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2015 Rewind and 2016 Forward Look

January 6, 2016 | By Warren Waite

Now that 2015 has drawn to a close it’s a fruitful exercise to rewind time and recap some of the year’s big events.

In this week's Get the Point, we’ll unwind the high and low points in the energy markets during 2015 and highlight important records that were set in supply, demand and price fundamentals. We will also take a forward look of what might be in store for 2016 from PointLogic Energy’s point of view. 

If you thought 2015 was a bumpy ride, hold on tight because 2016 is setting up to be a year of transition, with important records yet to be set and curious events set to occur!

Lower Hydrocarbon Prices, Different Supply Responses

Regardless of which energy commodity you talk about, the theme was more or less the same. The U.S. energy market is oversupplied and inventories are abundant, so falling rig counts and low prices are necessary for the market to realign the supply and demand balance (Figure 1).

The question becomes: Have we hit rock-bottom prices, or at least prices that will induce the equilibrium the industry is seeking? The consensus is that we've likely not hit the bottom. Most analysts say we will incur ‘’lower for longer’’ -- meaning a sustained period of low energy prices. 

To be sure, the drop in rig counts is finally starting to have an effect on overall U.S. supply, but PointLogic Energy believes we have at least another six months of ‘’weathering the storm’’ before a more material demand response in 2016 starts to kick in and commodity prices increase. 

Of course a ‘’black swan’’ event could change that cautious scenario The recent low West Texas Intermediate (WTI) crude price of $35 a barrel wasn’t enough to spur immediate and widespread production declines. The unwillingness to curb production output in Saudi Arabia, expectations of increased output from Iran and other economies dependent on the price of oil are but a few of the factors which could drive oil prices (and which make predicting oil prices a very difficult question beyond the scope of this posting).

During the first half of 2016, PointLogic anticipates that producers (both U.S. and international) will remove marginal production. In the U.S. that likely means the lowest margin shale production.

It might be happening already. For evidence, consider that in late December, the Dallas Federal Reserve announced in its quarterly energy update that oil and gas sector bankruptcies "have reached quarterly levels last seen in the Great Recession,” and warned that more bankruptcies could follow in 2016. Forty oil and gas bankruptcies occurred in 2015, with Swift Energy joining the list on Dec. 31. The Dallas Fed warned that more may come, especially if global crude inventories don’t fall before 2017. 

Bankruptcies Up, Capital Spending Down

Exploration and production (E&P) companies slashed their 2015 capital expenditure budgets last year by 15%-50%. Further reductions in overall spending will happen again in 2016. 

However, many of the survival techniques producers enjoyed in 2015 will be harder to come by in the new year. Reductions in service sector costs in drilling, fracking and completions have been squeezed hard, and further cost cutting measures from this sector would be unlikely. Though producers enjoyed lower service costs and improvements in drilling techniques (faster drill times, longer laterals, increased initial production rates), their ability to focus on their best acreage has already taken place.

With the reduction in new drilling activity, energy companies have cut jobs to match. The Dallas Fed estimates U.S. oil and gas employment has fallen 14.5 %, or 70,000 jobs since peaking in October 2014.     

Simply put, cash-strapped U.S. shale producers don’t have much fat left to cut. The first half of 2016 will likely be a period of extreme transition. Sustained low prices and revenues will force some into bankruptcy, others will survive by increased borrowing, and some will be acquired as asset valuations diminish and market consolidation occurs. 

A key point to remember: Many of the midstream infrastructure projects commitments that were made when oil was $100 per barrel were backed by producers. Those new infrastructure projects are coming to fruition now, and with that producers’ commitments to use and pay for them -- regardless of whether it makes economic sense at today's prices.

Thus, the ability to access capital and service debt will likely make or break those who weathered market conditions in 2015. But surviving 2016 is an entirely new ball game. 

The market for oil, natural gas and natural gas liquids (NGLs) are each different, with their own set of challenges and supply and demand fundamentals. Below, PointLogic Energy data helps guide us to how things stood in 2015 and what may happen as we take a step forward into 2016.   

Crude Oil

According to EIA, lower-48 crude oil production has increased nearly 900,000 b/d to just shy of 9.0 MMb/d for January through October 2015 (most recent complete month of data available), compared to the same period in 2014 (See Figure 3). The areas of growth were within the Permian Basin, Eagle Ford Shale, Bakken Shale, Denver-Julesburg Basin, and in the offshore waters in the Gulf of Mexico.  

