National Commentary

Top 10 Energy Stories of 2015

#1.  The great oil price slide continues: The topic of oil prices dominated coverage of the broader energy story throughout 2015, thanks to a supply-vs.-demand imbalance variously estimated between 0.5 and 2 million barrels a day (b/d).  After the sustained 50 percent oil price decline during the second half of 2014 (from $107.52/barrel on June 16 to $53 at year-end), the price drop during 2015 was more modest yet more profound.  Oil started 2015 at $53 and ended the year at $37—down roughly 30%.  But the average price of oil during the two years tells a different tale: while a barrel of oil averaged $91 during 2014, the average price during 2015 was less than $49—down 46%.  Hopes for a substantial recovery of prices sometime during the year helped prop up a rally from the $40 range during the winter to the high $50s/low $60s in April.  But by mid-summer the rally fizzled.  Since August, oil hasn’t gotten above the $40s/barrel and spent all of December in the $30s.

What’s next? While everyone agrees that these low oil prices aren’t sustainable, the fundamentals don’t point to a price recovery anytime soon. During November and December of 2015, Goldman Sachs and a few other analysts fretted about oil bottoming towards $20 during 2016.  Bulging crude inventories in the U.S. and elsewhere will tend to keep prices low or drag them even lower; by mid-December 2015, storage had increased by 102 million barrels, or more than 25 percent year-over-year, hitting a new record according to EIA.

Commitments by OPEC to sustain current levels of production offer no relief, nor does the looming increase in exports by Iran, bookended by sustained output by large non-OPEC producers Russia and China.  Only the recent modest slowdown in U.S. production since a peak last spring gives some analysts any sense that the sustained price bust will turn later in 2016.

#2.  Oil industry devastated by rapid drop in prices: The sudden price decline has left many high-cost oil producers (mostly producing fracked shale, deepwater and heavy oils) with costs of new production well above current selling prices. This in turn has resulted in a massive reduction in exploration for oil and drilling of new wells with serious implications for the industry’s production in the years ahead, depending on how soon, how fast and how far oil prices recover. The prevailing sentiment within the industry is more gloom and doom, with some expecting an even tougher year in 2016 than they have just endured.

New projects are not economic at today’s oil prices.  That’s why the active U.S. oil rig count declined from 1482 units during the first week of 2015 to 536 at the year’s close—a drop of 64%. That’s primarily why Shell shut down its Arctic drilling campaign. Chevron announced Dec. 9 that it would slash capital spending plans by 24 percent to $26.6 billion during 2016. Devon Energy, one of the larger independents active in U.S. shale oil plays, said it would cut between $2 – $2.5 billion from its 2016 plans, down from about $4 billion during 2015. And the list goes on…

Perhaps Prince Abdulaziz bin Salman al Saud, Saudi Arabia’s vice minister of petroleum and mineral resources, best summarized the carnage last month: “Around $200 billion of investments in energy have been canceled this year [2015], with energy companies planning to cut another 3 to 8 percent from their investments next year. This is the first time since the mid-1980s that the oil and gas industry will have cut investment in two consecutive years.”

While industry players with stronger balance sheets can survive through cost cutting and commitments to efficiency and “drilling the best rocks,” debt and cash flow problems are swamping others.  As of mid-December, EnerCom Analytics reported that 41 oil and gas companies, indebted to the collective tune of $16.7 billion, filed with the courts for protection under either Chapter 11 or Chapter 7 of the U.S. bankruptcy code.  Note, however, that companies which have filed are generally small players with none of the diversification, such as refining and retailing, of the oil majors.

Unless prices recover soon, shifting into survival mode may get even harder for many smaller drillers.  Every six months, the Securities and Exchange Commission “redetermines” both the value and the amount of the reserves against which companies can borrow.  Last October, that borrowing base was reduced by nearly 12 percent on average; if prices remain in the $30s/barrel during the first quarter, the next redetermination will further erode industry borrowing power.

At the boots-on-the-ground level, last month Swift Worldwide Resources estimated that the number of oil industry jobs had declined by 233,000 since the price crash began.  In the early 2000s, an aging industry that was losing a disproportionate amount of experienced staff was struggling to bring in new blood during the early stages of the recent boom; now it is faced with yet another employment downturn that may slow the next recovery cycle.  Apart from direct industry employment, the broader impact on overall economy—from less pipe manufacturing to less truck driving to fewer home builders and service workers in the oil patch—is much larger than just direct industry jobs lost.

