What’s the Deal with the Green New Deal?

Freshman House Rep. Alexandria Ocasio-Cortez (D-NY) and some of her colleagues have made news recently by calling for a “Green New Deal” to combat climate change. Hearkening back to President Franklin Roosevelt’s aggressive countermeasures designed to pull the country out of the Great Depression, the Green New Deal sounds bold and dramatic. Speaking at a town hall meeting in December, Ocasio-Cortez called the plan “the New Deal, the Great Society, the moon shot, the civil rights movement of our generation.”

A draft bill calls for “meeting 100% of national power demand through renewable sources … eliminating greenhouse gas emissions from, repairing and improving transportation and other infrastructure … [and] eliminating greenhouse gas emissions from the manufacturing, agricultural and other industries.” What’s more, the bill calls for achieving these goals by the year 2030.

Reactions to the proposal have been mixed, to say the least, with some environmentalists hailing the GND as the sort of bold vision that the world needs in order to combat climate change, and some critics deriding it as fanciful and hugely expensive.

How you view the GND is up to you. But forming an opinion about any proposed public policy requires some background information. In that spirit, here are a few energy-related facts to keep in mind:

The Green New Deal calls for eliminating fossil fuels from the electric industry. Currently, the U.S. gets about three-fifths of its electricity from burning fossil fuels. In 2017, the last year for which complete government data are available, the Department of Energy reports that natural gas accounted for 32.1% of U.S. power production, followed by coal at 29.9%, for a 62% combined share. The other 38% largely consisted of emissions-free nuclear power (20%), hydro-electric power (7.4%) and wind (6.3%).

Most of our electricity does not come from conventionally defined renewable power such as wind and solar. Even if you expand “renewables” to include hydropower and emissions-free nuclear, only about two-fifths of our electricity “mix” is carbon-free. So, realizing the GND’s goal would require a major reduction in U.S. electricity usage, a huge increase in wind, solar or other renewable power, or some combination of the two.

The Green New Deal calls for eliminating greenhouse gas emissions from the transportation sector. Currently, the U.S. relies on fossil fuels for at least 92% of its transportation needs. According to this handy pie chart from the DOE, gasoline powered 55% of all transport in 2017; diesel accounted for 22%; jet fuel, 12%; and natural gas, either compressed or liquefied, 3%. Another 5% came from biofuels, which theoretically could count as renewable; and 3% from “other sources,” such as electricity (which, remember, mostly comes from fossil fuels).

The Green New Deal implies eliminating fossil fuels for winter heating needs. Currently, 57% of U.S. households burn some type of fossil fuel to keep warm. Again per the DOE, 47% of households burn natural gas; 5% use propane; and another 5%, heating oil. Electricity warms 40% of American homes, via systems such as electric heat pumps. (A small slice of the population, probably folks living in very warm climates, have no heating system. Another small slice primarily burns firewood.)

Keep in mind too that most of the electric heat in the U.S. is in the South, according to DOE. That makes sense, given the region’s relatively mild winters. The colder Northeast and Midwest, where heating needs are higher, rely far more heavily on furnaces and boilers running on natural gas, propane or heating oil.

The Green New Deal also calls for eliminating greenhouse gas emissions from industries beyond energy. Chemical makers and other industries currently use more natural gas than the power sector does. Even though the U.S. is generating a record amount of electricity by burning natural gas, it uses even more gas to make plastics, chemicals, fertilizers and more. Such “industrial” uses of gas also more than double the amount consumed by residential customers, who burn gas to heat, cook, power water heaters, clothes driers and the like.

Those are some of the facts about our energy usage today and the role that fossil fuels play. Hopefully they’ll be helpful as you hear more debate emanating from Washington about the Green New Deal.

Making Sense of Energy Market Turmoil

I don’t know how else to say this: Energy markets are going a little crazy. First, crude oil prices plummeted, turning an earlier autumn rally into a bear-market rout. From its high of about $76 per barrel on Oct. 3., benchmark West Texas Intermediate plunged to about $55 in only five weeks. Then, natural gas prices went haywire, with the benchmark gas futures contract leaping from about $3 per million British thermal units to nearly $5 in a span of days, only to plunge back to $4 today. What exactly is going on?

