Oil Industry To Regain Strength In 2017

Friday January 13, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Solar to become cheapest source of power

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- Solar is already cheaper than coal in some parts of the U.S. and some parts of the world. But within ten years, it will be the cheapest source of electricity in most of the world.
- The cost of solar has plunged by 62 percent since 2009. Savings have been achieved up and down the supply chain, with the largest reductions coming from the modules themselves. Although cost reductions are expected to slow, they will continue to decline every year for the foreseeable future.
- Bloomberg New Energy Finance predicts that solar will be cheaper than coal by 2025 on average across the globe.
- Solar systems cost on average $1.14 per watt for a 1 megawatt project. Those costs will decline to just 73 cents/watt in 2025.

2. American drivers want gas guzzlers

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- The U.S. auto industry had another record year in 2016, with sales topping 17.5 million vehicles.
- However, consumers are shifting their purchasing habits to heavier, less fuel-efficient vehicles. Cheap gasoline since the collapse of oil back in 2014 has led to a dramatic shift towards trucks and SUVs at the expense of sedans.
- Light trucks accounted for 60 percent of total sales, a share that is up from a 50-50 split between trucks and smaller cars back in 2012 when oil prices traded near $100 per barrel.
- U.S. gasoline consumption rose sharply in 2015, jumping by 270,000 barrels per day. But the growth in consumption started to fall back a bit last year, expanding by just 150,000 bpd.
- Rising oil prices could push up prices at the pump, which might start to reverse the trend towards heavier vehicles.

3. U.S. motorist to spend more on gasoline this year

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- Higher gasoline prices will force American motorists to spend an additional $52 billion on gasoline in 2017, according to estimates from GasBuddy.
- Gasoline prices are expected to average $2.49 per gallon this year, compared to just $2.13 per gallon in 2016. Last year motorists enjoyed a lower gas bill compared to 2015, saving $39 billion on fuel because of lower prices.
- As mentioned above, this could induce more preferences for fuel-efficiency and also cut into gasoline demand.
- Higher gasoline prices could also fuel inflation, pushing the Fed to act on interest rate hikes. Cheap gas is often likened to a "tax cut" for American consumers. Rising prices will have the opposite effect.
- The flip side of that equation is that the oil industry will receive a boost from rising prices, potentially offsetting the macro effect on the U.S. economy.

4. Returns on capital for oil industry have been falling for more than a decade

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- The collapse of oil prices since 2014 have created a lot of pain for energy investors. But returns on capital have been falling in the industry since 2006, according to Bloomberg Gadfly.
- During the mid-2000s, when oil prices were rising, the industry spent more and more to explore and drill. But the easiest oil reserves not under state control are increasingly hard to find. That forced oil majors to look for new reserves in far-flung places like the Arctic, ultra-deep water, and oil sands. Companies spent more, but did not necessarily create more value from higher expenditures.
- The Bloomberg World Oil & Gas Index offered investors a 22.7 percent return in 2006, a year when Brent averaged $65 per barrel. A year later, the index returned 19.6 percent even though oil prices rose to $72 per barrel. In 2008, when oil prices topped off at $143 per barrel and averaged more than $96 per barrel for the whole year, the returns on the index fell to 13.5 percent.
- In 2016, with oil prices bottoming out below $30 per barrel, investors essentially broke even.
- It is unlikely that we will be returning anytime soon to the days in which capital deployed would offer double-digit returns, so what's next?
- The oil majors might begin paying down debt and returning cash to shareholders, which could be a better strategy than reviving risky megaprojects.

5. Oil discoveries could rise this year

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- Even as the oil industry continues to repair balance sheets, spending is expected to increase in 2017. Spending on exploration plunged from $100 billion in 2014 to just $40 billion last year.
- As a result, new discoveries are expected to rise, bouncing off of the 65-year low reached in 2016. At just 3.7 billion barrels, the global oil industry discovered the least amount of oil last year since the 1950s, according to Wood Mackenzie.
- That has a lot to do with the dearth of drilling. In 2016, oil companies drilled only 431 wells for conventional crude, or about one third of the number drilled in 2014.
- With oil prices on the rise, those figures - drilling and new discoveries - should rebound in 2017.

6. More upstream investment coming in 2017

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- The oil industry is set to greenlight more projects in 2017 as oil prices rebound. Wood Mackenzie estimates that the number of new large drilling projects could be twice as high (20) as the number of projects that were given the go-ahead in 2016 (only 9).
- One third of the 20 projects that Wood Mackenzie expects to go forward will be in deep water, an area of drilling that has been hit hard by the downturn because of high costs. Many deep-water drilling projects in the Gulf of Mexico can now breakeven at $40 per barrel.
- WoodMac lists a few projects that could move forward: ExxonMobil's (NYSE: XOM) Liza prospect in Guyana; Shell's (NYSE: RDS.A) Kaikias project in the Gulf of Mexico; and Petrobras' (NYSE: PBR) Sepia project of Brazil's coast.
- A larger list of 40 other projects are a little further off, with rates of return at less than 15 percent when oil trades at $60 per barrel.
- The consultancy also expects spending on shale drilling to rise by 3 percent to $450 billion, following several years of reductions.

7. Oil speculators pause their bullish bets

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- Hedge funds and money managers slightly reduced their bullish bets on oil futures in the first week of 2017, trimming WTI net-long positions by 9 million barrels, according to Reuters.
- Long bets were reduced by 2 million barrels and shorts were increased by 8 million barrels.
- It was the first net-short move in five weeks (see orange line in chart) and put a halt to an unprecedented build up in bullish positions.
- It is too early to tell if a trend is emerging, but if the net-long movements run out of momentum and start to reverse, it could put downward pressure on crude prices.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.