The future is often difficult to predict with mathematical precision, and it's even more difficult when multiple unknowns drive one key question for investors, operators and policy makers: Where will energy prices go in 2012?
Many forecasts are available, but there is some general consensus about where oil, natural gas and its liquids will go this year. Crude prices are strong and expected to hold their own. Natural gas prices are weak and their relationship with crude is expected to remain low for at least the next year. Natural gas liquids, already valuable to operators, will continue to drive investment and operating priorities throughout 2012. In short, the expectations for 2012 look a lot like the reality at the close of 2011.
The wild card for many operators is the price of crude. Crude is still the driver for the majority of operators, and their investment decisions usually follow their expectations.
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“Most foresee growth as stagnant, at best, but if the macro world economy improves faster than expected, we could see a stronger foundation for prices.” — Adam Connors, director of corporate cinance, C. K. Cooper & Co.
Adam Connors, director of corporate finance at C. K. Cooper & Co., says the investment bank foresees crude prices in the range of $75 to $100 per barrel (bbl.) during the next 12 months. The price will likely stay capped in the $100 range per bbl. as emerging markets show the potential for slowing, even as demand in developed countries waxes and wanes for the foreseeable future.
Supply-side effects
The supply side for crude is even more uncertain, Connors says. OPEC announced it will continue to supply 30 million bbl. per day to world markets, but divisions within OPEC may call that commitment into question. Relations between Saudi Arabia and Iran are tense amid the fallout of an alleged plot by Iran to assassinate the Saudi ambassador to the U.S., Connors says.
The return of Libya to the world crude market should also keep a lid on prices in the foreseeable future. The country has announced it hopes to return to pre-war production levels of about 1.6 million bbl. per day by the end of 2012. Most economists are not overly optimistic about world economic growth next year, but if growth occurs faster than expected, prices could push above that $100 per bbl. ceiling.
"Most foresee growth as stagnant, at best, but if the macro world economy improves faster than expected, we could see a stronger foundation for prices," he says.
Connors says the possibility of severe weather or an unexpected incident similar to the blowout of the Macondo well in the U.S. Gulf of Mexico could cause an unexpected price spike. Additionally, if there is a policy shift with the Strategic Petroleum Reserve, "we will see some movement in prices," he says.
Meanwhile, Connors expects the disparity between Brent and West Texas Intermediate (WTI) prices to hold for the foreseeable future. "Crude is a global macro commodity, but this spread has not narrowed as fast as we would have expected," he says. WTI at Cushing is expected to hold a discount to North Sea Brent because of the incremental supply of crude coming out of the Bakken shale and the U.S. Rocky Mountains.
Other forecasts put crude in a similar range. The Bank of Oklahoma is projecting the 12-month average price for crude at $85 per bbl. for the 12-month period ending October 31, 2012, for lending purposes. The current price for the year beyond that is also capped at $85 per bbl.
Mickey Coats, executive vice president and manager of BOK Financial Corp., says the bank uses the forecast to build financial models for prospective energy clients and bases its forecast on the forward crude curve of the New York Mercantile Exchange. The bank updates its outlook monthly and applies it as a basis for analysis for the life of the asset.
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“There’s just more gas in supply and we don’t see more demand for it yet.” — Mickey Coats, executive vice president and manager, BOK Financial Corp.
The financial models, based on such commodity forecasts, have allowed upstream and midstream operators to have good access to capital markets in 2011, and that trend is expected to continue through 2012.
The market is willing to lend them money or to complete an initial public offering, or even structure a master limited partnership to access the public markets, according to Coats. Many loans are at low rates with long maturities. In many cases, fresh access to capital markets have led some operators to pay off debts and use banks only as a line of credit for short-term capital needs, Coats says.
Inherently bullish
Other assessments for the outlook on crude in 2012 are inherently more bullish. A recent report from Deutsche Bank Group forecast U.S. crude prices, as measured by the front-month WTI settlement price during fourth-quarter 2012, at $106 per bbl. The similar price for Brent crude prices is expected to reach around $116 per bbl. during the same period.