#3.  Major oil-exporting governments suffering greatly: Nearly all members of OPEC and several non-OPEC oil exporters such as Russia, Canada, and Mexico are suffering from large revenue losses brought about by the severe price drop. Ten out of 12 OPEC nations are dependent on oil exports for over 85 percent of their export revenues; when those revenues dropped during 2015, national budgets got squeezed and deficits grew, often explosively. Countries such as Venezuela, Nigeria, and Angola are facing political instability in the next year or so.

Consider Saudi Arabia, the world’s largest oil exporter with the strongest balance sheet.  During the first nine months of 2015, the International Monetary Fund (IMF) calculated the kingdom had spent $73 billion of its foreign reserves to cover their deficit.  That deficit would be the equivalent of 20 percent of the nation’s GDP.  The IMF said that if foreign reserves continued being tapped at the same rate, they will be gone in five years.  The reality of the long price battle they may face has convinced the Kingdom to cut popular gasoline subsidies at the start of 2016, with more budget belt tightening to come.

On the other end of the spectrum, the IMF assumes that Libya will rely on heavy borrowing through 2020.  Its 2015 deficit could reach nearly 70% of its GDP this year and over 40% during 2016, while the country struggles with low oil prices and its civil war.  Oil provides Venezuela with 95% of its export earnings and roughly 25% of its GDP, leaving it extremely vulnerable to continued low oil prices, especially in the aftermath of its recent election in which the ruling party lost badly.

The impact of lower oil prices on Russia’s economy remains serious but mixed.  On the downside, their economy slipped into a serious recession during 2015 as GDP dropped roughly 4 percent; their currency continued sinking, apparently to its lowest level on record; the value of exports dropped dramatically and the cost of imports rose; accordingly, inflation grew to 15+ percent; and geopolitical risks continue unabated. On the upside, oil production hit a new post-Soviet high in 2015; domestic oil production costs are lower than international costs due to currency problems; the agriculture sector is doing better; and the industrial sector is stabilizing.

#4.  Little economic growth seen from low gas and oil prices:  Despite economic theory saying that a large reduction in the retail price of oil products and natural gas should give a major boost to economic growth in the industrialized and oil-importing nations, so far little of this has occurred. Conversely, the rapid contraction of the oil and gas industry in the US is bringing economic hardships to many localities.

In the larger oil producing states, tax revenues are down due to lower oil prices plus job losses in the energy and related sectors. That led to substantial budget revisions in oil-producing states like North Dakota, Texas, Oklahoma, Louisiana, New Mexico and Alaska this fiscal year. More downward revisions are projected by Moody’s Investors Service for fiscal year 2016. In Oklahoma, for example, Moody’s says the cut for the remainder of the fiscal year will be 8 percent with a 13 percent cut for the following year. Loss of oil revenues in Alaska may lead to the reestablishment of a state income tax.

Declining fuel costs are often likened to a tax cut—in this case of 2015 a $290 billion cut—that puts money back in the pockets of consumers who then usually spend the windfall.  Not this time around.  Savings from $2 gasoline have gone into savings accounts, not shopping sprees, leading to a lackluster growth in GDP of 2% (annual rate) during the third quarter of 2015.  This doesn’t align with normal expectations, and perhaps wisely so.  Edward C. Chow, an energy expert at the Center for Strategic and International Studies, was recently quoted in the Washington Post as follows: “There’s something else going on. There’s some anxiety out there that is not comforted by low oil prices.”

Additionally, sectors of U.S. industrial production have slowed, in part due to the dramatic slowdown in oil drilling nationwide, though auto, SUV and truck sales are up.  Some businesses appear to be taking profits and working their way through inventories, rather than passing savings from lower-cost oil on to consumers.  Finally, crashing oil prices have undercut efforts to trim fossil fuel consumption, especially oil.  The IEA said in a recent annual report that if crude oil stays near $50 a barrel through 2020, cheaper conventional fuels will slow down adoption of electric cars and development efforts towards an ever-illusive advanced biofuel alternative.

#5.  Turmoil in the Middle East and North Africa increases: Moscow’s military intervention into the Syrian civil war on behalf of the Assad government has prolonged the situation indefinitely or, less likely, offered a path to a settlement. Prior to the Russian intervention rebel groups, newly armed by the West and the Saudis, were threatening to overrun areas of Syria still loyal to the Assad government. As an adjunct to the Russian intervention there was a marked increase in Iranian and Hezbollah militia fighting the rebels which gave the Assad government more offensive military capability than it has had for a long time.