PointLogic Energy data estimates concur with EIA that October production declined from September levels, and we suggest that production continued on a downward trajectory through December, ending the year around 8.5 MMb/d in the contiguous U.S.. That amounts to a gain of 600,000 b/d for the full calendar year (Green line v. Red line in Figure 4). 

Meanwhile, spot prices at WTI went from an average price of around $93/bbl in 2014 to just below $49/bbl in 2015, a 48% drop.  

L-48 Crude Oil Production

Crude oil imports averaged almost 7.300 MMb/d in the first 10 months of 2015, a downtick of a mere 69 Mb/d over the same period in 2014 (Figure 3). The mix changed, too, as imports from Canada increased by 316 Mb/d (heavy oil) but imports from OPEC nations declined by 473 Mb/d—mostly Iraq, Kuwait and Saudi Arabian lights. 

Crude oil input into refineries averaged 16.4 MMb/d through October 2015, a gain of nearly 300 Mb/d from same time period last year. Refineries operated at 90.9% utilization of operable capacity in 2015, a pickup of 1%. 

In December 2015, Congress and President Barack Obama approved and signed legislation immediately ending a four-decade ban on exporting U.S. crude. This very recent and ground-breaking development potentially has significant impacts on the domestic oil and refining markets. For example, big-ticket items like condensate splitters may no longer be necessary. 

Media reports indicate that deals have already been struck to export U.S. crude; ConocoPhillips and Enterprise Product Partners are selling crude to Vitol, a Swiss based international trading company. The first export shipment is already underway and will leave the docks near Corpus Christi with crude produced in the Eagle Ford Shale.   

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Until three weeks ago, there were only a few special exceptions on exporting crude from the U.S., such as shipments to Canada and certain transactions from production isolated from the grid in areas like Alaska and California. That being said, U.S. exports averaged 478 Mb/d through October 2015, a gain of 151 Mb/d over the same period in 2014. 

Though demand increased in 2015, crude oil supply growth outpaced demand by nearly 400 Mb/d through October 2015 compared to the same 10-month period in 2014. This is reflected in EIA’s reported inventory of crude oil stocks, which ended October at 1,178 MMbls, a surplus of 107 MMbls compared to the end of October 2014. That surplus continued through Dec. 25 (the latest inventory estimate), when U.S. crude stocks ended at 1,183 MMbls — which is only 3.3 MMbls below the highest mark on record set just two weeks prior. Needless to say, a heck of a lot of crude resides in storage.  

Natural Gas

Similar to oil, natural gas production rose in 2015 despite the lower price environment, gaining 3.2 Bcf/d year-on-year to average 72.9 Bcf/d. 

Much of the production gains that occurred in 2014 were back-weighted to the fourth quarter, and this set the tone for the record performance in 2015, especially through the first three quarters.

The tune changed in October, when falling rig counts, sub-$2.50/MMbtu gas prices and pipeline maintenance events took their toll on production to some degree. In late-December, an Arctic blast and freeze-offs in the Rockies, West Texas and Oklahoma continued the downward pressure. As a result, production ended the year at a rate of 71.9 Bcf/d -- making December 2015 1.1 Bcf/d lower than where production exited 2014. 

One question will be whether December's pullback is temporary or will be sustained. PointLogic notes that early-January recovery from the deep freeze is ongoing, yet some production may not return as decline curves take root, new wells are smaller in number and producers choke back on production output while prices are extremely low.

L-48 Dry Natural Gas Production

Looking into 2016, what helps give production of gas a boost to the upside is the lingering effects of approximately 4,000 drilled but uncompleted wells (DUCs) nationwide, with roughly 70% of those DUCs in the Northeast — many located in gas-focused plays. One can think of the DUCs as a pseudo-storage of hydrocarbons that can quickly be brought to market when prices rise sufficiently. But this is, of course, a self-correcting mechanism, as a strong rise in oil and gas prices will prompt a flurry of DUCs removed from inventory, and prices will drop when that new production hits the market.

However, PointLogic foresees a reduction of DUCs coming regardless of prices. During investor presentations, many producers stated a planned completion of DUCs in the first half of 2016 to meet contract commitments and their need for revenue. When this occurs, it could keep production levels aloft despite the pullback in new drilling.

The other factor supporting increased production is new pipeline projects that will ease transportation constriants -- many of these projects are producer backed. PointLogic is tracking over 23 Bcf/d of pipeline projects that are scheduled to come online in 2016, with two-thirds of that capacity set for fourth-quarter start dates.

