Five energy surprises for 2016: The possible and the improbable

Originally posted on resourceinsights.blogspot.com

By Kurt Cobb

Many energy analysts like to make predictions at the end of the year for the coming year. Instead, I'll point to five possible surprises in energy--surprises because few people expect them to happen. I am not predicting that any of the following will happen, only that there is an outside chance that one or more will occur. Naturally, these surprises would move markets and policy debates in unexpected directions.

1. Crude oil ends 2016 below $30 per barrel. With oil hovering in the mid-$30 range it doesn't seem implausible that at some point in the not-to-distant future, crude oil will dip below $30 per barrel, if only briefly. What would surprise most people is if the crude oil price finished next year below $30 per barrel. The conventional wisdom is that cheap oil is giving a boost to the economy that will lift worldwide economic growth and thus demand for oil. There is also a belief that high-cost producers will simply have to stop drilling new money-losing wells after more than a year of financial Armageddon in the oil markets. This will bring down supply just as economic growth is rising, sending prices much higher as the year progresses.

The alternate view is that oil in the mid-$30 range is a reflection of an economy that has been weakening since the middle of 2014 and foreshadows a worldwide recession which should hit in full force by the end of 2016. In addition, with Iran almost certain to add to the current oversupply as sanctions are lifted and with the continued determination of OPEC to destroy the viability of tight oil deposits in the United States, the oil price could surprise on the downside, even testing $20 per barrel.

2. U.S. natural gas production declines. Despite persistent low U.S. natural gas prices, U.S. production has continued to grow. Most of the growth has been coming from two places: the Marcellus Shale where ample deposits continued to be economical in the range of $3 to $4 per thousand cubic feet (mcf) and Texas where furious fracking for oil locked in deep shale deposits also produced associated natural gas without concern for the price of that gas.

With oil drilling across the United States in precipitous decline because of low oil prices, we won't see nearly as much new natural gas associated with oil drilling as we saw in 2014 and 2015. With natural gas now hovering around $2, even the very sweetest of the sweet spots in the Marcellus are unlikely to be profitable to exploit.

Having said all this, U.S. natural gas production growth has continually defied predictions that it would dip in the face of low prices. Part of this had to do with desperate drillers carrying heavy debt loads who had to produce gas at any price in order to pay interest on that debt.

3. Several approved U.S. liquefied natural gas (LNG) export projects are postponed or abandoned. One of the memes of the so-called shale gas revolution was that the United States would produce far more natural gas than it consumes and that that would open the way for liquefied natural gas exports to other energy-hungry countries. Two things went wrong. First, U.S. production, while growing, has not exceeded U.S. consumption. Despite the highest natural gas production in history, the United States had net imports of natural gas of about 3 percent of its consumption so far this year.

Second, with the price of landed LNG around the world between $6 and $7, LNG exports from the United States are currently uncompetitive. Even with U.S. natural gas at $2, when the cost of liquefying and transporting gas--about $6 per mcf--is added to the American price, landed LNG prices would have to rise to about $8 just for American suppliers to break even. And, of course, just breaking even is not a proposition investors are very much interested in.

Now, some of the export projects have already undoubtedly received commitments from buyers to take U.S. LNG under long-term contracts, usually priced at Henry Hub plus a certain amount for liquefying and transporting the gas (plus something to reward investors, of course). If those contracts are in place, then the builders of the LNG export projects don't care what U.S. prices are. They make money no matter what. And, it doesn't matter whether they export so much LNG that the United States is forced to IMPORT more from Canada via pipelines or possibly in the form on LNG itself.

Whether buyers make out under such an arrangement will all depend on how world spot LNG prices unfold over the next couple of decades. Undoubtedly, many of those with long-term contracts today would be better off buying in the spot market. But, of course, when prices are high, they have no protection.

What we'll find out this year is which projects have contracts from buyers and which do not. The ones that do not yet have such contracts will almost certainly be postponed or abandoned. For those that proceed, investors who are not careful to understand how much of the capacity of the project has been taken up by long-term contracts and how much will be sold on the spot market may be in for rude surprises if they are too exposed to the spot market and that market remains soft.

4. Bipartisan support for climate change measures emerges in the U.S. Congress. You will certainly think I'm reaching here, and it would be a surprise if this does happen. But expectations for the recent climate conference in Paris were extremely low. And yet, world leaders hammered out an agreement that committed the parties to emissions limits with regular reviews. True, there is no enforcement mechanism. But even so, this result was better than most anticipated.

The same could go for a U.S. Congress stalemated on the climate issue. Even though the Republican majority has taken the view that regardless of the science, Republicans are better off opposing any measure to address climate change, not all Republicans have taken this extreme position. If enough of them peel off and join Democrats on even a small measure, it will mark progress--though it will certainly be a surprise coming in an election year.

5. World oil production declines. In the past world oil production has declined only during recessions or once in the early 1980s following a long period of rising prices and the most severe recession since World War II (that is, until 2008). We've had a long period of price rises from 2000 onward, followed by a severe recession. But production continues to eke out some growth.

According to figures from the U.S Energy Information Administration, worldwide production of crude oil including lease condensate (which is the definition of oil) grew by 15.7 percent in the nine-year period leading up to 2005. In the nine-year period from 2005 to 2014, production grew only 5.3 percent despite record prices and investment.

If worldwide production declines, it will almost surely be because drillers simply lay down even more rigs and companies delay development of tar sands mining projects in Canada to wait for higher prices. This restraint would have to counterbalance additions to world production expected from Iran which will have sanctions lifted in 2016 allowing it to increase its oil production and exports substantially. If peace breaks out in Libya, then the rise in Libyan oil production will probably prevent an overall decline in world production.

Recap of 2015's list of possible surprises

1. U.S. crude oil and natural gas production decline for the first time since 2008 and 2005, respectively. While U.S. crude oil production in 2015 looks like it will exceed total production in 2014, production began to slide in June this year and continues downward. So, there was a surprise for those who thought the so-called shale revolution could go on without high prices. Natural gas production continued to rise so there was no surprise there.

2. World crude oil closes below $30 per barrel. This hasn't happened yet and probably won't with only a few days left in 2015. But a price in the mid-$30 range has certainly surprised a lot of people, especially those who were touting the midyear recovery of prices to around $60 as the beginning a new oil bull market. So, this did come as a surprise, but not quite (yet) the $30-per-barrel variety.

3. Developments in solar thermal energy show that it can solve the storage problem for electricity from renewable energy. Perhaps the biggest obstacle to broader use of electricity generated by renewable energy is the high cost of storing that energy for use when people need it. A Maryland inventor is still trying to put together funding for a prototype of a possibly revolutionary solar thermal capture device that he claims has 90 percent efficiency. There's no prototype yet. Perhaps in the coming year we'll find out whether the claim can be confirmed. So, no surprise here yet.

4. A climate agreement in Paris calls for binding greenhouse gas emissions limits. Okay, the greenhouse gas limits weren't binding. And, of course, that's not a surprise. What surprised me is how unanimous the world's leaders were about the problem of climate change and how specific they were about limits in the agreement.

5. Oil prices reach $100 per barrel before December 31, 2015. This possible surprise was premised on a robust world economy and an OPEC relenting on its war on frackers in America and tar sands in Canada. The OPEC war continues, and the world economy seems weaker at year-end than when it began.