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Oil Rally Gains Momentum Ahead Of OPEC Cuts

OPEC Rig

To begin, we will take a quick look at some of the critical figures and data in the energy markets before analyzing the key events of the week.

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Chart of the Week

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• Much has been made about the collapse of the coal industry in the U.S., with lots of blame on federal regulations. But the largest single factor in Big Coal’s decline has been cheap natural gas.
• The shale gas revolution led to the collapse of prices long before a similar trend unfolded for oil. Consistently cheap gas has undercut the case for coal in the electric power sector. Coal is still cheaper than gas on a strictly fuel cost basis, but gas has many more advantages over coal, leading to its displacement.
• Nevertheless, environmental regulations have added to the difficulties for coal, and more importantly, looking forward, utilities are planning for a lower-carbon electric power sector, which plays to the benefit of gas.

Market Movers

Panasonic (OTCPK: PCRFY) and Tesla (NYSE: TSLA) have agreed to ramp up solar PV manufacturing in the summer of 2017, with production set to hit 1 GW by 2019.
• Workers of Petrobras (NYSE: PBR) authorized a strike in Brazil’s largest oil producing region, the Santos Basin. The union has rejected a 6 percent pay raise.
Blackstone Group (NYSE: BX) is considering a purchase of the assets of Energy Transfer Partners (NYSE: ETP), a deal that could be worth more than $5 billion. ETP’s share price rose on the news.

Tuesday December 27, 2016

Oil prices moved up to start the week as light holiday trading and relatively low volatility have provided a rare period of calm in the oil markets. The looming OPEC cuts are adding a bit of optimism to oil, with WTI moving above $53 per barrel and Brent topping $55 per barrel. Related: Oil Consumption Is Immune To A Transport Transformation

OPEC and non-OPEC cuts set to begin next week. The oil production cuts that OPEC and a handful of non-OPEC countries agreed to will take effect on January 1. The deal calls for a six-month average, so even leaving aside the possibility of cheating, participating countries are not exactly obliged to start cuts immediately. The cuts could take place at a later date so that average levels hit the targeted range by June. Moreover, data on what exactly is happening at the ground level will come in on a delay, with January output levels not published until February. As a result, while the oil markets are optimistic that OPEC and non-OPEC countries are accelerating the move towards a balance, we may not get a clear picture if that is indeed the case for a few months. In the most bullish case, OPEC and non-OPEC take a combined 1.8 million barrels of oil per day off the market by mid-year, which would likely push the supply/demand balance into a deficit. Presumably that would lead to a rise in oil prices, but analysts are skeptical that such a scenario will truly play out. “To go above $60 is going to be difficult. We’re already close to the top rather than the bottom of the range right now,” Olivier Jakob, oil analyst with Petromatrix, told Reuters. “From January, we’ll start to have a better idea about the level of OPEC production. That is going to be more and more of a focus.”

Oil analysts see prices averaging $58 per barrel in 2017. A survey of oil analysts puts oil at $58 per barrel over the course of 2017, fueled by tighter conditions after the OPEC cuts. The prices would be up roughly a quarter from this year’s average. The big question, however, is how quickly and how substantially U.S. shale output comes roaring back. Citigroup estimates an increase of 500,000 barrels per day if oil prices average $60 per barrel. Macquerie largely concurs, with the firm predicting a 1 mb/d increase if oil prices rise above $60. “It’s going to take them a while to gear up,” Mike Wittner, head of commodities research at Societe General, told Bloomberg. “The investment’s got to gather pace, the drillers and the fracking contractors also need time. It’s a gradual process.”

Shell buys offshore wind. Royal Dutch Shell (NYSE: RDS.A) has agreed to purchase wind power off the coast of the Netherlands. Shell owns 50 percent of the offshore wind farm. The move is seen as the prequel to more renewable energy ventures in the years ahead, as activist shareholders are pushing oil companies towards cleaner technologies. The move could be a smart way for oil majors, under pressure from tightening climate policy, to diversify and hedge against policy risk. And who better to do the job than companies with engineering and offshore knowhow. “This agreement allows us to develop our expertise in wind management as well as to establish Shell Energy Europe as an active participant in the renewable electricity market in Europe,” Jonathan McCloy, an executive with Shell’s energy trading arm in northwest Europe, said in a statement.

Energy bonds one of juiciest returns in 2016. Oil prices bottomed out at roughly $27 per barrel in February, with the entire sector battered by the commodity bust. Yields on energy bonds spiked, particularly for those companies in distressed territory. But oil and gas companies that survived the downturn offered savvy investors the best returns of the year if they got the timing right. A survey of energy debt by Bloomberg found that energy bonds surged 37 percent from a low point earlier this year, way more than broader funds or even junk-bond indices. Related: The Craziest Oil Price Predictions For 2017

Mexico becomes net-importer of oil and gas products with U.S. Mexico has long been a substantial oil producer, sending crude north to its larger neighbor. But a few developments in just the past few years have upended that relationship. Mexico’s crude oil production is falling; U.S. oil production has surged and so has the export of refined fuels; and Mexico’s economy is expanding, leading to higher fuel demand. The net result is that Mexico’s rapidly rising imports of refined products has led to it becoming a net-importer of fossil fuel from the United States. American refiners along the Gulf Coast, as well as oil and gas producers in Texas, are benefitting from the evolution in the trading relationship. More pipelines are set to come online between Texas and northern Mexico in the next few years, which will lead to an expansion in U.S. gas exports to Mexico.

Alaska looking at oil drilling. Although President Obama moved to permanently ban Arctic oil drilling, a couple members of Congress from Alaska are considering legislation that will overturn the ban. The removal of offshore Arctic was done in such a way that the incoming Trump administration would have trouble overturning it. However, an act of Congress might do the trick.

By Evan Kelly of Oilprice.com

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