It appears that certain market expectations about future energy supply and demand are getting violently recalibrated. Oil rallied through most of autumn on expectations that the return of U.S. sanctions on Iran would crimp its oil exports at a time when the strong global economy needed more crude. But production ramped up elsewhere; the Trump administration granted temporary waivers to a few countries that buy Iran’s oil; and now there are signs that global economic growth is slowing. Suddenly, many bullish bets on crude oil needed unwinding. Oil prices fell for 12 consecutive trading days, a new record.

Natural gas prices soared when weather forecasts showed cold air poised to spread over the heavily populated Northeast and Midwest and traders suddenly noticed that the amount of gas in underground storage is low for this time of year. In a matter of days, gas prices shot up 50%, before giving back much of those gains today, when the Department of Energy reported that stockpiles grew modestly last week.

Here are the two main points that I take away from this volatility:

First, oil markets remain well supplied, largely thanks to the U.S. American oil production hit another record high this week, with output of 11.7 million barrels per day. That’s the most of any country in the world. And production should keep growing briskly next year, especially after new pipelines in Texas are completed, allowing producers to ship more crude to refineries and export terminals on the Gulf Coast. (Think about that for a moment: Texas is producing so much oil that it’s gotten difficult just to move it.)

Other countries stepped up their production in advance of the Iran sanctions taking effect, too. Just Russian and Saudi Arabian output combined more than offset the lost Iranian production. Granted, the Saudis said they will pull back, and OPEC may choose to do likewise when its members meet in Vienna next month. But that the cartel feels the need to close the taps a bit again shows that the world has plenty of oil.

Second, natural gas prices figure to be volatile throughout the winter, and the risk of sustained price hikes is real if the winter ends up being colder than normal. As with oil, the U.S. is producing record amounts of natural gas. But consumption is high, too. Utilities now generate more electricity from gas than they do from coal, and U.S. exports of natural gas are on the rise. Add in heavy demand during a sustained cold snap, and the gas distribution network will struggle to get enough gas everywhere it needs to go. Plus, extreme cold can cause gas wells to freeze up, cutting into supply when it’s needed most.

Consumers can look forward to bigger savings at the gas pump. The national average price of regular unleaded gas now stands at $2.67 per gallon, down from almost $3 earlier this fall. Prices should slip further as the big drop in oil prices filters through to the retail level. The drop in oil prices is also good news for propane and heating oil users. Prices of those two fuels started the heating season well above their levels of the prior year. And the unseasonably cold weather hitting much of the country means heavy demand. But with crude prices down, propane and heating oil should ease, too, or at least hold steady.

If you heat with natural gas, budget for higher bills than last winter. Even before this week’s spike in gas futures prices, residential prices were running higher than last year. The Department of Energy recently forecast that U.S. households that heat with gas would pay about 5% more this winter they did last year. But that’s assuming a near-normal winter. In a colder scenario, the department projects those customers’ heating bills would jump by 16%.

Still, don’t worry too much about actual shortages. Although supplies of gas in storage are below average, output will keep growing at a steady clip as energy companies get ever more efficient at tapping into America’s sprawling gas reservoirs. It’ll probably cost more than last year, but barring a new ice age, there will be enough gas for everybody to stay warm.

Can Trump Make Coal Great Again?

After more than a year in the works, President Trump’s proposal for regulating carbon dioxide emissions from the nation’s power plants is out. His plan, dubbed the Affordable Clean Energy (ACE) rule, would impose far less stringent standards on coal-fired power plants than President Obama’s Clean Power Plan (CPP), which Trump put the brakes on. Last year, when announcing several executive orders aimed at easing government regulation of the coal industry, the president declared that “My administration is putting an end to the war on coal” – a reference to his predecessor’s regulatory approach.

First, a quick rundown on Trump’s power plant regs and how they differ from what Obama tried to do:

States would be responsible for regulating their power plants’ carbon emissions, whereas Obama’s CPP would have given each state a target for reducing emissions consistent with a nationwide goal.

Owners of coal-fired plants could improve plant efficiency to keep them running longer and get more electricity from each ton of coal burned. The CPP would have encouraged utilities to use less coal and more natural gas and renewable energy.

