Looking at the energy sector, 2010 was largely the year of the bailout. While supplies remained plentiful and demand never fully recovered, the fiscal policy of several central banks supported energy prices, except for natural gas. Crude, heating oil and gasoline futures all hit yearly highs as we turned the calendar.
"If you look at the big picture going into 2011, the question is, ‘Is oil ready to stand on its own two feet?’" says Phil Flynn, senior energy analyst at PFGBest. "As impressive as the end of 2010 was as we pushed back toward 2-1/2 year highs, let’s face it, oil got a lot of help. Looking over 2010, it was the year of oil price bailouts where oil prices got bailed out time and again."
Between the Dubai credit crisis in late 2009, the European sovereign debt crisis in the spring, and the announcement and subsequent initiation of the second round of quantitative easing (QE2), nearly every time oil prices were falling some government bailout plan provided a boost (see "Down, but not out").
A lot of these issues are still with us in 2011 as the U.S. economy is still struggling, the Federal Reserve wrestles with an exit strategy and European debt problems are far from being resolved. Further, China continues to face soaring inflation at a rate that may affect the global economic recovery should the new asset bubbles collapse.
While the United States is still struggling with high unemployment numbers and other vestiges of the recession, some positive signs are beginning to take shape.
"Nearly all of the macroeconomic data that has come out the last couple months has been very suggestive of the global economic recovery continuing," says Dominick Chirichella, founder of the Energy Management Institute. "We’ve seen energy demand growing and for the first time in several years we’re seeing inventories pointing toward a more normal level."
While still higher than pre-recession numbers, weekly ending stocks of crude oil are beginning to decline as demand is picking up. This is particularly evident in the performance of U.S. equities, which largely have moved in correlation with crude prices (see "I move, you move").
"The perception trade has been to watch currencies and the equities markets because equity markets are very correlated to GDP and GDP is correlated to energy consumption. That’s been the driver, but now we’re seeing perception and reality moving a little closer," Chirichella says.
Even though crude oil stocks are higher now than they were a year ago, the U.S. Energy Information Administration (EIA) is projecting stocks to fall throughout most of the year to more normal ranges (see "Return to normal").
With the U.S. economy gaining strength at the end of 2010, many analysts wondered how the Federal Reserve would react, considering it had just initiated its $600 billion QE2 in November. During a "60 Minutes" interview in December, Fed Chairman Ben Bernanke said a third round of quantitative easing was "certainly possible."
"The most positive potential benefit for oil from QE2 was a weaker dollar. When Bernanke [telegraphed] QE2 in August, that was when we got the biggest bang for the buck on the push down on the dollar," Chirichella says.
Yet, the beginning of 2011 saw a rising dollar and improving equities leaving some to wonder if it were already time to remove the stimulus. The minutes to the Federal Open Market Committee’s (FOMC) December meeting showed that the Committee felt economic growth was slowing based on housing figures and did not make changes to QE2.
"QE2 did help stimulate the economy and increase oil demand expectations," Flynn says. "If QE2 is going to work, then it has to come to an end. If it comes to an end or the markets anticipate a stronger economy, then we should really see a stronger dollar and a stronger dollar should offset some of the upward pressure we’ve seen [on crude oil]."
Europe continues to be a concern for the energy sector in 2011. In 2010, we saw debt concerns and bailouts for multiple European countries. "Europe has really weathered the storm with the financial crises they’ve had, but there are still some countries with debt considerations," says Rob Kurzatkowski, senior commodity analyst at optionsXpress.
Largely, a split Europe is taking shape in which core countries, such as Germany, continue to grow and show robust manufacturing data while periphery nations continue to grapple with debt and recovery.
"If we look at the overall consumption for oil in 2011, most forecasters are looking at a 500,000-barrel-a-day lower growth rate than we saw in 2010. In 2010, on a global basis oil consumption grew by about 2 million barrels a day," Chirichella says. "Much of the difference is from Europe being in a slow and grow mode and the developing world being in inflation fighting mode."
Finally, the developing world, particularly China, is still a concern as runaway inflation continues to be a problem despite actions already taken.
"The big wild card is China and the entire developing world market," Chirichella says. "If we take oil demand growth over the last couple of years, about 80%-90% of the demand growth has been attributed to emerging markets with China being the leader of the pack."
Largely, Chinese growth had been viewed as one of the few bright spots in a struggling global economy. As that growth has gone parabolic with double digit gains, the People’s Bank of China has shifted into inflation-fighting mode, already raising interest rates twice as well as raising bank reserve requirements twice in November alone.
