Arizona Versus Alaska

When I travel, I tend to think about energy production and consumption patterns of the areas I visit. Two days ago I was sitting in Phoenix which was 118 degrees. Right now I am writing this from a hotel room in Seward, Alaska that doesn’t have air conditioning. In fact, I can see snow from where I am sitting right now.

Alaska and Arizona couldn’t be more different in their energy production and consumption patterns. As I indicated in the previous article, Alaska is still a major oil producer, while Arizona produces no oil at all. Arizona has a huge demand for power for air conditioning, while Alaska needs natural gas for heating. 

Alaska needs to move oil to market, and Arizona needs to bring finished products into the state (since it has no petroleum refineries). Solar power is a big deal in Arizona (although yesterday I was pleasantly surprised to see a solar business in Anchorage).    

The same sorts of supply and demand dynamics play out between different countries around the world. These differences determine where oil, natural gas, and finished products are produced and where they need to be shipped — which impacts producers, shipping companies, and refiners around the globe.    

To make things interesting, there are often unexpected shifts in supply or demand, such as when a military conflict impacts Libya’s oil production, or when the U.S. has an unusually warm winter, and natural gas inventories grow.  

Unforeseen circumstances like that can make or break companies. But they also create opportunities. We can earn money on disconnects if the market initially fails to reward (or punish) a company with a changing outlook. 

Speaking of outlooks… 

Projecting With The STEO

As investors, we plan for what seems likely, and perhaps make a small bet on the unlikely. But how do we plan for what’s likely? That can be a challenge, but we sort through information that has proven to be historically useful (if not always reliable), and we apply our own biases and filters to that information. One source of information I use is the monthly Short-Term Energy Outlook (STEO) published by the Energy Information Administration (EIA).

The EIA has an inconsistent track record, which can be said of anyone who tries to project the energy markets over an extended period. But many investors and companies rely on their projections to guide investment decisions. As a result, I always pay attention to what each month’s release has to say.

This week the July 2017 STEO was released. The highlights from the EIA press release were:

Oil Markets

“A lower forecast for crude oil prices is expected to shave a little off projected growth in U.S. oil production next year compared with the previous forecast, but annual output is still on track to reach a record high in 2018.”

“A revised oil price forecast that is $2 to $4 per barrel lower for late 2017 and during 2018 than the prior forecast will make it less profitable for some U.S. producers to drill for oil.”

“The United States will account for almost 90% of the increase in global production of crude oil and other liquid fuels by non-OPEC countries in 2018.”

Gasoline/Refined Products

“The price U.S. consumers are expected to pay for gasoline this summer has been revised down as lower crude oil costs provide a break at the pump.”

“The price of crude oil, which accounts for about half the retail price of gasoline, has declined in recent months on rising U.S. crude oil production and high petroleum inventories.”

Natural Gas

“U.S. natural gas production is expected increase through the rest of this year and during 2018 in response to higher natural gas prices and growing liquefied natural gas exports.”

“The United States will become a net exporter of natural gas this year, and U.S. liquefied natural gas exports in 2018 are expected are expected to increase 45%  from this year’s levels.”

“U.S. natural gas inventories at the start of the upcoming heating season this November are expected to be lower than last year, but still 2% above the five-year average.”

Electricity

“Forecast milder temperatures for this summer compared with last summer will reduce the need for air conditioning, resulting in the average U.S. household consuming 5% less electricity from June through August.”

Coal:

“Higher coal-fired generation and more exports are expected to be major contributors to an increase in U.S. coal production this year, with coal output in western states rising the most.”

Renewables

“U.S. electricity generation from renewables is expected to increase 12% this year and then remain steady in 2018 due mainly to a drop in hydropower next year.”

“U.S. ethanol production is on track to reach a record high this year of just over 1 million barrels per day, and then decline slightly in 2018.”

Summary

The news from the latest STEO continues to be bearish for oil prices but it is mildly bullish for natural gas prices. Should events play out as projected, it won’t bode well for oil companies but could lift natural gas producers. On the other hand, most, if not all of the bearish projections are priced into oil, and there may not be much more downside if prices hold above $40/bbl.

One sector that should do well in this climate is the refiners. In the next issue of The Energy Strategist, I will argue the case for refiners and add my favorite refiner to the portfolio.

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