Carbon emissions wouldn’t decline by nearly as much as they would under Obama’s plan, but are projected to decrease modestly. Trump’s EPA projects CO2 emissions will decline by between 13 million and 30 million tons in 2025, or 1.5% of the current level, compared to no regulatory action being taken.

Coal industry supporters cheered Trump’s proposal while environmentalists jeered it. National Mining Association President and CEO Hal Quinn stated that the plan “respects the infrastructure and economic realities that are unique to each state, allowing for state-driven solutions, as intended by the Clean Air Act, rather than top down mandates. It also embraces American innovation, by encouraging plant upgrades.” Fred Krupp, president of the Environmental Defense Fund, was rather more succinct, calling Trump’s proposal “a sham” that doesn’t address the risks posed by climate change.

I’ll leave those arguments to others. But what about the practical effects of Trump’s plan, assuming it survives the inevitable legal challenges?

There’s no question that the coal industry has been hurting for a long time. Back in 2005, according to Department of Energy data, coal-burning power plants supplied 50% of the nation’s electricity. Last year: Just 30%, mostly because of mounting competition from natural gas, which has become the top fuel for power generation. In 2005, the U.S. burned a massive 1.1 billion tons of coal. Last year: Just 717 million tons, the lowest figure since the early 1980s. According to the feds, in 2005 coal mining employed about 80,000 workers. By 2016, that figure had fallen to 52,000.

Coal’s struggles significantly reduced energy-related CO2 emissions in the U.S. Shifting from a coal-heavy fuel mix to one more reliant on natural gas, which emits less CO2 than coal to produce the same amount of power, has caused the utility sector’s emissions to fall by 28% since 2005, according to the EPA.

Will Trump’s regs revive the ailing coal industry? I put that question to Joe Aldina, Director of U.S. Coal Analytics at S&P Global Platts. “In the short term, this doesn’t move the needle at all” for boosting coal demand, he says, because of the competition posed by cheap natural gas. In other words, just because utilities can more easily burn coal now doesn’t mean they will if it isn’t the most economical choice.

But Trump’s rule change “will have a modest impact in the long term” because coal usage will decline by less than what would have happened under Obama’s CPP rules. Aldina thinks that coal’s 30% share of the electricity market will decline further, but only gradually over the next several years. He also notes that while the ACE regs make it easier to upgrade existing coal-fired plants to run more efficiently and generate more power, federal regulations still effectively bar building new coal plants. And there is little sign that utilities want additional coal plants, anyway.

That means that the nation’s fleet of coal power plants will likely keep shrinking. Many were retired because of Obama’s more-stringent CO2 and air quality rules, plus the competition from natural gas. The Department of Energy expects almost 10% of the nation’s remaining coal-fired generating capacity to shut down between now and 2020. Utilities can’t build new plants (even if they wanted to), so U.S. coal consumption will probably continue slipping.

Booming Energy Output to Shrink U.S. Trade Gap

As you may have heard, international trade has become something of a heated issue. President Trump left last weekend’s G7 meeting in Canada angry over the protectionist policies of some of America’s closest allies, which he emphasized by refusing to endorse the group’s written statement on shared economic, trade and environmental aspirations. Leaders of the other G7 members – the world’s seven most advanced economies – were none too pleased themselves, blaming Trump for what they viewed as undue hostility and breaches of diplomatic protocol.

It’s a fight I’ll leave to others. Reasonable people can disagree over how fairly or unfairly U.S. exports are treated by other countries. But I will note that, when it comes to foreign sales of U.S. energy products, the future looks very rosy.

Exports of American oil, gas and refined fuels are already booming. Remember back in 2006, when President George W. Bush lamented that American was “addicted to oil,” much of it sourced from abroad? At the time he issued that warning, net U.S. oil imports—the difference between what the country imported and what it sold abroad—totaled 10 million barrels per day. Flash forward to today, and net imports have been nearly halved, to a range of 5 to 6 million barrels per day, depending on the time of year.

