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A Happier New Year for Energy

By Robert Rapier on January 6, 2016

When I made my annual energy predictions a year ago, I noted that I foresaw a “lot of uncertainty in the energy markets” and indicated that “the direction on several fronts is unclear.” That certainly proved to be the case as numerous pundits missed on their oil price predictions.

Unfortunately, the market uncertainty is carrying over into 2016. This has implications for several predictions so, as I cautioned last year, it will be a challenge to repeat the perfect record I posted in 2014.

As a reminder, I strive to make predictions that are specific, measurable, and preferably actionable. If forecasts are broad and vague, one can almost always declare victory.

For instance, I recently saw a prediction that wind and solar power will grow robustly in 2016. A prediction without defined measurables has limited utility in my view. At the end of the year, “robustly” gives the prognosticator an awful lot of leeway to declare victory. What if solar grew rapidly through May and declined the rest of the year? The prognosticator can still declare the prediction to be true. He could declare victory in just about any case except a protracted and extended decline in solar power capacity — something that is extremely unlikely. I might as well predict that the average price for oil will be between $20/bbl and $150/bbl. That sort of vagueness is what I find wrong with many predictions.  

So I try 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. As always, the context is more important than the prediction itself, because context allows one to adjust one’s own views as events play out during the year. I may predict an oil price, but I also try to provide context as to what could go wrong with a prediction, so that readers can adjust their own expectations should that scenario materialize.

So here are my five predictions for 2016 along with the essential context. 

1. U.S. oil production will suffer an annual decline for the first time in eight years

I have noted in the past that President George W. Bush, largely viewed as a friend of the oil and gas industry, presided over annual declines in U.S. oil production in each of his eight years in office. Ironically, President Obama — whose policies have at times seemed openly hostile to the industry — has seen U.S. oil production rise in each of his seven years in office. It just so happens that President Obama’s terms have coincided with the shale oil boom in the U.S., even though the roots of that boom predate his first administration.

In any case, U.S. oil production has expanded dramatically since Obama took office. But that shale oil boom was driven by high oil prices, and while the collapse in oil prices has consumers smiling as they fill up their tanks, it began to affect U.S. oil production in 2015. Oil production still increased for the year as a whole, but the decline that began just before mid-year is likely to continue into 2016.

The main risk to this outlook would be a first-quarter spike in oil prices. There are a number of oil wells that have been drilled but not completed as a result of the depressed oil prices. In the unlikely event that oil prices rise to, say, $60/bbl within the next couple of months, oil producers would rush to bring these unfracked oil wells online, and that could yield production growth from 2015. But don’t bet on that happening.

2. The closing price of the front month West Texas Intermediate (WTI) crude contract will reach $60/bbl in 2016.

As I write this, the most recent closing price of the front month contract for WTI — for February 2016 delivery — was $36.14/bbl. Also as I write this, the highest price on any contract expiring this year is at $43.73/bbl, for December. In fact, you can go all the way out to December 2024 and the highest futures price you can currently find for WTI across this eight-year range is  $56.07/bbl.

I am pointing all this out to emphasize that, despite the fact that oil prices were at $100/bbl just 18 months ago, this is an aggressive prediction. It will require a gain of 66% from the current price in order to be proven right.

This is one of those that I will grade on a curve. If prices fail to crack $50/bbl this year (still 38% above the current price), then I will consider this a complete failure. I would give myself a C if the price reaches $55/bbl, and a B if the price reaches $58/bbl.

I think it’s much more difficult to attempt to pick an average price for WTI this year, because there is so much uncertainty around how long it will be before prices begin to recover. I am betting that happens by the second half of the year, and when prices move up I believe they will move up quickly. But I also believe there will be a lot of resistance as prices approach that $60 level given the number of drilled but uncompleted wells.

3. U.S. natural gas production will suffer an annual decline for the first time in 11 years

The average price for natural gas in 2015 was $2.62/MMBtu, down $1.75/MMBtu from 2014. It seems likely that natural gas prices will spend this year mostly between $2/MMBtu (approximately the current price) and $3/MMBtu. My intention had been to make a prediction on natural gas prices, but there seem to be few potential catalysts that might push prices either much higher or much lower, making a prediction on the price too much of a coin flip.

When the final numbers are tallied, U.S. natural gas production will have set another record in 2015 — the 10th straight annual increase. Natural gas in storage recently topped 4 trillion cubic feet for the first time ever, and these reserve volumes remain above the top of their five-year range. The high inventory levels are helping to depress the price and they are likely going to keep it from rising too high this year. The last time natural gas prices spent significant time in the $2/MMBtu range was 2012, and natural gas production responded by flattening for more than a year. So even though every month in 2015 had higher production than the corresponding month in 2014, I expect the current stretch of low prices to reverse that trend in 2016. I don’t expect a huge decline, but I think this year we will see the impact of lower prices on natural gas production after a decade-long expansion.    

4. The Energy Select Sector SPDR ETF (XLE) will rise at least 15% in 2016.

This was my worst miss of 2015, as I called for the ETF to rise 10% for the year. Instead, it fell 24.7% as the slump in oil and gas prices persisted all year. There is no question in my mind that oil prices will rally from where they are. But there is some question as to whether that will happen early enough to lift the fortunes of oil and gas companies in 2016. I think we are likely to see prices remain depressed for another six months, and there is some downside risk for oil prices as crude oil inventories continue to rise.

Nevertheless, fundamentals will ultimately win out, and I think we will see the industry’s prospects start to improve before the end of 2016.

5. Hillary Clinton will win the 2016 presidential election.

Eight years ago I told a skeptical relative that I thought Barack Obama would beat Hillary Clinton to the Democratic presidential nomination and go on to win the general election. I do not expect the same sort of upset by Bernie Sanders. I predict Clinton will win the Democratic nomination and the presidency.

The reason this matters is that Democrats and Republicans tend to advocate very different energy policies. Republicans are friendlier to the oil and gas industry, while Democrats generally lean toward renewables. We saw this play out in the spending bill adopted at the end of 2015, when Republicans won an end to the crude oil export ban in exchange for an extension of tax credits for wind and solar power.

I have friends and acquaintances across the political spectrum, and some have sworn to me that Bernie Sanders will win because the country is very angry. I have also heard some insist that Donald Trump will win on the same basis. I don’t think either of these candidates can win the general election, unless they end up running against each other. I just don’t see it happening. Expect President Hillary Clinton to pursue energy policies similar to those pushed by the Obama Administration.         

Conclusions

There you have my predictions for 2016. I believe the drop in oil production is the most likely to be proven correct, and the one on the 15% rise in the XLE is the diciest. My overall confidence level for my predictions looks something like this:

Lower oil production >Hillary wins>Lower natural gas production>Oil reaches $60>XLE returns at least 15%.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

 

 


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  1. avatar
    Bruce Hausman Reply January 20, 2016 at 5:39 PM EDT

    If Hillary wims you can kiss this country goodbye. She’s Just Obama in a dress.
    Even my Democratic friemds do not like her.