Another Rough Week

Last week was another brutal one for the energy sector. From a fundamental standpoint, the rout should have ended, but we are deep into emotional territory at this point. Investors are making little differentiation between good companies and bad; there were steep losses across the board last week.

Some companies deserve to be sold off. A company with a lot of debt and an average breakeven cost of $55/barrel (bbl) isn’t going to survive long in this market. But other quality companies that are essentially debt-free and have breakeven costs of $40/bbl suffered just as much last week. 

It is hard to say when reason will once again take hold in the energy sector. This entire sell-off has its roots in OPEC’s price war that begin in late 2014. That, along with surging output from U.S. oil producers, resulted in record global crude oil inventory levels. Those high inventory levels have persisted despite OPEC’s decision last November to cut production. Further, U.S. shale production is on the way back up. So the fear in the oil market is that gains in shale will wipe out OPEC’s cuts, ultimately leading to OPEC once again throwing in the towel. 

What the market needs to see are some major reductions in crude oil inventories. Any signs of unexpected inventory gains have resulted in oil prices being punished mercilessly. At play here are OPEC’s cuts, gains in shale production, and increases in demand. Regarding demand, fears are being fanned that electric vehicles will soon put an end to growing oil demand. As I showed in the most recent Energy Letter, crude oil demand growth continues at a strong pace (a case I also made in my latest Forbes article Peak Oil Demand Is Millions Of Barrels Away).

I can rationalize why I think the interplay between growing demand and OPEC’s cuts will trump the increase from U.S. shale production, but the theory ultimately has to manifest itself in lower inventories. When that happens, oversold energy producers should bounce back.   

Highlights From The Bible Of Energy Statistics

Last week the BP Statistical Review of World Energy 2017 was released. This report gives us the opportunity to review the big picture when it comes to global energy supply and demand. I believe the BP Statistical Review is the bible of energy statistics. The report provides a comprehensive picture of supply and demand for all the key energy sources on a country-level basis.  

Since its release, I have been busy analyzing the data and creating graphics. Today I want to cover some highlights from the report.

Petroleum

I briefly addressed oil consumption in the previous Energy Letter. Global oil consumption rose 1.6% to a new record high of 96.6 million barrels per day (BPD). This growth rate was well above the 10-year average growth rate of 1.2%. U.S. demand rose by 0.5% to 19.6 million BPD, the highest demand level since 2007. After falling steadily for several years, demand in the European Union has now risen two years in a row. EU demand in 2016 was up 1.8% over 2015 to reach 12.9 million BPD, the EU’s highest demand since 2012. 

The highest growth rate in the world took place in Pakistan, which saw a 12.0% increase in demand over 2015. Other countries with fast-growing demand included the Philippines (+9.0%), Poland (+8.8%), Slovakia (+8.5%) and India (+7.8%). China’s demand increased by 3.3%, well below its 10-year average growth rate of 5.7%.

The largest percentage declines in demand were observed in the Czech Republic (-6.0%), Ecuador (-5.9%), Venezuela (-5.7%), Switzerland (-5.2%) and Brazil (-4.8%).

On the production side, global oil production advanced by 0.5% to reach 92.2 million BPD. (Per BP: Differences between these world consumption figures and world production statistics are accounted for by stock changes, consumption of non-petroleum additives and substitute fuels, and unavoidable disparities in the definition, measurement or conversion of oil supply and demand data).

The U.S. remained in a dead heat with Saudi Arabia for the crown of the top oil producer. The top three producers were the U.S. (12.4 million BPD), Saudi Arabia (12.3 million BPD), and Russia (11.2 million BPD). It is worth noting that BP’s definitions include natural gas liquids (NGLs) in the oil production numbers, which is the only reason U.S. production numbers are as high as they are. 

The greatest percentage increase in oil production took place in two OPEC countries. Production in Iran rose by 18.0% (700,000 BPD) and production in Iraq was up by 10.8% (400,000 BPD). This marked the highest production level for Iran since the 1970s, and was the highest-ever production level for Iraq. 

