Finance News

Summer Is Producing Divergent Energy Trends

Crude Oil:

The forces driving crude oil prices are certainly confusing. As we pointed out last month, the reopening of the U.S. economy continues, albeit bumpy. Numerous states that reopened and whose economies were trending upward, were forced to retreat when coronavirus outbreaks emerged. The number of new cases has climbed nationally, partly due to increased testing, but also because people failed to practice social distancing. These backward steps have hurt the trajectory of oil demand, although air travel surprisingly seems to be steadily increasing. Around the world, various countries that were early in facing the COVID-19 virus, and beat it down, are now experiencing upticks in cases, raising concerns about a second wave of infections. Their governments are responding by reinstituting partial lockdowns, which will not help oil demand’s recovery.

ScreenshotImage SummerOilGasWhile demand remains uncertain, the trajectory is higher. This increases the pressure on successfully managing crude oil supply. Oil prices remain in a narrow range just over $40 a barrel. Price stability has been helped by OPEC members adhering to their reduced output quotas. As the organization debates increasing its output further, it remains frustrated by the continued cheating of several members. Stories of U.S. producers restarting shut-in wells from March and April further frustrates OPEC seeking to lift oil prices to help members meet their budgetary needs. OPEC’s frustration over producers’ willingness to restart production at such a low oil price reflects their failure to appreciate how low operating expenses for these wells are, making them profitable at current prices. What we haven’t witnessed is an uptick in new oil well drilling, which is highly sensitive to current oil prices, and importantly, projections for future prices.

Saudi Arabia has recently said it expects global oil demand to reach 97 percent of pre-COVID-19 levels, or only a 3-million-barrel shortfall by December. However, other energy researchers predict the slowing of economic activity will hold demand 7-9 million barrels below last January’s level. A 4-6-million-barrel demand gap could be the difference between prices in the $40s or maybe $60s. We likely need another month of data before having confidence in which outcome will prevail.

Screen Shot 2020 08 28 at 3.58.31 PMNatural Gas:

The optimism for higher gas prices that emerged last month seems to be in control of the market now. In the past month, helped by a heat wave that swept across the U.S., natural gas futures prices jumped by roughly 45 percent. Moreover, this momentum continues, as reflected in the natural gas futures price curve. The price for January 2021 gas, in the height of winter’s heating demand, points to a further 35 percent gain. If we view the futures price a year from now, they are trading around $2.80 per thousand cubic feet, nearly 16 percent higher than now. Although 12 months away, the tone of the gas market is encouraging for producers.

Has something fundamentally changed to drive gas prices up? Or, is it merely speculation? The answer to both questions is yes. After years of dismal gas prices due to surging supplies, market fundamentals are changing. Lower crude oil prices, and the prospect they remain low well into 2021, is taking a toll on associated natural gas output from oil wells.

ScreenshotImageSummerOilGasThe old mantra that the cure for low commodity prices is low commodity prices seems to be working. Low gas prices discourage explorers from seeking new supplies. However, the significance of associated natural gas output, which is tied to crude oil production and crude oil prices, cannot be underestimated. The growth of that supply distorted the commodity mantra, at least as it was applied to natural gas. Now that crude oil prices are low, discouraging new oil well drilling, the production decline curve is causing oil output to fall, along with associated natural gas volumes.

Contributing to the perception of a tighter natural gas market has been the combination of lower weekly gas storage injections at the same time LNG shipments fell. Weak international gas prices this spring, in addition to high storage volumes abroad, due to economic lockdowns and warm winters, caused gas customers to cut back LNG shipments. They are ramping up now, in anticipation of increased gas use in Europe and Asia, as economic activity improves and winter demand looms. More LNG shipments, coupled with increased gas use from greater air conditioning during hot weather, is boosting demand at the same time gas supply is shrinking.

The gas market is signaling it anticipates associated natural gas supply being limited this winter. Higher prices signal more supply (increased gas drilling) and a slowdown in consumption are needed. How high gas prices go depends on a myriad of factors. Will shale drilling rebound, adding more associated natural gas supply? Will hurricanes cause supply and/or demand disruptions? What happens to international gas prices and LNG shipments? How much of the recent price rise has been driven by speculators counting on the perception of an ever-tightening gas market? But the key question is: When will speculators decide they’ve made enough money?

By G. Allen Brooks | Author, Musings From the Oil Patch

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