the announcement of al-Naimi’s departure as a sign that the kingdom might be thinking of ditching its recent policy of keeping the oil spigots open to compete with archrival Iran. But a new oil minister doesn’t necessarily signal a new oil policy. Prestige Economics President Jason Schenker, whom we interviewed recently, says al-Naimi probably retired, rather than was forced out. Schenker attends OPEC’s regular meetings in Vienna, as well as private dinners with the Saudi delegation, and his read is that the kingdom will maintain its recent lofty production level to protect its share of the market as Iran boosts its exports.
So where does that leave prices? We figure that all the talk about supply disruptions will probably cause some brief but sharp price spikes in coming weeks. The approach of Memorial Day and the unofficial start of the U.S. summer driving season should also nudge prices higher. But unless some new disaster or geopolitical upheaval crimps crude flows, we look for WTI to return to a trading range of $40 to $45 per barrel by early July.
Meanwhile, drivers can expect gasoline prices to push a bit higher. According to AAA, the national average price of regular unleaded hit $2.23 per gallon yesterday, up about a dime from a month ago. The average price will probably top out somewhere between $2.30 and $2.40 late this spring before leveling off. No one likes paying more, of course. But with memories of $4 gas still fresh in the minds of many motorists, that probably won’t feel too painful as folks hit the road for the beach or the mountains this summer.
In this issue: China’s plan to build its own chip industry. What’s next for mobile laser technology? Big bets on smart cities. Drone consultants. The birth of quantum cloud computing. How to make your older car smarter and safer.
Two weeks ago, we sat down to talk energy with Jason Schenker, president and chief economist of Prestige Economics in Austin, Texas. He specializes in commodity markets and is known for the accuracy of his price forecasts, so when he talks about what’s ahead for oil and natural gas, it pays to take note. Here are highlights of our conversation, lightly edited for clarity.
Jim Patterson: We’re at $40 per barrel today [April 20, 2016] for West Texas Intermediate crude oil. First big question: A year from today, will we be higher or lower?
Jason Schenker: I think we’ll be higher. And the main reason we’ll be higher is we’re going to see strong oil and gas demand … just like high prices cure high prices, low prices cure low prices. So you’re going to see the layoffs, the downgrades, the bankruptcies, the defaults. All that stuff is just starting and it’s going to continue. As it continues you’re going to see reductions in additional production and you’re going to see reduced future investment, at the same time when low prices are incentivizing additional demand. And so you do end up with higher prices … by this time next year.
JP: If you had to ballpark it, a year from today, April 20, 2017, what’s your WTI forecast?
JS: In the first quarter of next year, we see prices on average for WTI of $45. We see an average price next year close to $50 for WTI. And that’s including the fact that we see a high risk of a U.S. recession … if the U.S. does not fall into recession, then we’d see even higher prices.
JP: So say you’re right on and 50 bucks is about where we end up for next year. Is that manageable for the average shale operator? Can these guys live with [oil] at $50 a barrel?
JS: You know, I think there’s not one answer because there’s not one kind of producer. I think at $50 per barrel, the guys who are pumping the oil are OK. If you get up to $50, you’re going to see more hedging activity, you’re going to see some additional drilling come on. We see prices going higher next year, but even though we’ve had that view, we think there could be choppiness just in the nature of the drilling and spending cycles.
JP: Are there particular regions/plays where you’re looking for drilling to continue to plummet? Who’s going to take the hit here?
JS: I think it depends a lot on the operators and it depends on who the leaseholders are and the companies in place more than the regions. You could be in a relatively cheap region like the Bakken, but if you’re overleveraged and you just had a write-down in your assets, it doesn’t matter how cheap it is to drill … you might be capital-constrained and that’s going to prevent more marginal drilling. I think you’re going to see a lot of M&A activity. You’re going to see a lot of assets change hands and a lot of consolidation.
What you really need right now is good rocks, a leaseholder that has capital to spend and an operator that can do it at a low price point. Unless you have all three of those, drilling is frozen.
There are some things that need to happen to continue to restrict supply before I’d be confident in additional [price] upside … if companies in the space continue to get beaten up, that will eventually result in higher prices. The worse it is for the industry now, the better it will be later for the guys who do make it. It’s very tough right now and it’s going to get tougher. They’re going to be writing off billions.
On natural gas
JS: You’re going to see additional marginal natural gas production diminution. You’ve got an industrial recession going on right now in the U.S. economy. You had the El Niño trade, which last year resulted in weak gas demand …
JP: It was 70 degrees here in Washington, D.C., the day before Christmas …
JS: So it’s not cold out, you’ve got a lot more natural gas … none of this is terribly pleasant for producers.
JP: Do you see any price rebound for natural gas?
JS: We see higher prices by the end of the year, but it’s not a massive move. As we go into the winter, we see higher prices. Q4, we see prices averaging $2.25 per million British thermal units. [As of May 3, natural gas futures were trading at $2.09 per MMBtu.] These are not terribly high prices, no matter how you slice it. Relatively, that’s very low. You would need to have the most sweltering summer to see more upside for natural gas. Of course, weathermen exist to make economists look good.
JP: Longer term, there’s a lot of plans to export liquefied natural gas, there’s clearly a move to burn more gas and less coal. Is that enough to move the needle [on gas prices]?
JS: Even if natural gas is cheap, if oil is cheap, too, the upside to exporting gas is lower. You’ve seen a number of proposed terminals being mothballed. There’s been a ratcheting lower of expectations for exports as a result of low oil prices.
I think the eventual future is to continue to reduce coal usage but … what does the Supreme Court have to say [about the Obama administration’s crackdown on coal usage], what about a new [presidential] administration? Is it plus ça change or is it je ne sais quoi?
On the Economic Front
JP: Let’s talk big picture. You’ve written a whole book about what people should do to prepare for what you believe is a coming recession. First, do you still see that coming, and any sense on the timing?
JS: I think there’s a lot of data out there. When I look at different data, I’m very concerned …
Oil and gas is in a recession. Manufacturing is and has been in a recession. Even though it’s only 13% of GDP, it is a critical bellwether for access to capital in the overall economy.
If we look at a longer-term piece of data like industrial production, it’s been negative year over year for seven consecutive months. The Fed has been collecting IP data since 1919. The number of times we’ve had seven months of negative industrial production and we were not in or after a recession is zero. So either it’s the first time in 97 years that this has happened or the U.S. economy could be in a recession.
The risk is high. There are no guarantees, but the risks are quite high.