Low Energy Prices – Will They Continue?

by Elliott Morss, Morss Global Finance

Introduction

As Table 1 indicates prices of the world’s leading energy sources fell precipitously in 2015 and 2016. Recently, they have rebounded a bit but are still 50% less than what they averaged during the 2010-14 period.

Table 1. – Prices of Leading Energy Fuels

Source: IMF WEO Database

The reasons, while complex, are easily stated:

• A surge in energy production and
• Reduced energy demand.

Below, details are presented along with predictions on what the future holds.

Increase in Energy Production

As Table 2 indicates, US oil production has surged in recent years because of the shale boom. In addition, anyoption points out that major oil exporters like Saudi Arabia and Iraq have been consistently producing crude oil at high levels. The core members of the OPEC (Organization of Petroleum Exporting Countries) have sustained their oil production at the same level throughout 2015 despite declining oil prices in an effort to retain or increase market share. Beyond the huge US production increase, it is noteworthy that production in Iraq, Canada, and the UAE also increased dramatically. Despite these production jumps, total production grew by only 5.8% in this period or by a compounded annual rate of only 1.42%. The EIA does not have final 2015 production data, but the OPEC Monthly Oil Market Report indicates production grew by only 1% in 2015.

The oil production of Libya, Nigeria, and Venezuela are also included in Table 2. These are countries in political and economic disarray. Venezuela has the largest oil reserves of any country (298 billion barrels vs. 268 bbl. of Saudi Arabia) but has food shortages, Nigeria is battling Boku Haram, and Libya has its own terrorists to deal with. Anything could happen in these countries with a resulting significant impact on global oil supplies, such as what has already happened in Libya.

Table 2. – Oil Production, 2010-14 (thous. barrels/day)

Source: US Energy Information Administration (EIA)

Table 3 gives another interesting breakdown on energy supplies. Most notable are the production growth rates projected for India, China and the US. However, the compounded annual growth rate for India is somewhat misleading inasmuch as its production is only one quarter of its consumption.

Table 3. – Total Energy Production (mil. tons oil equivalent)

Source: BP Energy Outlook 2035: February 2016

The conclusion to be drawn from these data: the production of oil and other energy sources has grown only modestly in the 2010-15 period, and certainly not enough to cause prices to plummet by the amount they have. There are serious political and security problems in many of the major oil producing in countries meaning a significant supply disruption could take place at any time.

Declining Demand

We hear a lot about slowing economic growth rates contributing to lower demand for oil. And certainly, as Table 4 indicates, there have been problems for certain countries and regions. However, the global growth rate continues strong, held up by the growing demand of middle classes in emerging markets.

Table 4. – GDP Growth Rates, Constant US$

Source: IMF

China’s economic slowdown in 2015 was a significant factor impacting global oil prices since it is now the largest importer of crude oil. According to OPEC data, China’s oil import growth rate has fallen from an annual growth rate about 4% for the 2012-14 period to just under 3% for 2015-16 period. The economic slowdowns in Japan and Europe have also contributed to the decline in oil demand. Overall, OPEC projects oil demand to grow by only 1.3% in 2016. The laggards are Europe (0.1%,), Latin America (-0.2%), and the former Soviet Union states (0.9%). India’s demand is expected to increase 5.7% and China’s 2.6%.

The Energy Mix

In a recent report, British Petroleum made projections of energy use by type of fuel from 2015 to 2020. It is notable that the uses of all types of fuel, including coal, are projected to increase between 2015 and 2020. Renewable use will grow most rapidly, but only from 3% to 4% of the total.

Table 5. – Energy Use by Type of Fuel, 2015-20

Source: BP Energy Outlook 2035: February 2016

^ Includes oil, biofuels, gas-to-liquids and coal-to-liquids.

* Includes wind power, solar electricity and other renewables.

Predictions

1. International Energy Agency

The prospect of oil prices remaining low for an extended period cannot be ruled out. In the Low Oil Price Scenario, a new oil market equilibrium emerges at prices in a $50-60/bbl range that last until well into the 2020s before edging higher to $85/bbl in 2040.

Lower prices stimulate oil use and diminish the case for efficiency investments and switching to alternative fuels. Some $800 billion in energy efficiency investments from the New Policies Scenario fail to materialize over the period to 2040. Without additional policy efforts, low oil prices could lock in a less efficient and less climate-friendly capital stock that leads to higher long-term emissions.

2. EIA

EIA expects global oil inventory draw downs to begin in the third quarter of 2017, contributing to price increases expected to accelerate later in 2017. Brent prices are forecast to average $52/b in 2017, $1/b higher than forecast last month.

3. OPEC

Political disruptions and disasters, such as the recent wildfires in Canada will occur. As a result of the fires, more than 1.5 mb/d of the region’s 2.5 mb/d capacity is now offline. Fires have also affected expected production in Azerbaijan and in Mexico. Hedging is also likely to influence oil supply developments for US onshore production. And investments in currently producing non-OPEC oil fields are forecast to fall to levels last seen in 2005.

4. Others

Global energy giant British Petroleum anticipates the price of oil to range between $50 and $55 during 2017. According to reports from BBC, Goldman Sachs has also forecast the oil price to remain around $50 for the rest of 2016 and see it rising to $60 a barrel by end of 2017. The analysts from Citigroup have also stated that oil production will decline for a period with spot prices reaching as high as $65 a barrel by the end of 2017. Citigroup has also mentioned that it has only 65% confidence in the price path, since they fear a possibility of output hike once the price increases from $50 to $60.

According to anyoption, “Oil prices are heading higher due to the decline of crude the oil supply in US and other oil producing countries like Nigeria and Venezuela”.

Investment Implications

The fossil fuel price collapses have opened up new investment opportunities. The oil industry has reacted cutting way back on investments, some of which is reflected in the dramatically reduced drill rig counts (Table 6).

Table 6. – Drill Rig Counts

Source: OPEC Monthly Oil Market Report

This means supplies will be lower than earlier thought going forward. In addition, lower petroleum prices have caused Westerners (at least Americans) to buy more gas guzzling SUVs and pickup trucks. This means greater demand for petroleum than earlier. And more disasters/political problems resulting in further supply disruptions are likely. Are all of these elements currently captured in oil prices/equities? No. Prospects for the oil industry look better than they have in some time.

On the other hand, it will once again be a tough time for renewables until fossil fuel Prices recover.