What’s in Store for Natural Gas and Crude Oil Prices
To hear some analysts tell it, geopolitics and the weather are exogenous events when it comes to energy prices.
That is, somehow both natural gas and crude oil prices would operate quite “rationally” if it weren’t for either of them.
According to these guys, supply and demand is what drives the market, and from time to time these “outside elements” only muddle things up.
Well, I hate to break it to them, but there hasn’t been a “normal” market for some time now.
To assume that Mother Nature dumping snow, Vladimir Putin misplacing his army somewhere in Ukraine, and/or the Middle East falling into chaos are just one-off occurrences is simply not rational.
So as we begin the fourth quarter, I’m going to handicap where energy prices are likely headed with these two overriding factors in mind.
The real wild card will undoubtedly be crude oil prices….
Where Crude Oil Prices Go From Here
When it comes to crude oil prices, geopolitical events will have the widest sway.
Despite the fact that North America is rapidly approaching self-sufficiency, thanks to tight and shale oil reserves, oil remains in an integrated global market.
As such, events abroad will still impact U.S. prices regardless of how much more oil is added to the domestic market from local drilling. And remember, the cross-border trade in oil is also directly affected by flows from both ends (the raw crude produced and the processed volume). U.S. refineries just happen to have become the largest exporters of refined oil products in the world.
As a result, crises situations will continue to weigh upon the oil market, even here at home.
As it stands, the crises in both Ukraine and Iraq have been discounted by traders because of the time of year and the adequate supply. Traditionally, August and September are the months when oil demand lags.
Even the unraveling in Libya, and the cut-off of its supply, hasn’t been enough to send oil prices higher.
This will certainly change, but absent a major geopolitical collapse I just don’t foresee a rapid jump in crude oil prices. The key here, however, is what I see as the pricing floor.
As I write this, West Texas Intermediate (WTI) is trading in New York at about $96 a barrel; Brent in London at $103. Those levels will likely be the low price through the first quarter of 2015, while the average will likely be closer to $100 for WTI and $106 for Brent.
As for the “standard” market pressures, global oil supply is currently adequate. Yet, should we start to see the projected demand increases expected by OPEC, the International Energy Agency (IEA), and the U.S. Energy Information Administration (EIA) kick in toward the end of the year, there will be some rather noticeable international regional pricing differentials in the oil market.
This won’t be because we are running out of oil. I can’t emphasize that enough.
Instead, the difference will be caused by the premium certain regions – such as Asia and West Africa (for oil products) – are prepared to pay for needed volume.
Now in these situations, which occasionally do turn into actual supply constrictions, oil trading tends to push up the cost of futures contracts, reflecting the higher prices registered in selected expanding markets.
Remember, contracts in “normal” market trading reflect the expected price of the next available barrel of crude. On the other hand, contracts in “uncertain” markets tend to take their bearings from the expected price of the most expensive next available barrel. This uncertainty will manifest itself in cycles over the next several months.
So all told, on average oil prices have likely formed a base at about where we are now, but will experience periods of higher pricing due to geopolitical events.
Bracing for Another Long Cold Winter
As for prices in the rest of the sector, that’s where the weather comes in – especially in terms of natural gas.
From the standpoint of temperatures, this winter is likely to be about the same as last year, according to most estimates, although snow falls in New England should be less than last year but heavier in the Mid-Atlantic. Prolonged frigid snaps will undoubtedly keep demand higher in most regions of the country.
That means we can expect U.S. natural gas prices to be between $4.20 and $4.45 per 1,000 cubic feet given a slight increase in overall demand. And as more electricity is generated from gas, that will also contribute to a higher pricing floor.
However, the regional differences will be more pronounced than in recent years. Given the continuing pipeline and distribution problems, prices will be higher in New England than in 2013, with some concerns already expressed for a possible regional shortfall in propane.
In Europe, you can add the geopolitical to the mix, as the likelihood of a continuing Ukrainian crisis will test the ability of Europe to sustain imports of full natural gas consignments from Russia. But the knock on effect for North American gas prices from Gazprom’s European exports will be limited.
On the other hand, 2015 will see the inauguration of significant liquefied natural gas (LNG) exports to both Europe and Asia from the U.S. That will be the start of a fundamental realignment of energy trading routes to the continent, but not until later next year.
Meanwhile, coal prices will actually improve in specific areas of the U.S. (especially the Appalachian basin), where it remains the primary source of power and heat, and metallurgical coal exports will continue to rise to the level of exporting ability. Both of these will allow specific coal production and distributional limited partnerships to improve in value through the first quarter of next year.
However, inferior coal grades in the Western U.S. will experience declines in both demand and prices. That may actually improve the overhead at regional power plants, but it won’t create resurgence of coal use in electricity generation.
Rather, the improving value of utility stocks will be confined to those with the ability to source from coal, gas, nuclear, renewables, even biomass and geothermal. The expense of long-distance lines will be picking up, so those utilities that produce much of their bottom lines from distribution may see lower returns as operations and overhead take a bigger bite out of revenues.
So, the world is hardly coming to an end. But it is likely that the energy needed to run it all will continue to increase.
The good news is the cost the raw materials will continue to be a manageable factor in the overall economic expansion, regardless of what happens in an American off year election.
Given this scenario, the success of your energy portfolio will revolve around the careful selection of individual companies, partnerships, and exchange traded funds (ETFs). And as we move into the end of the year, I’ll be certain to keep you informed on the best way to position your portfolio.