ENERGY MARKETS DIVERGING Oil and natural gas are dancing to different drummers. For oil, the story at the end of 2018 was all about ‘supply, supply, supply’. For natural gas, it is all about the weather, as an early polar vortex of cold air reached southward and brought a light dusting of snow, even to Houston. Let’s take the crude oil market first.
The US has firmly established itself as a key swing producer in the global crude oil market. Production in 2018 hit 11 million barrels a day (mbd) and is on track for moving to over 12 mbd in 2019, putting the US just ahead of Russia and Saudi Arabia in the oil production league tables.
Chart 3: Price of Nearby Soybean Futures
$50 $55 $60 $65 $70 $75 $80
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One key factor that may not be fully appreciated with U.S. shale oil production is the lags between price changes and future production. Shale wells have an 18-to-24-month lifetime, with peak production during the first year. Once wells are completed and put into production they are going to run for their full life cycle, since keeping them going involves less cash flow than the capital investment to drill the well. In forecasting future oil production then, a large drop in price, say into the $40/barrel, is not going to impact production for over a year, because it is the new wells that do not get drilled that matter, not the ones already producing. On the flip side, higher prices can bring forth more production, as they did in 2018. One must remember, though, that it is not all about price, as there are infrastructure bottlenecks to consider, from supplies of sand, well casings, skilled workers, constraints on pipelines to get the oil to market, etc.
Supply, Supply, Supply
Diagram 1 Source: Bloomberg Professional (USCRWTIC)
Source: Bloomberg Professional (USCRWTIC)
As noted, natural gas dances to a different drummer; namely the weather. A colder and wetter winter is possible in 2018-19 as El Niño has returned, bringing back memories of the 2014-15 winter. Natural gas prices are seeing sharp increases in volatility as weather patterns shift with expectations of a colder and snowier winter in some parts of the country compared to the milder winters of 2015-16 and 2016-17.
Source: The National Oceanic and Atmospheric Administration’s Office of Satellite and Product Operations
https://www.ospo.noaa.gov/Products/ocean/sst/anomaly/
26 | ADMISI - The Ghost In The Machine | November/December 2018
US$ Price per Barrel
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