Indiscriminate Russian bombing, mostly of the more moderate rebel groups which posed an immediate threat to the Assad government, initially had some success, but recently the situation seems to have evolved into a stalemate with Tehran pulling out some of its forces due to heavy casualties.

The significant increase in airpower being used against ISIL last year is beginning to take a toll on the group’s military capabilities in Iraq and Syria. So long as the caliphate can keep its military assets mostly in urban areas it is relatively safe, but its ability to advance and hold fixed military positions is becoming limited. Thus we are seeing the group step up activities in the EU and elsewhere as the means of keeping up morale and attracting recruits.  At a minimum the increased, less inhibited, and better targeted bombing is resulting in the destruction of what remains of Syria’s oil production that has been in the hands of ISIL.

As military pressure increases on the Islamic State in Iraq and Syria, the organization has been increasing its recruiting of new adherents in Libya and has recently been in a position to begin threatening some oil production. There are indications that the growth of the Islamic State could eventually lead to European intervention to suppress the organization, stop its threat of infiltrating Europe via the refugee stream, and to maintain the oil supply.

Over the longer term, however, the increasingly savage fighting has major implications for state, tribal and theological relationships throughout the region. Saudi Arabia’s direct military intervention into the Yemeni civil war and support for the anti-Assad forces in Syria during the past year has further exacerbated the situation and could eventually lead to political instability in the kingdom. The bottom line is that national boundaries and political institutions that have been in place for many years are slowly crumbling.  So far there has not been a major impact on the region’s oil production, but given the trends this may not be the case for much longer.

#6.  Repercussions from Russian involvement in Ukraine: Moscow’s continuing efforts to keep Ukraine within its sphere of influence and prevent the country from aligning with the EU have triggered a series of repercussions affecting the oil markets. The sanctions, counter sanctions and animosities resulting from the confrontation have left many European countries looking for ways to reduce their dependence on Russian gas and oil. Meanwhile, Moscow is seeking to offset the decline in oil and gas sales to the EU with increased sales in China and Asia at the time when demand in the Far East for oil and gas seems to be lessening.

A combination of low oil and gas prices, the US and EU sanctions, and the Putin government’s efforts to reestablish itself as a major player in world politics are placing severe strains on the Russian economy. While oil production from Moscow’ older fields continues to creep higher for now, new and potentially productive ventures such as shale or Arctic oil, which Moscow had been counting on to offset a decline in conventional oil production, are on hold indefinitely due to the sanctions and lack of foreign investment.

#7.  The Iranian nuclear agreement and the lifting of sanctions: As the year closes, it seems likely, but not certain, that the sanctions against Tehran will be lifted soon, freeing the country to produce and export as much oil as it can. The Iranian government already has millions of barrels of oil stored aboard tankers ready for immediate delivery and hopes to increase its oil production by 500,000 to 1 million b/d during the coming year. The lifting of the sanctions will also free Iranian assets that have been frozen for years, which many believe will enable to Tehran to increase its involvement on behalf of its fellow Shiites throughout the region.

The immediate effect of the pending sanctions removal has been an effort on the part of Tehran to regain its previous share of the global oil markets. To do this, the Iranians have been offering to lower the price of their relatively cheap-to-produce crude as much as necessary to gain an increased share of exports going to South and East Asia. These discount prices could have a major impact on the markets in the year ahead.

However, fears are rising among the conservative elements in Iran that the new agreement will lead to more Western influence and in the long the erosion of their position in Iran’s power elite. Resistance to the agreement in parts of the Iranian government has already led to highly provocative actions by conservative forces designed to warn the Rouhani government against becoming too close to the West and particularly the US. This has resulted in new pressures to cancel the agreement, which still seems safe for the moment, but the situation could change.

Iran’s efforts to protect Shiite minorities in the Middle East against the majority Sunnis puts the country squarely in the middle of a growing religious confrontation as the recent reaction to the Saudi’s execution of a Shiite imam shows.  The year ahead should tell how successful Iran will be in rejuvenating its economy through increased oil sales or whether its involvement in so many regional confrontations will lead to still more troubles. The deteriorating climate in Iran will become an increasing important issue governing the country’s behavior in the next few years.

#8. China’s economy continues to slow:  For the last 35 years, Beijing’s spectacular economic growth has led to steady increases in its demand for oil. During the past year, however, many signs point to a slowdown in China’s industrial production as the country shifts from an export-oriented economy to one based on domestic consumption. So far, numerous government efforts to get the economy back on track seem to have had little effect. Many fear that China’s economy will continue to contract, eventually leading to a global recession and a reduction in the demand for oil.

