Each month the U.S. Energy Information Administration (EIA) publishes a Short-Term Energy Outlook (STEO). This report describes the current state of energy markets (mostly domestic), and then provides projections for the next 18 months.

Last week the May outlook was released. Today I want to highlight that report, and discuss the current outlook for oil and natural gas — as well as the factors expected to drive those markets in the future.

Crude Oil Projections

Global demand for crude oil is forecast to continue to grow robustly, and the EIA has been forced to make upward adjustments to its previous estimates for both historical and projected growth. Global consumption of petroleum and other liquid fuels is now estimated to have grown by 1.4 million barrels per day (bpd) in 2015, which is 100,000 bpd higher than previously estimated — but still lower than the 1.8 million bpd the International Energy Agency (IEA) estimated for 2015. The primary driver for the upward revision to 2015 growth was higher than previously estimated demand in both China and India.

The EIA now projects global consumption of petroleum and other liquid fuels to increase by 1.4 million bpd in 2016 and by 1.5 million bpd in 2017. These estimates reflect upward revisions of 300,000 bpd and 200,000 bpd over the past month. China’s demand is now forecast to grow by 400,000 bpd in both 2016 and 2017, with India close behind at 300,000 bpd for 2016 as well as 2017.

This is bullish news for crude oil prices, but what about supply? The main cause of the low oil prices in 2015 was that, despite strong global increases in demand, supply increased at an even faster rate. The EIA estimates that non-OPEC production of crude oil increased by 1.6 million bpd in 2015, with OPEC adding another 800,000 bpd. The total gain in output was far greater than the increase in global demand, and as a result global crude oil inventories continued to swell which kept downward pressure on prices.

This is projected to change in 2016. The EIA expects non-OPEC supply to decline by 700,000 bpd in 2016 and by 200,000 bpd in 2017, with most of the production declines occurring in the United States. U.S. crude oil production averaged 9.4 million bpd in 2015, and is forecast to decline to 8.6 million bpd this year and 8.2 million bpd in 2017. EIA estimates that U.S. crude oil production averaged 9 bpd in April, a decline of 100,000 bpd from March and 700,000 bpd below the 9.7 million bpd level a year earlier.

OPEC production is projected to increase by 900,000 bpd in 2016, with Iran accounting for most of the gain, followed by an additional 700,000 bpd rise in 2017. (This assumes no collective action from OPEC to reduce production).

If these forecasts hold, global crude oil inventory growth will slow this year, and inventories should begin to decline in 2017.

The tightening in supply and demand is projected to push crude prices higher. The EIA forecasts that the global Brent benchmark will average $41/bbl in 2016 and $51/bbl in 2017. Notably, these projections are respectively $6/bbl and $10/bbl higher than the prices projected in April’s STEO. The EIA cites improving economic data, growing supply disruptions and falling U.S. crude oil production and rig counts as the factors contributing to rising oil prices.

West Texas Intermediate (WTI) is forecast to average slightly less than Brent crude in 2016, and to trade at the same average price as the Brent over the course of 2017. If the EIA is correct, this is another reason to tread cautiously with the refiners, which have benefitted greatly from the past discounts on the WTI relative to the Brent.

Natural Gas Outlook

The EIA reported that marketed natural gas production in the U.S. was 80.1 billion cubic feet per day (Bcf/d) in February 2016, which is the second-highest production level on record and an increase of 1.4% from January. Growth continues to be led by the Marcellus and Utica production areas.

However, the EIA projects that production growth will tail off over the next few months as low prices and declining rig activity finally begin to weigh on output. I would add that falling oil production in the U.S. will also help push down the output of natural gas, some of which comes from wells producing mainly oil. The EIA projects a small increase in natural gas production overall this year, while I expect a small decline. They expect production to rise a stronger 2.2% in 2017 in response to price increases driven by higher demand.

U.S. natural gas consumption is forecast to rise to 76.5 Bcf/d in 2016 and 77.4 Bcf/d in 2017, compared with 75.3 Bcf/d in 2015. This year increases in natural gas consumption are being driven primarily by the electric power sector, which is expected to increase consumption by 4% in 2016. But the EIA projects a decline of 1.6% in the power sector’s gas demand in 2017 as natural gas prices rise and contribute to a shift to coal by those power plants that can easily switch between the two fuels.

However, the increases in demand from new fertilizer and chemical projects as well as liquefied natural gas (LNG) exports are expected to more than offset the projected decline in the utility sector. New fertilizer and chemical projects are expected to boost demand by 2.4% in 2016 and by 2% in 2017, while LNG exports are projected to rise from 0.5 Bcf/d in 2016 to 1.3 Bcf/d in 2017.

The immediate challenge in the natural gas market is that inventories are at record highs. At the end of March there was 2,478 Bcf of gas in storage, the highest level on record for the end of the withdrawal season, and nearly 50% above the five-year average. By the end of the injection season around Nov. 1, EIA forecasts inventories to climb to 4,158 Bcf, which would be the highest level on record for that time of year.

High inventories have helped to keep natural gas prices depressed. The Henry Hub natural gas spot price averaged $1.92 per million British thermal units (MMBtu) in April, an increase of 19 cents from the March price. But the outlook is for higher prices. Henry Hub spot prices are forecast to average $2.25/MMBtu in 2016 and $3.02/MMBtu in 2017, compared with an average of $2.63/MMBtu in 2015.

This outlook is consistent with our message here, which is that natural gas prices are likely to rise substantially over the next year. Last week I attended Investing Daily’s Annual Investing Summit in Las Vegas, and one of the recurring questions I received was “Which natural gas companies do you recommend?” I will be providing an overview of my presentation in the next issue, but the answer to that particular question is that we currently favor Cabot Oil & Gas (NYSE: COG) and EQT (NYSE: EQT), which are among our three highest rated Best Buys, as well as Peyto Exploration & Development (OTC: PEYUF; TSE: PEY).

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