We begin 2020 with the stock market again testing record highs. We just finished a year in which oil prices rose by more than 30%. However, natural gas prices closed the year nearly 40% lower, emphasizing the extent to which these two commodities have become unlinked.
It’s also an election year. Those tend to inject additional unpredictability into the markets, as short-term decisions are often made to influence voters (e.g., releasing oil from the Strategic Petroleum Reserve to drive gasoline prices lower).
Against this backdrop, it’s harder for me to get a clear handle on the trends in the energy markets this year. Nevertheless, there are some disconnects in the market that I believe are likely to correct this year. I believe there are some high probability predictions we can make based on those disconnects.
Below are my predictions for some of the significant energy trends I expect this year. As I usually point out, the discussion behind the predictions is more important than the predictions themselves. That’s why I provide extensive background and reasoning behind the predictions.
I also make predictions that are specific and measurable. At year’s end, there are specific metrics that will indicate whether a prediction was right or wrong.
1. For the first time since 2014, the closing price of WTI will not drop below $50/bbl
Oil is still the world’s most important commodity, so I always try to lead off with a prediction on the direction of oil prices. I generally make this prediction by looking at supply and demand trends, as well as inventory levels. I also usually do a sanity check of my prediction by reviewing predictions from other analysts.
Over the past few years, we started the year with an oil price that I felt was too low. So my prediction in recent years was for higher prices. This year, West Texas Intermediate (WTI) opened at $61.17 per barrel (bbl), and averaged $56.98/bbl for the year. The year has only started above $60/bbl one other time since the downturn of 2014-2015. In 2018 the year opened at $60.37/bbl, and it ran up to just over $75/bbl before ending the year below $50/bbl.
The Energy Information Administration (EIA) expects crude oil prices to be lower on average this year, because of forecast rising global oil inventories in the first half of 2020.
In contrast, JP Morgan is projecting an oil market deficit this year of 200,000 BPD, because of OPEC production cuts and demand growth in emerging markets. They expect oil demand to grow by 1 million BPD globally, which is consistent with most other forecasts.
U.S. crude oil inventories are about average for this time of year. Global inventories are slightly below the five-year average.
I believe there is a disconnect in the oil market between expectations and reality. There are lots of expectations that we are on the cusp of peak oil demand, but in reality I think we are still several years from that. Nevertheless, those expectations are creating headwinds for oil prices. But the only way the market corrects those expectations is for crude inventories to decline. Given the strong growth in U.S. shale oil in recent years, that just hasn’t happened.
That’s a lot of verbiage to set up the prediction, but there are a lot of moving parts here. Ultimately, I believe OPEC will continue to cut production in order to prop up oil prices. I think U.S. shale production growth is going to continue to slow (next prediction), and that global oil demand will once again growth to a new record high.
But the oil markets looks to be pretty balanced this year on average. That argues for modest oil price movements. In any case, crude inventories aren’t high, and I believe OPEC will continue to cut production in order to prop up oil prices.
Some have called for oil prices to imminently collapse in the face of peak oil demand. I don’t believe prices will go much lower than they are presently in 2020. In fact, for the first time since 2014, I don’t believe they will drop below $50/bbl.
2. U.S. oil production growth will fall below 1.0 million BPD
According to the EIA, U.S. oil production closed 2019 at 12.9 million BPD. For all of 2019, production averaged 12.2 million BPD. To put that in perspective, that’s a higher production rate for crude oil than any other country has ever had.
But production growth in 2019 — 1.2 million BPD year-over-year — was significantly less than 2018’s record 1.6 million BPD gain. And there is a lot more pressure on oil companies to deliver cash flow to investors. That is going to increase the incentive to focus on producing instead of drilling new wells.
Thus, I think shale production growth will fall below 1.0 million BPD this year versus last year. That’s also supportive of the previous prediction.
3. The average natural gas price will be at the lowest level in more than 20 years.
Last year I passed on making a natural gas prediction, because I saw too much uncertainty in the market. What ultimately happened was a steady decline in natural gas prices, which dropped below $2.00/MMBtu by the end of the year. The average price for 2019 was $2.56/MMBtu. That’s not much above the $2.52/MMBtu price recorded in 2016, which represented the lowest price since 1999.
The problem with the natural gas markets is similar to the problem in the oil market. Demand growth has been strong, but supply growth has been much stronger. And natural gas can’t be transported as easily as oil, so prices have been hit even harder.
Natural gas production growth flattened in 2016 in response to low prices. The same thing is likely to happen in 2020 as a result of low prices. But production growth was extremely strong in 2019, and that momentum will carry over into early 2020. That means prices will remain under pressure for a while.
Another important piece of the puzzle is natural gas inventories, but those are average for this time of year. Thus, I don’t see prices bouncing back as they did in 2017 and 2018. I think it’s likely that we see another year of depressed natural gas prices. In fact, I believe this year they will drop below the 2016 average price, which would mark the lowest level in more than 20 years.
4. On average, the U.S. will be a net exporter of crude oil plus finished products for the first time
In 2018, Bloomberg reported that the U.S. had become a net crude oil exporter for the first time in 75 years. That was inaccurate. It was actually for the sum of crude oil exports and finished products, and that was for only one week.
In September 2019, that feat was achieved on a monthly basis for the first time. However, the average for the year through October still showed the U.S. to be a net importer to the tune of 755,000 BPD.
In 2020, I predict the net import number will be switched to a net export number for the year overall. There are likely to be months that are still in the net import category, but I think the year overall will switch into the net export category. To be clear, the U.S. will remain a net importer of crude oil in 2020. If that picture changes, it won’t do so for at least a couple more years.
5. ConocoPhillips will have a total return of at least 20%
Oil prices rose by more than 30% last year. But ConocoPhillips — the world’s largest publicly traded, pure oil and gas producer — had a total return of 6.6%. That might be reasonable if COP had a bad year. But it didn’t.
Since the deep downturn in 2015, the company has increased cash flow each year. In fact, today ConocoPhillips is generating more cash flow with oil prices in the $50s than it was in 2013 when oil prices were over $100.
Net debt is a quarter of what it was just three years ago, but the company’s oil and gas resource that breaks even at a $40 WTI price has increased by 50%.
Over the next decade, the company projects a total return to shareholders through dividends and share buybacks of $50 billion. This is substantial, given the current market cap of $65 billion.
I expect the market to recognize COP’s value in 2020, and for the company to return at least 20% for the year.
There you have my 2020 energy sector predictions. This year is challenging to read because there are so many important variables in motion. But as always, I will grade them at the end of the year.