Crystal Ball Shows Better 2015
For the past five or six years, I have been making annual energy market predictions. I am generally happy if I can hit on 60% to 80% of them. In 2014 I went 5 for 5, but I can say with a fair amount of confidence that this is a feat that’s unlikely to be repeated in 2015.
The reason is that I see a lot of uncertainty in the energy markets at this point. There are many changing variables right now, and the direction on several fronts is unclear. And if you look at some of the predictions others have made, that becomes obvious. I have seen people predicting $30 per barrel (bbl) oil and $100/bbl oil, and some suggesting that we would see both extremes. I have also seen people predict that oil production will decline in the U.S. after rising for six straight years.
Nevertheless, it’s time to take a stab at 2015. I will offer up my predictions, and explain the reasoning behind them. Understanding the narrative around the prediction can be more important than the prediction itself, because that can better prepare you for reacting to changing market conditions. This year I am going to offer six predictions.
I strive to make predictions that are specific, measurable and preferably actionable. If predictions are broad and vague, one can almost always declare victory. For instance, consider a recent prediction I saw that oil prices will firm up in 2015. Firm up from where? From the yearend price? What if they fall another 20% first? Such predictions have limited utility in my view. So I strive to make sure that mine are specific enough that at the end of the year there is no room for interpretation. They are either right or they are wrong.
There are a number of things that I think are likely, but not so likely that I will make them official predictions. Since I think natural gas prices will be softer, I think we may see gas production fall for the first time in 10 years. I also think lower natural gas prices are going to result in a slowdown in the growth of renewables like wind and solar power.
I think OPEC is going to come under tremendous pressure internally to make substantial production cuts, and I expect the group to announce a production cut of at least a million barrels per day. I think there is a high likelihood that the new Republican majority will push through several key energy bills (approving the Keystone XL Pipeline, for example), but whether they survive a presidential veto is a different story. So while I still don’t think the crude oil export ban will be overturned this year (a correct prediction from last year), I don’t have a high enough level of confidence to make that a prediction.
I think that when BP (NYSE: BP) releases its 2015 Statistical Review of World Energy, we will once again see records set in the consumption of all the major fossil fuels, and once again we will see a new record for global carbon dioxide emissions. We will also see new records for renewables, but the pace of growth in renewables will continue to be insufficient to keep pace with growth in the world’s energy demand.
I believe that low oil and gas prices that may linger into the summer are going to seriously distress many of the smaller, highly leveraged producers, and you will see a number of names scooped up by the more financially stable players like EOG Resources (NYSE: EOG) or ConocoPhillips (NYSE: COP).
I also think we will see another publicly traded advanced biofuel company go bankrupt. I am thinking of a particular company, but it’s in somewhat better financial shape than KiOR was, and so might last beyond 2015. But it’s unlikely to make it another three years.
So those are some of the things that I believe will happen, but here are my official predictions, along with the necessary context.
1. The closing price of West Texas Intermediate (WTI) crude will not fall below $40/bbl in 2015.
The price of West Texas Intermediate (WTI) crude was in freefall during the second half of 2014, and it isn’t clear that the drop is over. WTI closed the year at $53.27/bbl, but due to a strong first half of the year the average for the year was $88.80/bbl. As I write this, WTI has dipped into the $40’s. Barring a major international development that rocks the crude oil markets, prices probably aren’t going to begin to recover until the second half of the year. I think it’s a no-brainer that crude oil prices will average less in 2015 than in 2014, but the average relative to the year-end price is a much more difficult question.
Nevertheless, I believe we are close to bottoming out. It is true that in 2008 WTI did drop into the $30s, and a number of pundits (and some technical indicators) have suggested this will happen again. But this isn’t 2008. Most of the production that has been added around the world since 2008 has been shale oil. Much of that isn’t economic at current prices, and we will see production respond to that. I believe this will put the brakes on the decline soon, and that oil prices will bottom out above $40/bbl. (However, this is also a prediction that could prove to be wrong relatively quickly at the rate crude has been dropping).