Soaring domestic production is the main reason that the U.S. has been “breaking” its addiction to foreign oil. But America isn’t just producing more crude; it’s exporting more, too. Crude exports have jumped from practically nothing at the time of Bush’s speech to about 2 million barrels per day. Congress lifted the decades-old ban on most crude exports in 2015, largely because domestic producers were pumping more light, sweet crude oil than U.S. refineries could process. Many overseas buyers are eager for that type of oil. And U.S. crude tends to sell at a discount to Brent, the global oil benchmark, making it even more attractive to foreign refiners.

Exports of refined fuels are going even stronger than sales of crude itself. In fact, America is a net exporter of gasoline, diesel and other fuels. Net exports of refined petroleum products hit a whopping 3.5 million barrels per day last week, according to the Department of Energy. Back when Bush warned about being addicted to foreign oil in 2006, the U.S. was a net importer of refined products, to the tune of more than 2.5 million barrels per day.

Where do all those barrels go? Mexico is the biggest buyer, followed by Canada and then China. G7 members Japan, Italy, Great Britain and France are sizable customers, too. (See a breakdown of U.S. fuel exports by destination here.)

What does this all mean for the U.S. trade deficit? At the time of Bush’s 2006 State of the Union address, oil and refined fuels accounted for 35% of the total trade deficit. By April of this year, that figure had fallen to just 10.5%, according to the Census Bureau.

Natural gas makes the trade deficit look even better. Long a net gas importer, America became a net exporter last year. And those exports are bound to keep growing as domestic gas production rises and more of that bounty flows by pipelines to Mexico and Canada, and on ships in liquefied form to customers all over the world.

Your Memorial Day Weekend Road Trip Just Got More Expensive

If you’re hitting the road this holiday weekend, buckle up for the highest gas prices in several years. AAA’s website reports that the national average price of regular unleaded gas has climbed to $2.96, the highest level since late 2014. (Of course, some parts of the country are already paying quite a bit more. The national average encompasses a wide range of prices.) A year ago, the price at the pump averaged a much more wallet-friendly $2.37 per gallon, according to AAA.

And prices probably aren’t done climbing. Last month, I warned that the national average was likely to reach $3 this spring. That likely will hit Memorial Day weekend. Crude oil prices continue edging up, but such increases generally don’t reach the pump until a week or two later.

Drivers in the West have it worst, according to AAA. In California, regular-grade gas averages a whopping $3.72 per gallon, the highest in the country. Seven Western states are averaging more than $3. The Northeast isn’t faring much better; five states there are paying $3 or more, as are three Great Lakes states (Michigan, Indiana and Illinois).

Prices are far lower in the South. Mississippi drivers enjoy the cheapest gas—an average of $2.64 per gallon. Neighboring states are similarly low.

But there is some good news: The price gains may be nearly over. Jeff Lenard, vice president of strategic industry initiatives at NACS, a trade association that represents convenience stores, says that prices tend to rise in late winter and peak around now. Whether that happens this year depends on what crude oil prices do. I believe that the rally in oil prices is almost over. If so, gasoline prices should peak soon and maybe even retreat slightly.

“Daily Drumbeat”

Even so, gas prices are certain to remain higher than they’ve been the last few years. The national average price actually dropped below $2 per gallon in early 2016 and has mostly remained closer to $2 than $3 since. Consumers no doubt enjoyed paying less at the pump. Many folks have been buying pickup trucks and SUVs instead of cars, partly because they aren’t worrying about fuel economy. And in general, spending less on a fill-up leaves money for other purchases.

A recent NACS survey shows that consumers don’t plan to cut back on driving this holiday weekend just because gas prices are up. But many respondents do plan to eat out less or cut back other spending. Gas prices aren’t necessarily the culprit, but Lenard notes that consumers “just don’t feel as good” when gas goes up. And lately, there’s been a “daily drumbeat” of news about higher gas prices: Something motorists are reminded of every time they pass their local station.

For convenience stores that sell gas, this is particularly concerning when it comes to the roughly 25% of customers who pay cash. Lenard says that those shoppers tend to allocate a fixed amount to spend at the convenience store, whether on gasoline or snacks or drinks. If filling up takes more of that cash, sales of everything else suffer. Convenience stores make only a nickel of profit per gallon of gas they sell; they’d rather you buy a sandwich or a soda than a gallon of regular.

