Last week, the most overall US domestic rig count dropped to an all-time low since data tracking began in 1949, signaling that even the producers with healthy balance sheets are finally curbing new output. The steep contango we saw for much of Q1 in the crude oil forward curve contributed to an increase in drilled-but-not-yet-completed shale wells as a storage play. Although these “DUCs” add to the inventory of crude that can readily be brought on-stream, this lag in well completions still slows US crude production in the meantime. The EIA estimates that US crude oil production averaged 9.0 million bopd at the end of March, down from 9.2 million bopd in January. While US crude stock builds have continued, recent Weekly Petroleum Status Reports have shown large draws in refined product stocks.
Outside North America, OPEC-Russia discussions around a production freeze, an arrangement in which members would maintain their existing output levels (and approximate market shares) have provided additional lift to crude prices in spite of increasing Iranian crude exports and doubts over Iran’s participation in such an agreement. There are significant doubts as to whether such an agreement could materialize at all – many believe these discussions are just words for headlines and nothing more. In the final days of March, for example, Kuwait and Saudi Arabia agreed to resume production at a joint offshore field shut in October 2014. Any multinational production deals are likely to be tenuous at best, with many exporting nations operating under distressed fiscal conditions and struggling to arrive at the level of mutual trust required to adhere to such terms.
Our view is that global crude oil prices likely reached their bottom in early Q1 and will continue to spend the next few months struggling to find a strong trend either way in choppy, volatile trading. The time to sustained higher prices is still uncertain and North American producers must continue their relentless pursuit of efficiency. Though reality is sure to be more dynamic, our forecast reflects a slow march upward for crude oil prices as market fundamentals balance, with our long term Brent and WTI price expectations down 3 USD/bbl in real 2016 dollar terms from our previous forecast to 75 USD/bbl and 72 USD/bbl, respectively. We expect both benchmarks to occupy a range centered around the mid-40s for the remainder of 2016.
Canadian crude prices have actually experienced less of a recovery than their USD-denominated counterparts due to a rapid strengthening of the Loonie since mid-January. The heavy (Western Canadian Select) crude spread is a little tighter, sitting around 13-14 USD/bbl below WTI, and has not seen the same volatility as it has in recent years, with a more robust pipeline transportation infrastructure and fewer refinery-driven demand interruptions. Light, sweet crude in Alberta has been hovering at a historically normal discount to WTI of 2-4 USD/bbl. Alberta condensate prices have remained fairly stable, hovering around par to WTI.
North American natural gas prices saw a wild end to 2015, with a violent short squeeze bringing an end to Henry Hub spot price lows not seen in two decades. Since then, gas prices have experienced a steady decline in the face of stubbornly warm winter weather and spot prices have broken through even the lows seen in late 2015.
Despite extremely low rig counts, US gas production reached a record high last month and gas storage is hovering above 2012 highs. Increased power burn is expected to provide some uplift to prices as we move forward in 2016, as current low gas prices make it look attractive as an alternative to coal. If some market observers are correct that the elastic part of power demand has already shifted from coal to gas, some further downside risk to gas prices is present, even if gas manages to remain cheaper than coal for the rest of the year.
LNG exports from North America are looking more difficult in the current environment as well, particularly to Europe, with UK NBP prices hovering just above 4 USD/MMBtu. Our long term Henry Hub forecast is down from 3.85 USD/MMBtu in real 2016 dollars to 3.75 USD/MMBtu, and we’ve reduced our other major regional benchmark forecasts, AECO and NBP, as well.
Alberta (AECO) gas prices have hovered between 0.40 and 0.90 USD/MMBtu below Henry Hub prices, with spot prices dropping below 1.00 USD/MMBtu recently. Prices have struggled due to a warm winter, high output and increased competition in US export markets. Marketing challenges are expected to continue, with futures indicating an expectation of continued weakness in Alberta gas prices relative to other North American benchmarks for the next few years. We think this could be somewhat pessimistic, possibly building in some recency bias given the exceptionally warm winter and recent production strength in the WCSB. Output has grown in part to an activity shift toward high-productivity gas wells with robust economics to weather the difficult oil price environment.
Although the gas picture presents us fewer reasons for optimism than the oil picture does, we are growing more optimistic that the worst is behind us and fundamentals continue to become more constructive for the industry. With that, it’s also a good time to remind ourselves just how much uncertainty is involved in forecasting commodity prices. According to the market in mid-March, the 95% confidence interval for WTI crude prices for December 2016 delivery is between 20 and 81 USD/bbl. The same December 2016 95% confidence interval for Henry Hub gas prices is 1.40 to 4.45 USD/MMBtu. These ranges are very wide by anyone’s standards and highlight the uncertainty the industry contends with in difficult investment decisions.
Tyler Schlosser is GLJ’s Director of Commodities Research, focusing on economic modeling, risk analysis, commodity pricing and business development. Tyler is responsible for generating GLJ’s commodity price forecasts and modeling fiscal regimes across a broad range of international jurisdictions. With expertise in unconventional evaluations, probabilistic modeling and machine learning techniques, Tyler routinely tackles unique and complex problems for GLJ’s clients.