The report stresses that the global economic outlook remains the key to the near-term oil market forecast. Deutsche Bank's own forecasts for global economic growth were around 3.4% for 2012, down from an expected 3.7% in 2011. Its numbers were slightly below other economic forecasts. The prospects for growth in Europe are falling while the U.S. economy looks better for 2012. Meanwhile, every one percentage point of lower gross domestic product (GDP) growth equates to about one percentage point less in oil demand, or about 900,000 bbl. per day, according to the report.
But oil prices can vary widely with many factors, the Deutsche report states. "Despite our concerns about the economic outlook, we think there are just as many upside risks in the oil markets in 2012 as there are risks to the downside."
Total world oil consumption is expected to increase from about 89.4 million bbl. in 2011 to about 90.6 million bbl. per day, provided that global economic growth does not stumble.
Deutsche Bank sees an industry consensus that overall growth for crude will rise by 1.27 million bbl. per day in 2012. The expected growth in oil consumption could come under "further downside pressure" if economic growth is less than expected. Demand within counties from the Organization for Economic Cooperation and Development is falling, while virtually all of the stronger growth is coming from non-OECD countries.
Asian effects
For many analysts, the potential for an abrupt increase in oil demand from Japan is a source of uncertainty in many forecasts. "Nuclear power availability has fallen as local communities refuse to allow plants to reopen following maintenance checks," Deutsche Bank reports.
With the availability of nuclear power uncertain in 2012, many analysts don't know how much crude Japan will need to offset this loss of production, which makes any worldwide demand forecast for crude less certain.
On the supply side, Deutsche Bank forecast a modest increase in non OPEC crude production in 2012, rising to 53.7 million bbl. per day in 2012, from an estimated 52.7 million bbl. per day in 2011. Other analysts expected a similar increase, with additional supplies expected from Brazil, Canada, Colombia, Australia, Russian and China, as well as from unconventional sources such as U.S. shale production and Canadian oil sands.
Meanwhile, the U.S. Energy Information Administration expected declines in Russia, Mexico, Syria, Brazil and Yemen. OPEC crude production is expected to increase from 30.2 million bbl. per day to 30.3 million bbl. per day in 2012.
High-price environment
Hart Energy is forecasting global GDP growth in 2012 to reach 3.6%, a forecast it revised downward after the policy stalemate between President Obama and the U.S. Congress. There is also continued downside risk in Europe if the debt crisis severely impacts Spain and Italy—which account for 5.5% of the global economy.
The firm forecasts that WTI spot prices will average $96.50 in 2012, while Brent will reach $104.50 during the same period. Conrad Barnes, manager of petroleum research at Hart Energy, sees a fair amount of uncertainty in the market over the direction crude prices will take in the interim.
"Oil prices are very dynamic. It's a global commodity. It's impacted by everything and anything from supply and demand, geopolitical turmoil and market expectations," he says.
The current price forecast includes estimates about the marginal cost taking of crude out of the ground outside of OPEC nations, the expected return for producers and the premium on prices caused by speculation and geopolitical uncertainty. "These things all work together to push us into the current range," he says.
Hart's current price forecast is relatively high by historical standards. Only once in history have crude prices averaged near $100 per bbl. for an entire year—and that was in 2008, when front month prices on the New York Mercantile Exchange peaked at $145 in July 2008. "There is no doubt we are in a high price environment," Barnes says.
An increase in geopolitical uncertainty as the Arab Spring continues to unfold could push prices higher than Hart's forecast for 2012. The uncertainty about the availability of oil from Iran is another source of geopolitical instability which could push prices higher. On the other hand, a meltdown of the European financial system could restrict demand and pull prices below the forecast, Barnes says.
Hart forecasts the premium for Brent above WTI, which fluctuated around $20 per barrel for much of 2011, should fall to about $8 per bbl. for two reasons.