"With China getting more aggressive about fighting inflation, China will play less of a role in the commodity rally and that means the commodity rally will be less pronounced," Chirichella says.
Flynn adds, "China is going to be a big story. Will they be able to raise their interest rates or will their inflation continue and create bubbles that could pop and slow the entire global economic recovery?"
Crude oil ended 2010 with momentum that quickly turned into volatile trading days. "There was a lot of upward moment going into 2010, too. You’ll see that at the end of [2009] and it really didn’t follow through because of all the crises that awaited us. We could be in for a similar situation this year," Flynn says.
Much of crude’s strength last year came from bailouts following crises that may not be resolved, so analysts are focusing on areas like Europe and China.
Chirichella expects crude to trade between $80-$100 a barrel for most of 2011, but it may reach $105 if $100 is breached. Kurzatkowski also sees resistance at $100 and $110 if that is breached., adding the last time oil prices were that high they went parabolic and did not create many resistance levels. He places support at $85 and if breached, $70. Flynn places oil in a range of $75-$95 for most of the year.
Natural gas
Natural gas continues to be a very different story, mostly because supplies continue to be plentiful because of shale gas.
"The shale gas revolution goes on. It has changed the world and thrown out the rulebook for the ratios between natural gas and crude oil," Flynn says. "Production of natural gas is cheap, it’s really going to be plentiful and even as the economy improves, the demand for gas is going to keep the market only somewhat supported."
Chirichella agrees with that assessment. "I don’t see any signs that the drilling is going to stop or that supply will outstrip demand. Once the cold weather goes away, we’re going to find inventories after the winter heating season will be above their average levels," he says.
Natural gas does have some positives going for it, though they may take a while to materialize. Chief among them is the use of natural gas as a major alternative fuel source as proposed in T. Boone Pickens’ plan for American energy. And this belief (see Cover Story) has kept drilling ongoing despite depressed prices, as no one wants to be left out
"Barring a hurricane in the Gulf or the government adopting the Pickens Plan, natural gas will continue to be traded on a short-term basis and be driven by short-term weather conditions," Chirichella says.
For now, though, natural gas is expected to stay in a fairly narrow range for much of 2011. Chirichella sees downside support at $3.75 with a distant ceiling at $5. Kurzatkowski expects support around $4 with more at $3.75 and resistance at $4.50. Flynn sees a potential low of $2.50 and the upside to $5.50, but most of the year spent below $5.
Products
We have seen some destocking on the supply side, but heating oil stocks are still about 20 million barrels above the five-year average for this time. As usual, weather forecasts are the thing to watch.
"There have been some weather concerns in Eastern Europe, where they still use heating oil," Kurzatkowski says. "They’ve had a pretty cold winter and that can be supportive of energy prices as a whole. The last few years Europe has really taken the brunt of the cold winter weather."
Chirichella sees heating oil staying in a band of $2.20-$3 per gallon for much of the year. Kurzatkowski expects support at $2.315 and more at $2 with resistance first at $2.715 and then at $3. Flynn expects supplies to stay plentiful and price to stay in a range of $2-$2.60, with most of the year closer to $2.10.
While RBOB gasoline futures rallied to yearly highs at the of 2010, much of those gains were because of a French refinery strike that limited delivery to the eastern shore of the United States. For 2011, watch economic reports, particularly employment, to judge the state of economic recovery.
"Gasoline is going to be directly related to unemployment. If companies start to hire again, we could see gasoline [rise] quicker than it has been," Chirichella says. "Gasoline will be more related to the unemployment story than other commodities in the energy sector."
Chirichella sees RBOB gasoline support at $2.10 per gallon and resistance at $3. Kurzatkowski expects support at $2.20 and $1.85 with resistance at $2.40, $2.70 and $3. Flynn expects prices to remain between $2.20 and $2.40 for most of the year, but they could get up to $2.70 and as low as $1.90 he says.
For much of 2010 energy prices reacted to central banks putting out economic fires. While a solid recovery and sovereign solvency still may be a bit too much to ask for in 2011, a return to stability seems to be on everybody’s mind, whether that is slow and steady growth in Europe or a cooling of parabolic growth in China.
Moving forward, growth and demand may be the most important factors to watch. "The biggest threat to demand is that we have another sovereign debt crisis that we can’t handle," Flynn says.
A bigger question may be how high can prices go if we do see a robust recovery?
