Oil Supply and Demand Mismatch – 1/14/16

Possible impacts of the lift on crude oil exports: an increase the market for crude pumped out of US shale deposits and make oil trading more efficient by bringing the reference point of the US (WTI) in line with the Brent benchmark for oil. With the lifting of the ban, shale oil supply is set to make a big comeback when prices rebound and the strongest companies buy up the assets of competitors unable to survive the worst of the price collapse. With the best assets free of debt after bankruptcy and sale, shale oil is likely to start flowing at higher rates than ever. And once US oil finds its place in the market at large and the benchmarks adjust to reflect open trade, the WTI price should rise as lighter shale oil can reach foreign refineries better suited to it than the American ones equipped for heavier mixes.

With oil-trading at 12-year lows, it might be surprising for energy company shares to do well. For the most part, the declines in share prices have been across the board for oil and gas companies except for a few which investors still have confidence in thanks to their relative strength in a time of uncertainty. Many low-cost producer companies like Diamondback Energy Inc. are bringing in hundreds of millions in capital from stock offerings as they pay down debt in preparation for a rough year of low prices. Thanks to low costs and rich wells, companies in the Permian Basin drilling region are poised to ride out the storm in relative comfort. Not to say they won’t be facing the same massive budget cuts as everyone else. Budgets of US producers are set to get slashed by about 50% from 2014 levels in the wake of oil prices falling to a fraction of what they were at that time.

Global demand expectations are pessimistic as market sentiment turns against China and no other country stands out as a possible replacement. In the coming years, India may be the new driver of global growth as a breakthrough has been a long time coming for the nation that matched China in size but not progress. If the country’s leadership can weed out some of the corruption and bureaucracy, then the increased demand may be forthcoming though unlikely to happen so soon as to make up for China slipping.

Europe, America, and the Middle East are unlikely to pick up the slack in demand. Europe is facing down its own set of issues as waves of migrants and the eurozone debt showdown with Greece threaten open border travel, while increased fuel-efficiency standards in both Europe and the US limit the potential upside of cheap gasoline and diesel. Meanwhile, lost oil revenue is forcing governments in the Middle East to raise prices and eliminate subsidies on fuel making increased demand from the region very unlikely.

A prolonged glut threatens to harm some countries much more than others. With domestic issues and few fiscal buffers available, the nations that would suffer the most are likely to be the “fragile five” – Algeria, Iraq, Libya, Nigeria, and Venezuela – as they have been called by some analysts. The Gulf states are going to see unrest as well since they will need to make large cuts to domestic spending that includes subsidies on food and fuel. Saudi Arabia in particular houses a population critical of the government’s expensive and unpopular inventions in Yemen and Syria. Iran and Russia are also going to be hurt by low prices but are better equipped to handle financial issues and domestic unrest as opposed to Venezuela. Venezuela expects continued triple digit inflation and the Opposition party, after successfully taking control of the legislature, prepares itself to lock horns with the President.

In renewable energy news, the US Energy Information Administration (EIA) released its short-term energy outlook earlier this week. The report predicts significant changes in the mix of resources used to generate electricity in the US as older coal plants are decommissioned in response to the low costs of natural gas competition with nearly 5% of the current capacity going offline in 2015. A greater percentage is expected to be replaced in the coming years as the Clean Power Plan policies favoring natural gas and renewables come into effect.

The EIA expects total renewables used in electric power generation to increase by 9.5% in 2016. Projections also show solar power to increase significantly in usage breaking past 1% of total supply by 2017.

With the investment tax credits attached to the bill lifting the oil export ban, solar and wind projects can breath a sigh of relief. The tax credit for wind will apply an additional five years retroactively to a lapsed 2014 incentive while the solar credit will add five years to a solar tax credit due to expire at the end of 2016. Renewables have managed to do well in the last year in spite of low fossil fuel costs and stagnant European investment thanks to increased demand from China and the US so the legislative victory adds to optimism about future growth. Clean energy getting cheaper is making many hopeful that investment will reach an explosive turning point before 2020.

One explanation for how well renewables are doing is that people are losing faith in fossil fuel based companies to deliver in the long-term. Low oil prices have put many oil companies on the defensive as projects are delayed or cancelled amid budget cuts while the low prices haven’t hurt renewable investment nearly as much as expected. Thanks to improving cost-competitiveness and increasingly stringent emissions rules, renewables seem like a safer place to put money in the long-term. Strong demand from emerging markets is likely to continue as renewables tend to be more competitive in areas with weak infrastructure and the need to reduce air pollution.

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