If oil does drop below $40/bbl, that will represent the sort of buying opportunity that rarely comes around. A little patience may be required, but if you can pick up oil stocks with their principal product that cheap, they should prove a real bargain in the long run.
2. West Texas Intermediate (WTI) will average more than $60/bbl on a daily closing basis.
If we look at the current futures curves, every month in 2015 currently has WTI priced near $56/bbl, plus or minus $3/bbl. However, I believe the market has overshot to the downside, and that fundamentals based on the production cost of the shale oil added over the past five years support WTI at around a $70/bbl floor. It may not happen in 2015, but I do think we will see $70/bbl as a reasonable floor price over the next one to two years. When oil prices do begin to recover, probably in the second half of 2015, speculators will begin to pile back in and we will likely see prices overshoot to the high side. I can see oil trading back up to the $70-$80/bbl range in 2015, and I believe that most of the year will be spent above $60/bbl (but it may be summer before we get back to that level).
3. The average Henry Hub spot price for natural gas will be below $3.50/MMBtu in 2015.
A month ago I was getting ready to make the bold prediction that we would see natural gas drop below $3/MMBtu in 2015, and that after 2 years of increasing natural gas prices, 2015 would see prices trend back down. But natural gas has been in freefall lately, and the price has already dipped below $3.
The handwriting has been on the wall on this for a couple of months. At the end of the last year’s withdrawal season in early April, natural gas inventories had been drawn down very low due to the unusually cold winter. If natural gas demand in the summer was normal or high, natural gas producers would have struggled to replenish inventories. Instead, we had a mild summer in the U.S., and by the time injection season ended in early November inventories had almost recovered to normal.
So that shifts short term natural gas prices back to the severity of the winter. If we have another extremely cold winter, we will see depleted inventories and higher natural gas prices. But a normal or mild winter could send natural gas prices back down as there is enough supply to cope with those scenarios. Thus, two of three possible winter scenarios would likely result in lower natural gas prices since natural gas inventories are in decent shape, and that was the call I was prepared to make. In fact, I had alluded to this in a couple of interviews since November.
But the market reacted before I got my prediction in. The average closing Henry Hub price for natural gas in 2014 was $4.37/MMBtu. The price on the last day of 2014 had plummeted to $2.89/MMBtu. So, the odds are extremely high at this point that natural gas prices will average less in 2015 than they did in 2014. Unusual weather can always upend these short term predictions, but right now the outlook is for lower natural gas prices with the potential — in the case of a particularly mild winter — of revisiting the sub-$2/MMBtu prices of April 2012.
I won’t go so far as to say we will see those prices, as it would require a particularly mild winter. But after two years of higher prices, we will see lower natural gas prices in 2015. Since the year has already started out under $3/MMBtu, I need to be a bit more aggressive than “natural gas will average less in 2015 than in 2014.” In fact, I think it will average less than in 2013 ($3.73/MMBtu) or 2014. The futures curves presently anticipate natural gas reaching $3.80 this year, but my bet is that we average under $3.50/MMBtu in 2015.
I am still bullish longer term on natural gas, but I believe the next one to two years will be challenging.
4. US crude oil production growth will probably slow, but will still expand for the seventh straight year.
After U.S. output rose at a record pace for the past two years, many pundits were projecting that the U.S. could become the world’s top oil producer by the end of 2015. Indeed, if the pace of recent production increases continued, the U.S. would pass Russia in 2015 and Saudi Arabia in 2016.
The price plunge will all but ensure that this won’t happen. While some have suggested that U.S. oil production could decline in 2015, price signals don’t have a significant effect on production that quickly. The oil that will be produced in 2015 is a result of wells that are already producing, or that are near completion. The capital budget cuts that have been announced won’t substantially affect production until two or three years down the road. There will likely be some slowing of production next year as there is insufficient incentive to produce all-out at these prices, but the major slowdown won’t take place in 2015.
