Oil Prices in 2016

Every now and then we find an article that demonstrates why we hold our philosophy of wisely managing oil and gas minerals as an asset, without emotional ties, that has a certain value today, but nobody knows about tomorrow. I hope you will find this article interesting and informative.

Forecasts are always wrong until they’re right

Four years ago, Michael Lynch told a joke at an OPEC seminar in Austria that fell flat.

“If you’ve been doing oil economics for 35 years, you either have to have a sense of humor or a drinking problem.”

Was it the liquor reference? Maybe it was Mr. Lynch’s prediction that oil prices could fall as low as $50 per barrel that kept the mood somber. Despite his research showing oil has remained at a $30 equilibrium, adjusted for inflation, for its entire commercial existence with a few notable spikes, the oil and gas industry was predicting a new normal of $100 per barrel and climbing.

At the time of Mr. Lynch’s comments, oil was trading at around $97, having started the year north of $100.

When a reporter in the audience asked the CEO of French oil and gas giant Total to comment on Mr. Lynch’s forecast, one of the conference organizers was quick to clarify: “Surely, Michael Lynch was joking.”

He was not. Indeed, he was proven an optimist when the price of oil dropped to $31 per barrel Monday.

Natural gas producers, including those operating in the Marcellus Shale region, have been cutting their budgets and staff, and many have been losing money on their products since natural gas prices first took a dive several years ago.

The same forces that created the gas glut — shale-driven production growth and low demand — are now wreaking havoc in oil.

Back in 2012, Total’s CEO at the time, Christophe de Margeri, didn’t appear to have the sense of humor Mr. Lynch, president of Strategic Energy & Economic Research Inc., recommended regarding the prospect of oil returning to its historical average.

“Well, I don’t want to take anybody for an idiot,” he said, looking in Mr. Lynch’s direction. (A video of the panel is available on OPEC’s website.)

Then he said that his company and its peers could continue to function and invest in oil development at $100 long-term prices, or, in the short-term, at a floor of $80 per barrel.

“If we go to $50, the answer is easy,” Mr. de Margeri said. “All the projects which are today launched, will be either stopped, postponed, delayed.”

All projects have not stopped. Although Total was among the first companies to slash its capital budget, it is still drilling new wells and increasing oil production.

No one is predicting $100 oil anytime soon, but current forecasts are about as useful today as they were in 2012, Mr. Lynch said. “Most industries tend to predict higher prices,” he said. “Companies like the idea that their revenues will go up no matter what they do.”

Check the forecast, but don’t bet on it

In 2012, the Energy Information Administration, one of the most well-regarded data collection and analysis endeavors around, had as its reference scenario oil climbing steadily from $100 to $145 through 2035.

In its 2015 Annual Energy Outlook, the agency took the same curve and moved it down the Y axis, predicting a steady increase in the oil price stretching from the mid-$50s per barrel to $141 by 2040.

Like others in the energy industry, Lori Smith Schell, president of Colorado-based consulting firm Empowered Energy, pores over the EIA forecasts expecting them to be wrong. She reads them for the fine print — the assumptions the agency uses to guess the future. They answer questions like how much gas is in storage, how many wells are producing from each shale play, will an uptick in manufacturing create more demand for natural gas?

That data helps her make recommendations to clients, like institutions and industrial facilities, on hedging strategies.

“You hedge because you know forecasts are going to be wrong,” she said.

Then, you don’t look back.

Prices rise and fall. It’s impossible to predict when.

The most recent oil collapse is the result of a glut created by shale development in the U.S., steady production from Middle Eastern countries, and slower than predicted global growth that accounts for sluggish demand.

In January 2015, Dave Knapp, chief economist with Energy Intelligence Group in New York, predicted the year would end with $35 oil.

Given the chance to boast about his prediction last week, Mr. Knapp recalled another from January 1986 when he warned that in two weeks’ time, oil prices would be slashed in half. And that’s what’s happened.

“The interesting part of it,” he said, “is that I gave the same speech in November of 1985, and in August of 1985.”

Mr. Lynch, too, has been saying that oil would go back to $30 per barrel for a while. It took 10 years for his prediction to sound prescient instead of just wrong.

No guarantees for oil and gas investments

Mr. Lynch and Mr. Knapp, who are friends, say they have been fighting for years against the idea that because oil and gas are finite resources, their prices have nowhere to go but up. Technology has and will take care of the resource side of the equation. The economics are the trickier to predict.

“You can know what the true situation is and it’s not investable, because the market can just go in a different direction,” Mr. Knapp said.

Mr. Lynch attributes some of that to short institutional memory, or just wishful thinking. “People tend to look at a short term market change, usually on the upside, and say, ‘Aha — it’s a new paradigm. This time prices won’t go down.’”

When they do, those whose predictions that had up until then sounded wrong, all of a sudden seem right.

“They say a forecast is great as long as you don’t put a date on it,” Ms. Schell said.

Source: Anya Litvak / Pittsburgh Post-Gazette