While admitting that annual GDP growth has fallen from some 12-13 percent a few years ago to around 7 percent today, the government remains optimistic and predicts that oil consumption will increase in the coming year even as it undertakes major efforts to reduce air pollution and switch the country away from fossil fuels. China’s leaders realize that cutting back on the use of fossil fuels is essential for the future of the country, but fear the social and economic repercussions of moving too quickly. Beijing seems to be at another turning point in its tumultuous history. Its economic and social well-being over the next decade will have a major impact on the global economy and the demand for oil.

#9. Increasing concern about global warming and hazardous air pollution: Recent surveys show that some 87 percent of the world’s population is living in unhealthy air due to the burning of fossil fuels. Only those in the advanced countries that have been working for decades to mitigate air pollution have seen improvements in air quality. In some places, such as northern China, India, Iran and even now in Italy, the air pollution has become so critical in recent weeks that governments have had to place restrictions on the use of motor vehicles.

The agreements at the Paris climate change conference, while not binding, clearly show that the majority of the world’s leaders have come to appreciate the dangers of climate change and the need to restrict the use of fossil fuels as quickly and completely as possible. Until recently a few major polluters such China and Russia were reluctant to make any effort to reduce emissions, believing that the cost of such efforts would be too heavy. Now this seems to be changing due to the deteriorating climatic and air quality situation.

In the long run this situation will have major consequences for the fossil fuel industry. Although there are non-polluting alternatives to fossil fuels, the transition to new sources of energy will be a lengthy and expensive process.

#10. New policies — Keystone XL, US crude exports, renewables subsidies: Keystone XL pipeline:  After a multi-year contentious campaign by the oil industry to gain approval for completion of the Keystone XL from Calgary down to the U.S. Gulf states, President Obama rejected the proposed oil pipeline in early November.  The President’s decision was not a surprise; the actual surprise may be the decision’s very limited impact. After the announcement, a number of analysts opined that the decision wouldn’t hurt the industry since imports of Canadian crude, which set a record in August (3.4 million b/d), are moving down other pathways to American refiners.

Ending crude oil export ban:  Supporters of the lifting of U.S. oil exports finally won their multi-year battle when the $1.1 trillion omnibus spending and tax bill was passed December 18.  Yet it may end up being a Pyrrhic victory, or at least another decision with minimal impact.  Since the campaign started several years ago, the $5 to $10 differential between lower-priced US oil and higher-priced oil elsewhere has disappeared.  As OPEC’s secretary-general Abdalla El-Badri observed, “The net effect of export of American oil on the market is zero. This will have no effect on the price because the U.S. still is an importing country. They export some, but they need to import the same quantity from somewhere else.”

Oil producers have argued for years that the ban is an outdated relic that needs to be lifted in order to let free markets work efficiently.  And indeed, the first shipment of crude oil left U.S. shores on the last day of December, less than two weeks after passage of the bill. Yet significant transportation costs from the primary potential export region—Texas and Louisiana—may undercut the economics of shipping much crude, other than blend-mismatched oil, to foreign refineries.  It may take five or ten years before an evaluation of the ban’s repeal determines whether it had has much impact.

Renewable energy tax breaks extended: Manufacturers, installers and purchasers of renewable energy equipment may end up being the biggest energy industry winners from the new omnibus budget deal.  As part of the bill’s grand compromise, those opposed to lifting the oil export ban were lured by their likely support for the bill’s extension of wind energy’s Production Tax Credit (PTC) and solar energy’s Investment Tax Credit (ITC).

Renewable energy advocate and writer Chris Nelder summarized the key details: “In a display of bipartisan compromise that has been vanishingly rare in recent years, Congress has agreed to extend the solar ITC at the current 30-percent rate through 2019, after which it will fall to 26 percent in 2020, 22 percent in 2021, and 10 percent in 2022. An additional commence-construction clause will extend the credit to any project in development before 2024. And the wind PTC will be retroactively applied to 2015 and extended through 2016, after which it will decline each year until it fully expires in 2020.”

The bottom line here: solar and wind energy, which have been growing rapidly in the U.S. during this century, are becoming more and more cost-competitive with traditional fossil fuels, thanks in part to previous tax breaks.  If costs keep coming down, by the time the newly extended tax credits fade away, those two industries may be sufficiently robust to survive and thrive in a non-subsidized environment.

Compiled by Steve Andrews and Tom Whipple

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