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Global Oil and Gas Prices Poised to Decline in 2014

Increased supply and weak demand growth will put pressure on most energy commodity prices, even as the economy strengthens.

Price of most oil and gas commodities are likely to decline this year as increases in supply outstrip gains in demand, according to industry analysts and government forecasts. Liquefied natural gas (LNG) should stand out as the exception to the overall trend, however, as the opposite scenario is unfolding in that widely traded petroleum product.

The global economy is expected to grow by 3.6 percent in 2014, according to the most recent forecast by the International Monetary Fund, up from 2.9 percent in 2013. Typically, stronger growth generates a corresponding increase in demand for oil and gas, but this year demand is likely to lag the economy because of increased energy efficiency and a growing contribution of renewables to the overall energy mix. For example, rising fuel efficiency standards in new vehicles are likely to limit demand increases for gasoline. According to a report released in December 2103 by the U.S. Environmental Protection Agency, fuel efficiency standards hit a record in 2012, with new American cars averaging 23.6 miles per gallon. Fuel economy has improved in seven of the past eight years, the agency found. Natural gas demand at power plants is expected to be moderated by rising wind and solar electricity generation, says Francisco Blanch, head of global commodities and derivatives research for Bank of America Merrill Lynch in New York. U.S. Department of Energy statistics show that wind energy accounted for 43 percent of new capacity in 2012, more than any other source.

OPEC predicts global demand for crude oil will rise 1.1 percent in 2014, to 98.84 million barrels per day (bpd). The International Energy Agency (IEA)forecasts a similar boost of 1.2 percent. On the supply side, gains in production from U.S. shale deposits, incremental output growth worldwide and a possible scaling up of production in Iraq and Libya will more than meet that demand, according to Blanch. Peter Dupont, who covers the oil and gas sector for Edison Investment Research, said in an interview with The Energy Report that he forecasts 1.7 million bpd of new supply in 2014.

The U.S. dollar is also expected to have a moderating impact on oil and gas prices, which are quoted in the U.S. currency. A stronger U.S. economy is expected to push up interest rates and encourage a further repatriation of U.S. capital from emerging markets, producing a relatively strong dollar. “The key factors are the level of supply and the U.S. dollar remaining strong,” says Blanch. “It’s hard to see how oil can rally on a sustained basis if the dollar is strong, pushing up the prices in other currencies. That will cap the ability of consumers to buy oil.”

From those common factors, the outlooks for main oil and gas commodities in 2014 diverge according to their specific market dynamics. For crude oil, the biggest factor boosting supply is the continued growth of U.S. shale oil. In April the U.S. Energy Information Administration (EIA) expected U.S. shale plays to produce 2.3 million bpd in 2013. A reassessment in December boosted the figure by more than 50 percent, to 3.5 million bpd.

For the world’s two main global crude benchmarks, Brent and West Texas Intermediate (WTI), the EIA projects the former will average $105.42 a barrel in 2014, compared with $108.64 in 2013, and the latter will average $93.33, dropping from $97.91, according to statistics released on January 7. Bank of America Merrill Lynch has a similar outlook, forecasting $104 per barrel of Brent in 2014 and $92 for WTI. Deutsche Bank is more bearish, predicting Brent will drop to an average of $100 in 2014 and WTI will fall to $88.75.

Brent prices are widely expected to be more stable because of the discipline imposed by Saudi Arabia, the world’s largest producer and most influential member of OPEC. The cartel has said it expects demand for its members’ output to decline by 300,000 bpd in 2014 but that prices will remain between $100 and $110. The cartel may need to accept a lower production target to achieve those prices if forecasts of buoyant non-OPEC supplies are accurate. The IEA, for example, expects demand for OPEC crude to drop by 900,000 bpd.

The outlook for WTI features a higher potential for imbalances. The U.S. network of pipelines, refineries, storage facilities and other supporting infrastructure is struggling to keep up with fast-growing production. Pricing volatility resulting from logistics bottlenecks will lessen in late 2014 as new pipelines come onstream, according to analysts at Deutsche Bank.

The EIA forecast projects that the spread between Brent and WTI will widen by more than a dollar, to just over $12 a barrel, reflecting the growing impact of U.S. shale oil production. The spread is important because a large enough gap makes it profitable for U.S. producers in the middle of the country to ship crude by rail to the East and West coasts, according to market research by RBN Energy, a Houston–based consultancy. Shipping by rail is more expensive than using the North-South pipeline network. But the latter sends crude to the common trading hubs in Texas, Oklahoma and Louisiana, where stockpiles are growing and prices weakening.

Spreads between WTI and other U.S. benchmarks are poised to get more attention in 2014 as investors seek to identify where gluts may develop. WTI prices are settled in Cushing, Oklahoma, and at a secondary trading hub in the West Texas town of Midland. North Dakota crude from the Bakken formation was trading at roughly a $10 discount to WTI in December, according to RBN Energy’s research, whereas Louisiana Light Sweet, the benchmark for Gulf of Mexico crudes, traded at a $3 discount to WTI.

Logistical bottlenecks and pricing volatility can be avoided if current pipeline projects are completed and deployed on schedule. Pipe capacity has been in short supply since 2011, according to Deutsche Bank researchers, but that problem will begin to ease in 2014, and the network is likely to have sufficient capacity by the middle of 2015. The U.S. government could upend all of those factors, however, if it allows crude oil exports to countries other than Canada.

The market for natural gas is more regionalized than that for crude because of transportation constraints, but in the U.S. factors similar to those for crude will shape pricing for the year. Demand growth is not keeping up with new supply, particularly from the Marcellus shale formation. Buyers for power plants tend to avoid gas when it costs $4 per million British thermal units (BTU) or more because coal is cheaper at that point, says BofA Merrill Lynch’s Blanch. Gas below that level may incentivize consumers to lock in supplies through long-term contracts, he adds. The EIA projection for 2014 is $3.78 per million BTU at the Henry Hub in Erath, Louisiana, the benchmark for U.S. natural gas.

The LNG market is also regionalized, with prices higher in Europe than in the U.S., and higher still in northeastern Asia, a market dominated by Japan. No matter the region, however, tight supply and increased demand are expected to boost spot market prices. Several new receiving terminals, where LNG is converted back into gas, are expected to become operational in China in 2014, but major new supplies will not become available until 2015 or beyond, according to Blanch.

Roughly three quarters of LNG is traded under medium- or long-term contracts. For shorter-term arrangements and the spot market, prices were rising in late 2013. Those rates vary by region and by price-setting methodology. Northeastern Asia, including Japan, which buys more LNG than any other country, paid an average of $19 per million BTU in mid-December. It has been customary in that region to link LNG prices to oil prices. In Europe’s biggest trading hub, the U.K.’s National Balancing Point, the rate was $11.50 per million BTU.

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