With the overall economy doing well and summer arriving, consumer spending will likely continue at a brisk clip, despite higher fuel costs. But merchants everywhere are no doubt rooting for pump prices to level off before their customers start feeling real pain.

Gasoline Prices Nearing Multiyear Highs

If you fill up your car’s gas tank with any regularity, you don’t need me to tell you that prices at the pump are on the rise. AAA reports that the national average price of regular unleaded now stands at $2.72 per gallon, up from $2.54 a month ago and $2.41 this time last year. (That national average contains a lot of regional variability. In California, for instance, regular sells for $3.55. In South Carolina, just $2.49.)

Will the run-up keep going? And just how high will prices get?

The answer to the first question is, almost certainly: Yes. Just as surely as winter turns to spring, gasoline prices tend to start climbing around the start of the year and peak several months later. Why? Partly because refineries begin making costlier, summer-blend gas. And partly because fuel demand perks up in the spring when more folks start vacationing.

This time around, the average price bottomed out at $2.45 per gallon a week before Christmas. It’s been mounting ever since. I expect the trend to continue a while longer.

Predicting how much higher prices will go is tricky, but recent history provides some useful guidance. Over the last five years, the magnitude of the winter-to-spring jump has averaged about 57 cents per gallon. So far this spring, the national average is up 27 cents. If this seasonal pattern holds, expect another 30-cent increase, topping $3 per gallon for the first time since late 2014.

What about crude oil’s role? All things being equal, the costlier oil is, the more expensive refined fuels, such as gas, are. But note that the seasonal gas-price hike tends to play out even when oil prices aren’t on the march. Last spring, gas prices climbed by 30 cents per gallon: A 14% increase. But crude only increased by 4%.

So, even if oil prices hold steady, gasoline can, and probably will, keep edging higher. If crude rallies beyond this winter’s boost, the resulting gas-price spike will be even sharper. For instance, the spring of 2015 saw oil prices rise by $20 per barrel, which helped fuel a 68-cent jump in gas prices. Such a scenario looks unlikely this year unless some sort of geopolitical crisis interrupts oil shipments somewhere in the world.

But under any realistic assumption, gasoline will cost more in a few weeks than it does now. If your tank is getting low, now might be a good time to fill it to the brim.

What To Make Of the Oil Market Stumble

It’s not just the stock market that tumbled this week. Crude oil prices are down sharply, too. But is this the end of the “epic price rally” that I wrote about two weeks ago?

Benchmark West Texas Intermediate crude has fallen by more than 10% from its Jan. 26th peak of $66 per barrel. Much of that selloff has coincided with the sudden drop in stock prices that began a week ago. This week, when the Dow Jones Industrial Average saw its two biggest single-day point drops in history, WTI came along for the ride.

It might be tempting to assume that oil was simply part of the stock market carnage’s collateral damage. After all, as my colleagues at The Kiplinger Letter write in this week’s issue, “the economy remains on solid footing,” despite the mayhem on Wall Street. The outlook for GDP growth is solid; the economy is creating jobs at a steady clip; and most of the world’s major economies are perking up, too. So, argue the oil bulls, crude prices should bounce back as strong oil demand around the world keeps pushing up prices.

But some supply and demand data paint a less rosy picture for the oil market. For starters, the U.S.’s oil stockpile is growing again as refineries that had been running full-tilt earlier this winter to churn out gasoline and other products have slowed their operations a bit. Bigger stockpiles point to less demand for oil, which is bearish for prices.

More significantly, the U.S. is pumping more oil than ever before. The latest Energy Department data peg U.S. production at a record 10.3 million barrels per day. That vaulted the U.S. past Saudi Arabia as the world’s second-largest crude producer and to within reach of overtaking Russia for the top spot. It is highly likely that America will become the world’s largest producer of crude oil in 2018.

