Energy Outlook: Looming Fears

 

Overview

The Energy Industry is a multi-factor industry that is not only affected by the performance of companies but the price of the commodity that is used by many companies within the industry. The global benchmark is Brent Crude, and the U.S. benchmark is West Texas Intermediate or WTI.

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Price Build-Up


The price of Brent and WTI have rallied since the crash to $30 a barrel but have recently undergone some strain. The rally was in part due to OPEC’s de-facto leader Saudi-Arabia working with Russia to put supply cuts. That combined with geo-political tensions including the death of Jamal Khashoggi at a Saudi-Arabian embassy in Turkey and sanctions announced on March 12th on Iran who exports nearly 3.5 Million barrels per day, have brought Oil futures to new 4-year highs.


Recent Decline


Oil demand is strongly correlated to GDP as it is inferred that as GDP increases, output has increased meaning a need for oil. We can see GDP globally being threatened specifically with South Korean GDP only expanding by 0.6% missing the expected 0.7% for Q3. The recent slow-down of the global economy has sent shocks to the price of oil. From the beginning of October, Brent is down 10.71% and WTI is down 12.48%. With the Federal Reserve set to raise interest rates again in December and planning three more hikes next year we see that the decade long bull run may be slowing down. There is also a rise in the U.S. dollar index of 1.44% hurting demand for dollar denominated oil futures. Most recently we’ve seen that Russia has weaned off its supply cuts and has no intention of freezing or slowing output levels with fear of undersupply combined with China and India looking to circumvent U.S. sanctions on Iran allowing for higher oil supply and hurting futures.

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U.S. Energy Industry

The U.S. has had a surge in oil production because of their ability to Frack. This allows them to drill multiple wells horizontally instead of one well vertically, allowing for more oil production per well. This practice has enabled the U.S. to surpass Russia as the largest oil producing nation. The largest area for fracking is the Permian Basin, an oil field in West Texas, second only to the Ghawar oil field in Saudi Arabia in production. This has come with some issues. The Permian Basin’s rapid increase of oil production to 3,496,000 barrels per day was not accompanied by an increase in capacity from oil pipelines which move oil to refineries to be turned into usable products. This has caused a supply glut in the Permian Basin forcing Upstream or E&P companies to sell their oil at a discount or transport it by rail hurting earnings. Refineries have benefited from this by acquiring oil at a discount boosting earnings. Refineries in Northern United States are also currently getting their oil at a discount from Canada. As Canada is a large oil producing nation that does not have enough refineries, drillers there sell their oil at huge discounts currently around 60% to American refineries.

By Joseph Vittoriano - Energy Director, Baruch IMG