5. The Energy Select Sector SPDR ETF (XLE) will rise at least 10% in 2015.
I don’t expect energy stocks to begin to rebound for a few months still, but in the second half of the year I expect money to begin flowing back into the sector. The Energy Select Sector SPDR ETF (XLE) declined 9.3% in 2014 as a result of weakening oil and gas prices, and it could have a bit further to go. But the energy sector doesn’t often have two bad years in a row. In the past decade, 2008 was its only losing year, and it was followed by a double-digit gain in 2009. The only caveat is that oil prices fell into the $30s by the end of 2008, and had suffered an even steeper decline than we have seen with the 2014 collapse. So there could be a bit more downside from here, but I believe — particularly for investors with a longer time horizon — the upside outweighs the downside and we will see that starting in 2015.
6. BP will be bought out or merged in 2015.
This is my most aggressive, wild card prediction for 2015. I first suggested this in a 2010 article shortly after the Deepwater Horizon oil spill in the Gulf of Mexico. Historically, companies have a difficult time recovering from a monumental disaster. The corporate brand will be damaged for a very long time. Twenty-five years after the Exxon Valdez oil spill in Prince William Sound, Alaska, I know people who still won’t buy gasoline from ExxonMobil (NYSE: XOM).
While that incident didn’t fatally hurt ExxonMobil, there is no question that long-term earnings were hurt. ExxonMobil rivals like Chevron (NYSE: CVX) continue to outperform the company.
ExxonMobil stayed the course, withstood the public outrage and the legal fallout, and is certainly not in danger of extinction today. But most companies will find that it is better to start fresh under a new name.
While it was without a doubt a disaster with a higher immediate human cost, the case of Union Carbide may be instructive. In 1984 an accident at a Union Carbide plant in Bhopal, India immediately killed 2,259 people, but it has been estimated that ultimately more than 15,000 people died as a result of the disaster. This tragedy destroyed Union Carbide’s reputation. It continued to function as an independent company for a number of years as the inevitable lawsuits played out, but this former component of the Dow Jones Industrial Average was ultimately swallowed up by Dow Chemical (NYSE: DOW).
I see a similar fate for BP. It might not happen as soon as 2015, but the company continues to suffer legal setbacks, its total liability for the Gulf spill is still uncertain, and its reputation in the U.S. is forever damaged. The carefully crafted image – rebranded “Beyond Petroleum” from British Petroleum — now looks like a joke given two major disasters suffered by BP in the past 10 years. (The other being the 2005 Texas City explosion that killed 15 people and cost BP well over $1 billion in compensation to victims.)
BP is already morphing into a different company than it was in 2010. Bits and pieces continue to be sold off, including that Texas City refinery where the explosion took place in 2005. The company’s market capitalization has been nearly halved in the past six years. But the BP name is still around.
So I predict that BP will not end the year as BP. I believe it will be sold or merged. Royal Dutch Shell (NYSE: RDS-A) has been mentioned as a potential suitor. BP and its near $120 billion market cap would be a huge meal to digest, and the integrated supermajors like Shell, Chevron, and ExxonMobil are the only realistic suitors outside of partially state-owned oil companies like PetroChina or Russia’s Lukoil, which would encounter stiffer political opposition.
It’s possible the BP will survive as ExxonMobil did, but it still has a tough road in front of it.
I will be going out on a limb on this one, as I did when I (correctly) predicted last year that KiOR would declare bankruptcy. But this is the prediction with the highest likelihood of being wrong, just based on the timing. While I feel that the odds favor a buyout or merger, it’s much harder to predict that this will happen in 2015.
There you have my predictions for 2015. As far as confidence level, I think the one on low natural gas prices is the most likely, and the one on BP being bought out in 2015 the least likely of the group, but only because it might take place later. There is a great deal of uncertainty around the rest of them.