Let that sink in for a moment. Less than 10 years ago, U.S. output, which had been sliding for decades, was about 5 million barrels a day. Production has since doubled and is expanding rapidly. Improved drilling techniques—specifically hydraulic fracturing and horizontal drilling—have powered the turnaround and turned the U.S. into an energy superpower. Texas alone now pumps more crude oil than every OPEC member except Saudi Arabia and Iraq. If North Dakota joined the cartel, it would out-produce half of its membership. Even some lesser-known U.S. oil states, such as New Mexico and Colorado, now dwarf OPEC’s smaller countries. Expect these trends to continue as energy companies put more drilling rigs to work. (Baker Hughes, the oilfield services company, reported a sharp rise in drilling this week, with 26 additional rigs drilling for oil, plus three gas rigs.)

What does this all mean for prices? I expect extremely volatile markets in the near term. Commodities such as oil figure to get buffeted by all the stock-and-bond turmoil. But the long rally in oil that began last summer may be over. If the U.S. keeps stockpiling crude, and if output keeps ticking higher, it will be hard for WTI to surpass that $66-per-barrel peak. I look for a price closer to $60 per barrel this spring, which might be a sweet spot of sorts: High enough to encourage plenty of drilling in the U.S., but not so high that consumers feel a major pinch from rising gasoline prices.

What’s Fueling Oil’s Big Rally?

If you follow the energy markets at all, you already know that crude oil is enjoying an epic price rally. In mid-July of last year, benchmark West Texas Intermediate crude was trading at $45 per barrel. Six months later, WTI has zoomed to $64 per barrel: A heady 40% advance, which makes the stock market look positively pedestrian by comparison.

So, what gives? And more importantly, can the rally continue?

A host of factors have collided to push oil prices higher. For starters, OPEC is delivering on its promise to pump less crude and tighten the global market. Data from S&P Global Platts shows that, in December, the oil cartel actually pumped below its quota. That’s mostly attributable to a steep production decline in Venezuela, which is in the grips of a full-blown economic crisis.

There’s also the weaker U.S. dollar. Because most oil contracts are denominated in dollars, it takes more of them to buy a barrel of oil when the buck loses value relative to other currencies.

And perhaps most importantly, economic growth is picking up both in the U.S. and around the world, which points to higher oil demand ahead.

Whether prices can keep climbing will hinge largely on whether stockpiles of crude keep falling because of heavy demand and restrained OPEC production.

After setting an all-time high last March, America’s stored crude oil supplies have dwindled. That trend is accelerating, and at a time when refineries normally slow down for winter maintenance. That hasn’t happened this season, says S&P Global Platts Oil Futures Editor Geoffrey Craig. Instead, refineries have been running at full-tilt to churn out gasoline and other fuels. Why? Because of heavy demand for heating oil amid the recent polar vortex that locked much of the country in bitter cold for weeks on end, he says. Assuming the weather moderates, Craig expects refineries to stop buying up so much crude, which should allow stockpiles to rebound. The question is: How sharp will the turn-around be?

If refiners slam on the brakes and crude starts building up in storage at a fast clip, look for oil prices to retreat. Conversely, a return of severe cold will keep them running overtime, which would further drain stockpiles and probably push prices even higher.

Meanwhile, keep a close eye on U.S. oil production. Weekly data from the Energy Department have shown small but steady increases in domestic production, and the government is projecting that production will rise to a new all-time record in 2018, eclipsing the mark of about 10 million barrels per day set in 1970. (The latest DOE data peg current production at 9.75 million barrels/day.)

Will U.S. energy firms open the oil taps further in 2018? So far, the rally in oil prices hasn’t spurred additional drilling, at least according to the widely followed “Rig Count” survey published by Baker Hughes. Back in early July, when West Texas Intermediate crude was trading for $45 per barrel, there were 763 rigs drilling for oil in the U.S. Today, with WTI at $64 per barrel, there are only 747 rigs running. That supports claims from several energy companies that they are cutting their capital budgets to focus on turning a profit instead of spending heavily to goose production. Investors in the sector have applauded that cautious tack.

But if oil prices continue climbing, look for some companies to throw caution to the wind and “drill baby, drill!” That would unleash an even bigger supply increase than the DOE is expecting and weigh on prices. As a side note: S&P Global Platts’ Craig observes that energy companies are already rushing to lock in current prices via oil futures contracts. That might signal significant amounts of new crude coming to market fairly soon.