First, the reversal of the Seaway Pipeline in the U.S. midcontinent should eliminate some of the glut of supplies in Cushing, supporting prices there.
Second, the gradual return of Libyan crude to world markets should alleviate some of the demand for Brent and help soften its price. With WTI gaining and Brent softening, the spread between the two should fall to around $8 per barrel, Barnes says.
Natural gas forecast
Analysts generally agreed that a series of factors are contributing to weak natural gas prices for the foreseeable future. The largest factor holding down natural gas prices—the influx of production from shale plays—is expected to continue to set a ceiling in prices in the U.S.
Producers continue to flood the market with natural gas, largely from unconventional shale sources, because if they don't drill, they risk losing the lease. Or, gas is produced as a bi-product with the more-lucrative oil.
Virtually all analysts expect prices to remain weak relative to crude because of the additional supplies from unconventional gas sources. "The industry consensus is that there is a lot of supply of gas," Barnes says.
Deutsche Bank forecast natural gas prices in the range of $4.50 per million (MM) Btu for front month delivery at Henry Hub in fourth-quarter of 2012. The forecast from the Bank of Oklahoma is lower, at $3.88 per MMBtu for the 12-month period ending October 31, 2012. For the 12-month period after that, the forecast is $4.50 per MMBtu. The absolute cap is $7 per MMBtu.
C.K Coopers reports that the prices would hold in the range of $3.00 to $5.00 per MMBtu for the foreseeable future.
A resurgence in natural gas prices depends on a clear increase in natural gas demand, Coats says. Although there are some signs of long-term demand shifting, Coats does not expect a significant shift to happen in 2012, leading to lax demand for natural gas and weak prices. Ample supplies and lax demand for the foreseeable future leads many analysts to expect natural gas prices to remain low in absolute terms and relative to crude for at least another year.
Hedge rolloffs
Many of the hedges on natural gas prices are expected to fall off in the next 12 months, further restraining natural gas prices as producing companies may no longer be able to justify the economics at current market prices. For many upstream natural gas players, current prices lead to marginal production levels. As a result, a significant amount of supply could be turned on abruptly if the market saw an unexpected increase in prices.
A cold winter would push up prices in the short term, but it would not cause a permanent shift in the current pricing structure, Connors says. In addition to their relatively low levels, today's natural gas prices are much less volatile than their historical standards, and Connors foresees this trend to continue this year. Although renewed demand this winter could cause some additional volatility, Connors says he doesn't expect anything like four years ago when a severe weather event could cause an unexpected spike in prices.
However, one potential fundamental shift that could choke the supply side of natural gas could be the legislative and government agency measures with fracking that are currently being contemplated. Though Connors does not believe fracking could be banned all together, similar to France, restrictions that make completing a well more costly or "overall onerous" could shift the supply side of the equation.
Crude versus gas
According to the analysts, and taking all the factors into consideration, crude prices are expected to remain strong relative to natural gas. The additional supplies of natural gas tapped by unconventional sources are expected to hold prices down for at least another year, while the industry looks for oil and liquids-rich gas plays.
Natural gas liquids, meanwhile, are expected to provide some relief to natural gas producers. The market consensus is that the spread between crude and natural gas prices—which is around 16 to 1, compared with a historical average of around 6 to 1—will hold at least through 2012.
"There's just more gas in supply and we don't see more demand for it yet," Coats says. In dry-gas areas, many operators are drilling at essentially zero profits, pulling gas out of the ground only to generate cash and to avoid losing the lease, he says. Operators and their bankers prefer crude or wet-gas plays at the expense of dry-gas plays, a trend expected to continue in 2012, Coats says.
In addition, the spread between natural gas and its liquids is expected to hold for the foreseeable future. Upstream companies should continue to search for crude and liquids-rich gas plays at the expense of the dry-gas plays.
The trend of inexpensive natural gas and relatively expensive crude prices has led to a price discrepancy between methane and liquids associated with natural gas, and that trend is expected to continue through 2012.
"Any place an operator can get some liquids, they will do that," Coats says.
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