Gas Supply & Demand 2015 v. 2014

Looking back at 2015, of the 3.2 Bcf/d annual gain in production (see Figure 6), 1.8 Bcf/d came from the Marcellus (Pennsylvania and West Virginia), 1.2 Bcf/d came from the Utica, 0.7 Bcf/d in the Greater Permian, and 0.6 Bcf/d from the Eagle Ford. Declines were measured in the Barnett, Haynesville, Piceance and Fayetteville, among others. 

The rest of the supply stack consisted of a mere 0.3 Bcf/d uptick in Canadian imports — less gas into the Northeast and a surge of imports to the Pacific Northwest. LNG imports were minimal, which brought the total U.S. supply increase from 2014 to 3.56 Bcf/d.

On the demand side, growth from gas-fired power generation dominated the year with a net gain of 3.6 Bcf/d. The credit stems from several factors: summer gas prices that were low enough to compete with coal-fired generation; the retirement of coal plants due to environmental regulations; weak hydro generation in the West; and a heavy nuclear outage season. Industrial and residential/commercial demand were lower in 2015 due to the absence of cold weather in the major consuming areas such as Chicago, New York and Boston. For more on demand trends, see prior PointLogic analysis in Natural Gas Demand Analytics and Weighing In On Winter

U.S. gas exports to Mexico were up nearly 1.0 Bcf/d in 2015 thanks to start-up of NET Mexico pipeline in south Texas that came online in late December 2014. 

LNG export volumes are beginning to take shape; for the first time ever, reported volumes to Cheniere Energy’s Sabine Pass LNG began in mid-December. Though the initial gas is for chilling and storing for the first liquefaction train, it’s expected that the first tanker could arrive by mid-January. 

The year 2015 ended net long 5.3 Bcf/d, an increase of 0.2 Bcf/d from 2014. Likewise, EIA reported gas storage inventories are bloated even further. Though it’s yet not yet official, PointLogic Energy estimates year-end inventories at 3,668 Bcf, a surplus of 533 Bcf compared to last year’s carryout and a new all-time high.

Natural Gas Liquids

Alongside the extraction of oil and gas are NGLs, which grew by 400 Mb/d to average over 3,800 Mb/d in 2015. Similar to oil and gas, the composite price of a representative NGL barrel at Mount Belvieu, Texas, fell nearly 50% to around $25/bbl in 2015 (Figure 7).   

L-48 NGL Production

Focusing in on EIA data through October 2015 (as shown in Figure 8), NGL output through refinery production gained almost 15 Mb/d to reach 667 Mb/d in 2015. Despite a small downtick in imports, overall NGL supplies were up by 434 Mb/d year-on-year.  

L-48 NGL Supply & Demand 2015 v. 2014

On the demand side, NGL exports climbed to 950 Mb/d in 2015, a pick-up of nearly 250 Mb/d on the year, thanks to over 300 Mb/d of LPG export terminal expansions along the Gulf Coast. A negative ethane fractionation spread prompted an increase of ethane rejection into the gas stream to the tune of almost 200 Mb/d. For more on ethane, see our analysis in Implications of a Tightening Ethane Supply and Demand Balance

The total offtake, including ethane rejection, for NGL amounted to nearly 4,500 Mb/d, a gain of 400 Mb/d from 2014 levels.  

Final Thoughts

In 2015, increased demand (whether it is from domestic consumption or exports abroad) wasn’t enough to offset the gains in production in crude oil, natural gas or NGLs. We are still in a global supply glut, and lower-for-longer commodity pricing is necessary to remove marginal production both at home and abroad. 

Now that all energy commodities can be exported in 2016, the world in a sense becomes flat, meaning price spreads and margin risk getting squeezed tighter. That said, capacity from newly opened pipelines, processing plants, fractionation facilities and export terminals face the reality of being underutilized — at least through 2016. 

Downward pressures on prices are significant. Any spike in prices would likely be met with a flood of new production from a substantial inventory of drilled and uncompleted wells. Meanwhile, production will most likely continue to grow in 2016 for a few select producing areas and decline in others. Overall U.S. production growth will be tempered. PointLogic expects a year of transition, and periods of such change aren’t without their ups and downs. 

Stay tuned as we help you navigate these changes through a multitude of data sets on our website and through our subscription services. A series of new product offerings and reports for PointLogic Energy clients in 2016 will aid your market knowledge of what is happening past, present and in the future.

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