This summer has been about as predictable as Donald Trump’s Tweets. Be it wildfires in Western Canada, hurricanes in the Gulf, earthquakes in Mexico or talk of nuclear war with North Korea, this summer has been full of unpredictable events. The oil and gas markets have not been spared by this string of unforeseen circumstances, creating volatility in prices.
World oil prices have risen by about 15% over the past quarter, bolstered by higher demand forecasts, increasing tensions between Kurdish Iraq, Turkey and Iran, and the continued production cuts by OPEC and its allies. With rumors of discussions in the works to extend the OPEC cuts further past March 2018 and mixed data from the US, there are reasons for near to medium term price optimism. Our view is that the balance of probabilities favours a breakout to the upside over one to the downside.
Henry Hub gas prices have been flat over the past quarter, remaining around the 3.00 USD/MMBtu mark. Recent injection numbers and storage inventory suggest these prices will remain close to the same range in the near term. Closer to home, a combination of restrictions on TransCanada’s NGTL system throughout Alberta, the strengthening Canadian dollar and a continued lack of access to alternative markets has contributed to soft and volatile AECO prices. In the past three months, prices saw a drop in value of 50% before recovering and then dropping again by over 50%. The extreme short-term weakness should be behind us by the end of October, though limited market access will keep these prices particularly sensitive to restrictions in the medium to long term.
The recent moves by the Bank of Canada to increase interest rates has made commodity prices appear a little weaker here at home. With the back-to-back rate hikes, the Loonie has gained on the US Dollar, reducing the local sticker premium. Interest rates and rate expectations based on Canada’s broader economic strength have been the primary driver of the exchange rate in recent times, with the “traditional” link between the Canadian Dollar and commodity prices weakening as the portion of the Canadian Economy made up by the oil and gas industry has shrunk somewhat since the major price decline a few years ago. It should be noted, however, that even small improvements in oil prices still result in the creation of a significant amount of GDP in Canada. A recent study released by CERI estimates that for every Canadian dollar increase in WTI price, the Canadian GDP rises by almost $1.7 billion.
In GLJ’s October 1st, 2017 price forecast, the biggest near term change is in our CADUSD forecast, which, due to the BoC rate hikes, we’ve had to increase from 0.75 to 0.80 relative to our previous quarterly forecast. Near term changes in our benchmark oil and gas price forecasts are relatively minor, and we’ve modestly reduced our long term oil and gas price forecasts on continued confidence in lower long term supply costs. Our long term Brent and WTI crude forecasts are now 68.50 USD/bbl and 65.00 USD/bbl, respectively, both expressed in real 2017 dollars. Our long term Henry Hub gas price forecast is now 3.60 USD/MMBtu (also in real 2017 dollars).
A recent model built by Michael Morgan of GLJ, comparing reductions in well costs throughout the Canadian industry, found that “on the oil side, the biggest driver behind the cost reductions appeared to be lower service costs that resulted from low oil prices.” This was not entirely echoed for gas though, as “it seemed to be more driven by technical innovation and operational excellence.” Morgan concluded that in the current state of the industry with prices at current levels, “if you can make money now, there’s every reason to believe you can make money for a long time.”
This article was co-authored by Tyler Schlosser and Justin Mogck. Tyler is GLJ’s Director of Commodities Research, focusing on economic modeling, risk analysis, commodity pricing and business development. Justin is a Professional Engineer at GLJ focusing on commodity price forecasting, corporate evaluations and economic risk modeling.