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Oil Ends 2016 On A Bullish Note

2016 has been a tumultuous year in the energy markets, but both oil and natural gas are showing promising signs heading into the New Year, with oil prices having nearly doubled since January and natural gas markets heading towards balance.

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Friday, December 30, 2016

Oil prices posted incremental gains at the start of this week on the eve of scheduled OPEC cuts, but had stalled by Thursday after the EIA reported a surprise uptick in oil inventories. Oil ends the year nearly twice as high as where it started, pointing to a more balanced market in the months ahead.

U.S. shale promises discipline. By most accounts, U.S. shale is poised for growth in 2017. A tightening oil market could push prices up: Should crude hit $60 per barrel, shale output could rise by 500,000 bpd, according to Citigroup. At $70 per barrel, production would grow by 1 million barrels per day. That of course, could merely induce another downturn as the world becomes once again flush with supply. Some shale companies are expanding operations, but cautiously. “There’s a real concern by industry that we could be in for another one of these price adjustments, if we get carried away with development," Harold Hamm, CEO Continental Resources (NYSE: CLR), told Bloomberg. “They’re going to be disciplined going forward."

U.S. imposes sanctions on Russia, expels diplomats. The Obama administration responded harshly to Russian interference in the presidential election, expelling 35 diplomats, imposing new sanctions on Russian officials and ordering the closure of two Russian compounds in the U.S. “All Americans should be alarmed by Russia’s actions,” President Obama said in a statement. “These data theft and disclosure activities could only have been directed by the highest levels of the Russian government.” The move puts President-elect Donald Trump in an awkward position of either having to go along with the Obama administration or defying U.S. intelligence agencies. As for oil and gas, it is unclear what comes next, but Obama’s decision could make it more difficult to lift sanctions on Russia, thus imperiling future drilling projects in the Arctic, although, to be sure, that is speculation at this point.

Related: Shale Spending Is Set To Soar

Ohio Gov. vetoes clean energy freeze. The Ohio state legislature passed a bill that would have made the state’s renewable energy standard voluntary, but Governor John Kasich (R) vetoed the legislation. The veto is an unexpected win for the renewable energy industry in a state controlled by Republicans.

Petrobras assets sales just shy of $15 billion target. The most indebted oil company in the world missed its target for assets sales in 2016. Brazilian state-owned oil company Petrobras sold off $13.6 billion in assets this year in an effort to pay down debt, just short of the $15.1 billion divestment target. However, Petrobras upped its planned divestment plans for the 2017-2018 period to $21 billion, higher than the original $19.5 billion plan. Brazil is emerging as a country of growing interest to international oil companies – the indebtedness of Petrobras, as well as the economic malaise in the country, is opening up the door to greater private sector investment. Companies like Royal Dutch Shell (NYSE: RDS.A) are poised to capitalize on the situation.

Natural gas inventories continue to plunge. The EIA reported another drawdown in natural gas stocks, with inventories falling 237 billion cubic feet in the week ending on December 23. That puts total stocks at 413 Bcf lower than last year’s levels at this time and also 79 Bcf below the five-year average. It is hard to overstate the significance of this development – inventories had been running well above the five-year average since late 2015, but are now back in normal territory. In other words, the gas market is no longer in a glut, which helps explain why prices are up above $3.81/MMBtu, the highest price in more than two years. Production has fallen this year while demand has climbed. If inventories continue to fall, prices will rise even further, potentially surpassing $4/MMBtu for the first time since 2014. That is good news for natural gas drillers, who are already adding rigs back to the shale patch. It is also good for coal-fired power plants, which are being called upon more than they have in the recent past to generate electricity. Oil prices often gain much more traction in the media, but the ongoing rise in natural gas is a huge untold story.

Related: Outlook For Coal Unlikely To Improve

Oil speculators sowing seed of another price downturn. Hedge funds and other money managers have built up such a speculative position on rising oil prices that they risk sparking a liquidation if OPEC does not delivery on their promised cuts. "The boat is loaded to one side in the market right now. Shorts have covered. People have piled in from the long side, waiting for these cutbacks to come through. If they don't, there's going to be big punishment in this market," John Kilduff, founding partner of Again Capital, told CNBC's "Squawk Box." He also said that China could be the oil market’s Achilles’ heel, as growth continues to slow. Oil demand could disappoint if China fails to come through. “That's the real demand center. That's the swing place, and I still see issues there," he said.

NYMEX trading floor shuts down. In a shift towards electronic trading, the NYMEX trading floor is set to shut down on Friday. The pit is home to the boisterous buying and selling that symbolized the frenetic and frenzied business of commodity trading. But CME group, which owns the NYMEX, had announced earlier this year that it would shut down the trading floor at the end of the year, as its share of options only accounted for just 0.3 percent of the overall trade in energy and metals. Most trading is done electronically at this point, making the trading pit a relic of the past. The trading floor’s share has plunged remarkably in just a few years – as recently as 2009 the trading floor accounted for more than 80 percent of the options volume.

OPEC deal begins next week. The OPEC deal goes into effect next week at the start of the New Year, but members are allowed to average their reductions over a six-month period, so immediate cuts are not a given. It will take a few weeks to figure out who is cutting and by how much – data for January will be released in February.

By Evan Kelly of Oilprice.com

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