However, some of the largest percentage declines were seen in two other OPEC countries, with Venezuelan production declining by 8.9% (234,000 BPD) and Nigerian production falling 11.9% (277,000 BPD). Overall OPEC production rose by 1.2 million BPD, while non-OPEC production declined by 780,000 BPD.

Natural Gas

There is currently no other energy source with such a long and consistent track record of demand growth as natural gas. For more than 50 years, natural gas demand has steadily grown, with only one significant down year during that time (during the financial crisis of 2008-2009): 

The U.S. is the world leader in both consumption and production of natural gas. The 75.1 billion cubic feet (BCF) the U.S. consumed in 2016 was more than the entire Asia Pacific region consumed, and was nearly double the 37.7 BCF consumed by Russia, the world’s second largest consumer.

The 5.1 BCF year-over-year (YOY) increase in U.S. consumption was also the world’s largest, but the largest percentage increases in consumption were seen in Israel (+14.5%), the Philippines (+14.3%), Ireland (+14.0%), the United Kingdom (+12.2%) and Chile (+11.1%).  

Natural gas production exploded in the U.S. as a result of the shale gas boom, growing by nearly 50% from 2006 to 2015. Last year low natural gas prices brought an end to an 11-year streak of increasing production in the U.S., but the 72.3 BCF produced by the U.S. was still far ahead of 2nd place Russia’s 55.9 BCF. To put U.S. natural gas production into perspective, it was greater than all Middle East production of 61.5 BCF in 2016.

U.S. trade in natural gas also surged in 2016. Pipeline exports of natural gas grew 23% over 2015, primarily driven by growing trade with Mexico. Liquefied natural gas (LNG) exports from the U.S. increased from 24 billion cubic feet in 2015 to 155 billion cubic feet in 2016. The U.S. exported LNG to about a dozen countries in 2016, with 34% going to South and Central American countries, and 23% destined for countries in the Asia-Pacific region.  

Coal

Global coal consumption declined by 1.7% to its lowest level since 2010. This decline marks the second consecutive annual decline in coal consumption. China remains by far the world’s top consumer and producer of coal, with 50.6% of the world’s consumption. But China’s consumption declined last year as well, which accounted for about 50% of the global drop in coal consumption. 

Almost every region of the world saw a decline in coal consumption. In the Organization for Economic Co-operation and Development (OECD) countries — primarily the world’s developed countries — coal consumption fell by 6.4%. In the European Union, it declined by 8.9%.

U.S. coal consumption continued to fall sharply. The 8.8% decline in consumption took U.S. coal demand to its lowest level since 1978. U.S. coal production followed, with a 19.0% decline to levels also not seen since the 1970’s.

India was a notable exception with a 3.6% increase in coal consumption. Indonesia, Malaysia, and Pakistan all saw coal consumption grow at double digits, but from relatively low consumption levels.

Coal consumption has fallen for a couple of reasons. Countries around the world are passing legislation to limit carbon dioxide emissions, and cheap natural gas and renewables are providing economic alternatives to coal. The results can be seen in the overall energy consumption numbers. 

World primary energy consumption increased by 171 million metric tons of oil equivalent (TOE) from 2015 to 2016. The actual increase in oil consumption accounted for 77 million metric tons of the increase. Coal consumption declined by 53 million TOE, and renewables (excluding hydropower) increased by 53 million TOE. So one could accurately argue that the increase in renewables like wind and solar power exactly offset the decline in coal.

But natural gas provided a bit more new energy than wind and solar power with a YOY increase of 57 million TOE. The balance of the energy consumption numbers was made up of increases in nuclear power (+9 million TOE) and hydropower (+27 million TOE).

I will close by noting, ironically, that despite coal’s loss of market share, coal companies have been some of the strongest portfolio performers over the past year. That’s primarily because these companies had become deeply oversold. Despite coal’s negative growth prospects, the world will continue to use coal for decades, and a number of companies will continue to profit from that. 

In the next article, I will cover renewables, nuclear power, and carbon dioxide emissions.