In the previous article, I graded the 2013 predictions that I made a year ago. I scored well on the direction of oil and gas prices, the shrinking Brent-West Texas Intermediate (WTI) differential, and continued growth in US oil production (although it grew even faster than I expected). My only complete miss was that I expected approval for the northern leg of the Keystone XL pipeline. (The southern leg, incidentally, is scheduled to begin shipping oil this week from the major crude oil storage hub at Cushing, Oklahoma to the Gulf Coast near Houston).
Today I offer up my predictions, and the reasoning behind them, for what I think will transpire in 2014. One thing I have learned in making predictions is that they must be specific, and not subject to interpretation at the end of the year.
“The US oil industry will continue to thrive” is much too vague. “The price of crude will rise” is also too vague, because perhaps crude rises for part of the year, or perhaps some crudes rise and some don’t. On the other hand, “The average price of Brent crude will be higher in 2014 than in 2013” is specific and measurable.
So here are my predictions, followed by the reasoning behind each prediction, and in some cases what could take place that would render the prediction invalid.
1. The crude oil export ban will not be lifted in 2014.
The crude oil export ban dates to the The Energy Policy and Conservation Act (EPCA) of 1975, and effectively bans crude oil exports to all countries besides Canada. Before the surge of US oil production over the past few years, refiners invested heavily in equipment that could process crudes that were heavy and sour, and thus deeply discounted relative to light, sweet grades. The current shale oil boom is producing light, sweet crude that isn’t optimal for many US refineries, which is why many refiners would prefer to run imported heavy crudes over domestic light crudes. This reduced demand limits the market for domestic crude producers and depresses domestic crude oil prices relative to global prices. The oil industry’s preferred solution to this is to repeal the export ban so that it could then export its premium crude.
There are some formidable obstacles to repealing this ban. Even though Energy Secretary Ernest Moniz has said that the ban should be revisited, there is significant political opposition. Several Democratic senators have voiced opposition because of the potential for increasing fuel prices for US consumers. The public will likely be largely opposed as the issue gains a higher profile. Some will object to the idea of encouraging more oil production in a world of growing carbon dioxide emissions. Others will instinctively balk at the notion of exporting oil while the US is still a large net importer of crude. And it is hard to imagine that this proposal will be fast-tracked by the Obama Administration, as it will likely generate the sort of resistance from environmentalists that the Keystone XL pipeline did.
2. Brent and West Texas Intermediate (WTI) crude prices will average less in 2014 than in 2013.
I made this prediction last year as well, with mixed results. Brent crude did trade down, while WTI was up. The same factors remain in place to put downward pressure on crude prices in 2014. Domestically, crude oil production is likely to expand again in 2014 (see prediction 4 below), and given the logistical constraints and insufficient demand growth in the US, prices will be pressured to the downside. There is the possibility of a recovering US economy boosting demand, but it is hard to imagine that demand will grow as quickly as oil production. However, if I am wrong and the crude oil export ban is repealed, then I will likely be wrong about this prediction as well.
Globally, demand has grown faster than new capacity has come online over the past decade. Spare capacity is still tight, but some of the hotspots from the past few years, like Libya, are stabilizing. There is also the possibility of seeing crude oil exports from Iran start to pick back up. This may allow global crude oil capacity to gain a little bit of a cushion this year. However, OPEC is also capable of restricting supplies, and if Iraq heats back up this year and a new wave of unrest impacts Iraqi production then my prediction of lower Brent prices will also likely be wrong.
3. The average Henry Hub spot price for natural gas will be higher in 2014 than in 2013.
I also made this prediction last year, and it was correct. Last year it was pretty obvious that gas prices couldn’t sustain 2012’s low average price, but this year the picture is less clear. The long-term fundamentals favor gas prices creeping higher in my opinion, but on a year-to-year basis, it’s going to be heavily influenced by whether we have an exceptionally cold winter (as has been the case thus far this winter).
Over the next three to five years I expect natural gas prices to rise beyond $5/MMBtu as liquefied natural gas (LNG) projects come online. The first exports from the Lower 48 will most likely happen in 2016 when Cheniere Energy (NYSE: LNG) starts the first two liquefaction trains at the Sabine Pass Liquefaction Project. Two more trains are scheduled to come online in 2017. I think it’s likely that investors will start to bid up the price of gas as these projects move closer to completion. The EPA has also proposed regulations that would effectively preclude new coal-fired power plants from being built in the US, so as older coal-fired power plants are retired, natural gas will pick up some of that capacity.