So, don’t bet too much on the oil rally just yet. High prices have a funny way of curing high prices. I look for WTI to pull back modestly this spring as refineries slow down their crude buys and American shale producers ramp up output. Of course, some sort of geopolitical shock, such as the shutdown of oil production in crisis-ravaged Venezuela, could always send the market soaring again. Or another cold spell could spur heavy demand for heating oil. But absent that sort of extraordinary event, the market looks due for a breather.

Where Do Oil Prices Go Next?

The oil market has been nothing if not volatile this autumn. At the beginning of September, the price of benchmark West Texas Intermediate hovered near $47 per barrel after spending most of the summer trading in the mid-$40s. Then suddenly, in the wake of Hurricane Harvey, WTI went on a tear, shooting up to $57 per barrel by early November: A tidy 21% gain at a time when oil demand tends to be low.

Had crude finally begun a sustained rebound after several years of depressed prices? Many oil bulls seemed to think so. Or at least, many did until earlier this week, when WTI dropped sharply after the International Energy Agency issued a prediction that global oil demand will grow more slowly next year than previously expected. Are oil prices just taking a breather before the next leg up? Or did this week’s drop mark the end of the autumn rally?

I asked two highly regarded oil market analysts that question, and got two very different answers. Stephen Schork, editor of energy investing newsletter The Schork Report, believes that the rally is “pushing up against the ceiling” and can’t last much longer. He attributes much of the price rise to speculators who have taken out long positions in oil futures, meaning they are betting heavily on continued gains. Many oil producers, he adds, are locking in today’s prices via hedging strategies: A sign that the sellers of the commodity don’t expect prices to keep rising.

Schork also notes that Saudi Arabia has been cutting its production substantially, perhaps in a bid to push up prices as it prepares for an initial public offering of part of Saudi Aramco, the state oil company. (Higher oil prices would make the Aramco IPO easier to sell to investors.)

Overall, he thinks WTI might top out at $60 per barrel. But if so, it’ll quickly retreat.

Phil Flynn, an oil analyst with trading firm PRICE Futures Group, thinks there’s room to run. Oil prices fell from $100 per barrel in 2014 to as low as $26 per barrel in 2016 because of oversupply. Now, Flynn notes, global inventories of crude oil are shrinking, which is exactly what OPEC was trying to accomplish when the cartel decided late last year to curb its collective output. The global economy is expanding briskly, which should prompt higher oil consumption. (Flynn thinks the IEA is low-balling global oil demand.) “I think we’re going to $60 per barrel,” he says; it’s just a matter of how quickly.

In the long term, Flynn sees prices rising beyond the $60-level as demand outruns supply.

Both make compelling arguments, but who is right?

I think the answer is a bit of both. It seems clear that, barring a sharp global economic slowdown, oil demand will keep growing. OPEC succeeded at reining in excess supply. Data from the IEA show that stored oil supplies stashed around the world’s developed economies have been dwindling for months (though they remain ample relative to the historic average). Strong demand and reduced supply usually push prices higher.

U.S. shale oil production is the wildcard for prices, however. American oil production has been rising steadily week by week, according to the Department of Energy’s data. Domestic output now stands at more than 9.6 million barrels per day, up almost 1 million b/d from a year ago. As I wrote last week, more and more of that crude is reaching the global market now that the U.S. allows oil exports. So, crude from Texas and other oil-patch states is just supplanting the oil that Saudi Arabia isn’t pumping, undercutting OPEC’s efforts to prop up prices.

This rally may be over. Late autumn is generally a time of weak demand in the U.S., the world’s largest oil consumer. The summer vacation driving season is in the rearview mirror. Domestic crude production looks set to keep rising. And Wall Street probably got too excited in bidding up prices. The market was due for a pullback.

But I think prices will gradually trend higher next year. WTI has averaged about $50 per barrel this year. I look for the average to run closer to $55 per barrel in 2018, though volatile day-to-day prices fluctuations will no doubt continue. I can’t rule out steeper gains, but they seem unlikely. Higher prices only serve to spur more drilling in places such as the Permian Basin of Texas. Many wells that might not be profitable at $55 per barrel start to look good at $60 or higher. And shale producers have shown they can ramp up output quickly when prices spike.

