Last week, energy investors got the first of several reports that should confirm for Wall Street analysts that the physical markets for crude oil are responding to the sharp drop in oil prices. I believe supply/demand will work back to a balance during the second half of this year.
On January 16th the International Energy Agency (“IEA”) issued their monthly Oil Market Report (“OMR”) which stated, “A price recovery (for crude oil) - barring any major disruption - may not be imminent, but signs are mounting that the tide will turn.”
Highlights of the IEA report: https://www.iea.org/oilmarketreport/omrpublic/
The Paris based agency’s report caused a short-covering rally for NYMEX crude oil futures contracts on Friday and sent energy sector stocks higher. Some of our model portfolio companies closed up more than 10% on the day. Had it not been for the actions of the Swiss National Bank, which sent the U.S. dollar higher, I think the price of West Texas Intermediate (WTI) would have pushed over $50.00/bbl.
There is still not much evidence of an increase in demand due to lower fuel prices, but I think that will happen a few months from now. It takes time for consumers to adjust their spending habits after Christmas. Outside of the United States the rest of the global economy is weak, which is restraining oil demand.
The IEA cut 2015 non-OPEC supply by 350,000 barrels per day since their December OMR. Per highlights of the IEA report, “The most tangible price effects are on the supply front. Upstream spending plans have been the first casualty of the market's rout. Companies have been taking an axe to their budgets, postponing or cancelling new projects, while trying to squeeze the most out of producing fields. For the most part the supply effects will not be felt immediately, but further down the road, through project delays and faster decline rates.” It now appears that supply and demand for refined products could be in balance by the 3rd quarter of this year.
It is important to remember that demand for oil always increases in the 3rd quarter due to the seasonality built into the market. World oil demand is expected to jump by more than a million barrels per day from the 2nd to the 3rd quarter. Overall demand is expected to increase year-over-year by 900,000 barrels per day. My opinion is that IEA will begin raising their demand forecast for the back half of this year and for 2016 within a few months.
Less Drilling Means Lower Supply
On Friday, Baker Hughes reported a drop of 74 in the United States onshore active drilling rig count. Fifty-five of those rigs were drilling for oil. Based on discussions with my contacts in the South Texas Eagle Ford and West Texas Permian Basin, the number of drilling rigs moving back to the yard will accelerate through March. I believe we will see the number of active rigs in the U.S. drop below 1,000 by the end of May. Keep in mind that drilling projects all over the world are being cancelled or delayed.
Natural Gas Could Get A Boost From The Weatherman
On January 15th the EIA reported a large draw from U.S. natural gas storage. The 236 billion cubic feet (Bcf) taken from storage for the week ending January 9th dropped storage levels to 55 Bcf below the 5-year average and sent natural gas prices higher. The deficit to the 5-year average should grow over the next six weeks.
My favorite weatherman, Joe Bastardi (www.weatherbell.com) is now forecasting that the coldest weather this winter will occur from January 26 to February 10. He is also predicting that winter weather will hang around in the eastern half of the U.S. until Mid-April. This is good news for the gas market.
There is an abundant supply of natural gas in the U.S. market and I remain bearish on natural gas prices for at least the rest of this year. We could see the front month NYMEX contracts trading over $3.50/mmbtu for a brief period during the first quarter, but I am afraid gas will average less than $2.50/mmbtu for April-September.
The combination of less associated gas supply from the Eagle Ford & Permian Basin and demand growth for the liquefied natural gas (LNG) exports starting late 2015, should push natural gas prices higher heading into 2016.
The next few months will be “challenging “ for many upstream oil & gas companies and energy sector investors, but I believe oil prices will rebound to the mid-$50s this quarter and share prices of the better companies will also move up. My prediction remains that we see WTI trading over $70/bbl sometime during the 3rd quarter of this year.
The markets are forward looking and the IEA’s OMR report last week is just the first indication that oil supply/demand will tighten much faster than all the “gloom & doom sellers” have been predicting. Do your homework before investing and the reward should be a profitable year.
By Dan Steffens for Oilprice.com
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