4. US crude oil production will expand for the sixth straight year.
Crude oil production increased for the fifth straight year in 2013. In fact, after a very strong advance in 2012, crude oil output grew even more in 2013. So even though I know a number of people who are expecting production to slow down soon, so far there are no signs of it happening. US crude oil production has been growing at the fastest pace in US history, and the US has recently accounted for the bulk of the global increase in crude oil production.
Rising production from the shale oil boom may reverse direction by 2020, but it won’t do so in 2014. The US Geological Survey (USGS) more than doubled the reserves estimate in North Dakota’s Williston Basin last year by including the Three Forks Formation that lies underneath the Bakken. Inclusion of Three Forks — which has already begun to produce oil — added an estimated mean resource of 3.73 billion barrels of oil to the estimated 3.65 billion barrels reserve of the Bakken. Oil production is also expected to continue to increase (among other places) in the Permian Basin and the Eagle Ford Shale in Texas, and in Colorado’s Denver-Julesburg Basin.
5. KiOR will declare bankruptcy in 2014.
KiOR (Nasdaq: KIOR) — highlighted in the recent 60 Minutes piece on cleantech — is one of three advanced biofuel companies that venture capitalist Vinod Khosla took public in 2011. The other two were Amyris (Nasdaq: AMRS) and Gevo (Nasdaq: GEVO). Each of these companies has seen its share price drop sharply since the IPO. While KiOR is one of the few companies to have produced advanced biofuel for sale, the volumes have consistently come in below company guidance, and I expect production costs to remain above the sales price for the foreseeable future.
I really went back and forth on this prediction, because the variables are far more opaque than in the previous four predictions. A major investor could make a unilateral decision to keep the company solvent, and future EPA decisions on biofuel mandates could have a major effect. Either of these events could cause the stock price to surge. But insiders have been unloading their positions since September, and recent news has not been good.
Production volume guidance, for one, has been extremely poor.
On May 9, nearly halfway through Q2 of last year, KiOR CEO Fred Cannon stated, “We expect that total fuel production during the second quarter will range between 300,000 and 500,000 gallons, keeping us on track to fall within our projected production range of 3 million to 5 million gallons for 2013.” The actual amount of product shipped for the quarter came in at only 75,000 gallons. When the actual volume was announced, the share price plummeted and investor lawsuits were filed.
In August Cannon lowered guidance: “We expect our full year production levels will be in the 1 million to 2 million gallon range.” Another statement in November was considerably weaker when he said, “We believe that our full year production levels will exceed 1 million gallons.” The actual production number for the year was reported to be 894,000 gallons — lower than even the reduced guidances and about 7 percent of the stated capacity of the plant. Investors can’t be very confident in future projections given last year’s track record.
The share price is now down about 90 percent from the IPO price, and KiOR’s plant in Mississippi has shut down to work on improvements and save money. The company has said it will need $10 million to invest in the plant and $22 million for research and development for the year. The market still values the company at ~ $150 million, which is less than 10 percent of the value in 2011 when I argued that KiOR was grossly overvalued.
The reason this is my riskiest prediction is that someone could just write a check to keep funding operations. Vinod Khosla is not only a major shareholder, he has been loaning the company money. He may choose to continue doing this. Bill Gates made a token investment in October 2013, with another potential investment contingent on KiOR getting additional financing. Mr. Khosla has proven himself to be a very good fundraiser, so if he continues to believe the company can ultimately be profitable, he will pull out all the stops, and could just loan them more money if he can’t get anyone else interested.
I think he will probably throw in the towel, but I have seen lesser companies manage to remain solvent for years before finally giving up. If Mr. Khosla decides to press on with KiOR, I expect we will at least see a KiOR shakeup (personnel and possibly strategy).
Rest assured that it is not my wish to see KiOR go bankrupt. I have 2 friends that work there, and I would be happy to be wrong about this prediction. I think the company has been an interesting study in trying to scale up and convert biomass to drop-in fuels, but I believe they are at a much higher cost point for their fuel than they imagined they would be.