The U.S. oil industry looks well-positioned. Global oil demand will grow. OPEC will keep its output in check. U.S. production will ratchet up. And overseas demand for American crude is expanding. Simultaneously, U.S. operators are coaxing more oil from each new well in a bid to lower per-barrel production costs. Given all of that, prices won’t need to jump much to pump up energy sector profits.

 

 

U.S. Oil Exporters Cash in on Higher Prices, Strong Demand

Here’s something the oil market hasn’t seen lately: A price rally.

After falling as low as $46 per barrel on Aug. 30, when Hurricane Harvey forced Gulf Coast refineries to shut down, benchmark West Texas Intermediate crude oil has soared to about $57 per barrel. The price run-up reflects several factors: Improving economic growth around the world; hints from OPEC that its current policy of limiting crude exports will continue for longer than first scheduled; and turmoil in Saudi Arabia, where several high-ranking officials and members of the royal family have been arrested on corruption charges. (Anything that threatens the internal stability of OPEC’s largest oil producer is bound to raise concerns about potential interruptions in crude shipments.)

OPEC members undoubtedly are celebrating oil’s sudden bull market. Starting in 2014, the cartel watched oil prices tumble from $100 per barrel to as low as $26 in early 2016. Prices have since recovered in fits and starts but seemed unable to break above $50 per barrel. Originally, increased U.S. production was to blame. And American firms’ ability to keep wringing more crude from shale fields has kept a ceiling on the price recovery.

What’s good for OPEC is also good for Texas and North Dakota. Why? Because U.S. energy firms are filling the void in the global market left by OPEC. Pumping fewer barrels has helped lift crude prices, but the barrels that OPEC isn’t selling are increasingly being supplied by American wells instead.

Last week brought a milestone for the U.S. energy industry: Exports of American crude oil jumped to 2.1 million barrels per day, the highest level on record and the first time that daily exports topped the 2 million-barrel mark. That underlines the trend of steadily rising exports that began after Congress lifted a ban on U.S. oil exports in late 2015.

The U.S. is still a net importer of oil. Daily production of about 15 million barrels of crude and other liquid fuels is nowhere near enough to satisfy demand of roughly 20 million barrels. So why is American oil departing the country for overseas markets?

Not all oil is equal. And American barrels are highly sought overseas. Much of the shale oil bounty unleashed by advances in hydraulic fracturing and horizontal drilling is “light and sweet” crude, meaning it is low in density and sulfur content. Many refineries around the world covet such grades of crude, whereas many U.S. refineries are designed to process heavier, “sour” grades with higher sulfur content.

Also, not all oil costs the same. American oil enjoys a distinct cost advantage over foreign rivals. The most familiar American crude benchmark, West Texas Intermediate, currently trades at a wide discount to Brent, the most prominent global benchmark.

That price “spread” makes it cost-effective to export more U.S. crude. In a recent webinar held by S&P Global Platts, Associate Editorial Director Matthew Cook estimated that it costs about $2 per barrel to export American oil to Europe. The price gap between WTI and Brent of $7 per barrel makes such a sale highly profitable for firms able to take advantage, such as BP and Trafigura, two of the biggest crude exporters operating in the U.S.

Given the favorable economics of exporting, expect more U.S. barrels to flow from the Gulf Coast to Europe, Asia and elsewhere. S&P Global Platts Managing Editor John-Laurent Tronche says that ports such as Corpus Christi, Texas, can ship out even more and are racing to add to their export capacity. Today the U.S. can export up to 2.7 million barrels of oil each day, comfortably above last week’s record-high level.

The combination of higher prices and strong exports is especially good for companies operating in the prolific Permian Shale basin of West Texas. S&P Global Platts estimates that a new well can break even in the Permian when oil prices are as low as $30 per barrel. Today’s $57 price makes many Permian wells quite profitable. And the Permian region is connected to Gulf Coast ports by an extensive pipeline network. Not surprisingly, production is growing fast in the Permian.

Of course, today’s profits can evaporate tomorrow if oil prices suddenly retreat. And the oil market has been nothing if not volatile recently. In my next issue, I’ll look at this rally’s durability and where prices are headed.