Crude’s direction on a day-to-day basis has become harder to anticipate, as a growing mix of long and short-term factors influence sentiment and drive volatility. Brent has been in correction mode after breaching $59/barrel on September 25, but the downside has been limited. For those trying to gauge expectations on market rebalancing, the benchmark managing to hold on to the mid-50s on the way down is perhaps more significant than its failure to breach $60 on the way up. The new floor — which could be in the low-50s, as we believe it has not been fully tested yet — signals cautious optimism over supply and demand continuing to be balanced, going into 2018, as OPEC and non-OPEC producers prepare to pump less for longer and US shale looks ready to settle down after a red-hot pace of growth earlier in the year. Meanwhile, widening WTI discounts to Brent and Dubai are spurring US crude exports to new all-time highs. The trend is likely to get a fresh boost as India’s public sector refiners finally begin importing US crude, both conventional as well as tight oil from shale.
Brent continued correcting this week from a 26-month high of just over $59/barrel notched on September 25, as fears of Iraqi supply disruption owing to the Kurdish independence referendum receded fully into the background. The last rally proved resistance at the psychological ceiling of $60, but the North Sea benchmark
may have found a floor in the low-$50s, as market consensus has consolidated around a slow-motion rebalancing in progress.
A troika of factors underpins a more constructive view of fundamentals over the next 12-18 months:
- Growing confidence in the OPEC/non-OPEC cuts being maintained through the end of 2018, pushing aside concerns of an untimely flood of supply returning to the market. Optimism over the world’s two biggest oil producers Russia and Saudi Arabia remaining joined-up in their mission to restrain supplies received a boost this week from Saudi King Salman bin Abdulaziz’s high-powered maiden visit to Moscow.
- Moderating expectations of US production growth as shale producers appear to have reached the limits of productivity gains and face cost and shareholder pressures that are likely to curb aggressive new drilling. Taking into account the US Energy Information Administration’s somewhat divergent weekly and monthly production data so far this year as well as its forecasts, we are factoring in an annual output growth of around 400,000 b/d in 2017, tapering off in 2018 as long as crude prices remain in their current range.
- Cautious optimism over strong global economic growth supporting strong oil demand growth in 2017. The views on the quantum of increase vary and there is plenty of skepticism around the most optimistic 1.6 million b/d year-on-year jump predicted by the International Energy Agency. But few in the market would be willing to bet against it until and unless the upcoming monthly consumption data squash the narrative.
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In its latest Short-Term Energy Outlook (STEO), released on January 12, the U.S. Energy Information Administration (EIA) forecasts that generation from natural gas-fired power plants in the U.S. electric power sector will decline by about 8% in 2021. This decline would be the first annual decline in natural gas-fired generation since 2017. Forecast generation from coal-fired power plants will increase by 14% in 2021, after declining by 20% in 2020. EIA forecasts that generation from nonhydropower renewable energy sources, such as solar and wind, will grow by 18% in 2021—the fastest annual growth rate since 2010.
The shift from coal to natural gas marked a significant change in the energy sources used to generate electricity in the United States in the past decade. This shift was driven primarily by the sustained low natural gas price. In 2020, natural gas prices were the lowest in decades: the nominal price of natural gas delivered to electric generators averaged $2.37 per million British thermal units (Btu). For 2021, EIA forecasts the average nominal price of natural gas for power generation will rise by 41% to an average of $3.35 per million Btu, about where it was in 2017. In contrast, EIA expects nominal coal prices will rise just 6% in 2021.
The large expected rise in natural gas prices is the primary driver in EIA’s forecast that less electricity will be generated from natural gas and more electricity will come from coal-fired power plants in 2021 than in recent years. EIA expects about 36% of total U.S. electricity generation in 2021 will be fueled by natural gas, down from 39% in 2020. The forecast coal-fired generation share in 2021 rises to 22% from 20% last year. However, these forecast generation shares are still different from 2017, when natural gas and coal each fueled 31% of total U.S. electricity generation.
Significant growth in electricity-generating capacity from renewable energy sources in 2021 is also likely to affect the mix of fuels used for power generation. Power developers are scheduled to add 15.4 gigawatts (GW) of new utility-scale solar capacity this year, which would be a record high. An additional 12.2 GW of wind capacity is scheduled to come online in 2021, following 21 GW of wind capacity that was added last year. Much of this new renewable generating capacity will be located in areas that have relied on natural gas as a primary fuel for power generation in recent years, such as in Texas.