Oil & Gas Predictions For 2017

This will be my last article of 2016 as I am taking a couple of weeks off to return to England and spend Christmas with my family. I mention that not because I expect any of you to care, but to explain why this week's article will deal with the prospects for energy markets in 2017 a couple of weeks earlier than is customary.

Before we get into what to expect next year, though, it is worth looking back on 2016 and seeing what lessons we can learn from the two big energy markets, oil and natural gas. Both are markets that are frequently volatile, but even taking that into account this year has been one of wild swings.

(Click to enlarge)

(Click to enlarge)

After starting the year virtually in freefall both natural gas (top) and WTI (bottom) turned around in the first quarter and have since more than doubled in price. In both cases, though, fundamentals have actually changed little and it appears that the anomaly was the low point early in the year. Yes, we have an agreement from OPEC but that came recently once the move up was almost over and has not yet taken effect. Similarly natural gas has benefitted from the beginning of exports and many power plant conversions coming on line, but inventory builds are still the norm. It seems clear that the fears that drove WTI below $30 and natural gas to around $1.60 were overdone.

I guess the lesson to be learned from the first half of the year, therefore, is an old one…when fear dominates the market and is the motivation for a move, opposing that move is the only sensible thing to do. Markets always overreact and tend to revert to the mean. The trader or investor that understands that has a huge advantage.

So, how do we apply that lesson in our analysis of what 2017 may bring? I learned a long time ago that one time Yankees manager, Casey Stengel, was right when he said that "Predictions are hard, especially those about the future", and that that is definitely the case with energy markets. That said, though, given where we are now and what has caused us to get here we can have a stab at predicting at least the next few months for WTI and natural gas.

Basically what has pushed WTI to current levels is the opposite of fear…hope. The hope is that the OPEC deal will hold and have a real effect on global supply. There is also hope that the "Trump Effect" will boost growth in the U.S. and therefore elsewhere. In both cases, though, there are reasons not to be too optimistic.

Back in March when some anticipated a production cut from OPEC, the then Saudi Oil Minister, Ali Al Naimi, said in a speech that there was no point in agreeing a cut or freeze as nobody would stick to it. Al Naimi had been in that job for decades so he should know what he was talking about. It is possible that after all those years of acting one way all of the signatories to this agreement changed overnight and will be faithful to the agreement, but if you believe that then I have a bridge to sell you.

The boost to the economy, and particularly to energy, that could come from a Trump administration is also not as clear cut a positive as it might at first seem. Cutting corporate taxes and reducing regulations will certainly help companies' bottom lines but if some of his other stated intentions, such as a trade war with China, actually come about there will be negatives too, at least in the short term. In addition things like cutting regulations, encouraging pipelines and opening access to drilling in deep water and on federal lands will be welcomed by the industry, but all would have a negative rather than positive effect on oil prices by increasing supply and lowering lifting costs.

What has actually changed is that the market, instead of focusing only on the bad news, as was the case at the start of this year, is now focusing only on the good. In both cases that kind of narrow focus usually leads to a market that overshoots logic. I can easily see oil prices continuing higher into January as the enactment of the OPEC deal approaches and Trump (hopefully) tones down some of his more [populist campaign rhetoric, but is WTI in the high 50s or even 60s sustainable? For all of the reasons above I would suggest not.

Natural gas, though, may well do just the reverse. We are now seeing a perfectly understandable correction after a strong run up in gas and, once again, the momentum from that move could continue into January. Sooner or later though the fundamental shifts in the market will force prices back up again. Exports are relatively low right now, but with natural gas prices double or triple those of the U.S. in many parts of the world there is plenty of incentive for them to increase. That would go some way towards offsetting domestic supply increases that result from Trump's policies.

Even if those policies include abandoning the insistence on "clean" power generation that has forced many power plants to convert to natural gas though it is too late for them to change back. The full effects of a shift to where one third of U.S. electricity is now generated from natural gas are yet to be felt, but as they are, a push up in price looks almost inevitable.

What looks most likely then is that 2017 will start with both oil and gas buoyed by a generally positive sentiment amongst traders and investors. That positive outlook, though, like the fear that prevailed at the start of this year, will fade and when it does pricing will revert to being based on fundamentals. When that time come the two commodities could well diverge. Both will see possible supply increases, but there would seem to be little to boost demand for oil beyond what we expect now, whereas natural gas has chance of offsetting that supply increase. In that case oil will retreat again before long, but gas can continue to climb.

Whatever happens, though, one thing is for sure. Energy markets will continue to be volatile, and therefore to provide enormous opportunity to traders and investors in 2017. I therefore wish you not only a happy holiday season, but also the best of luck for the coming year!