The volatility that marked energy markets over the past year is almost guaranteed to continue in 2012. Geopolitical factors, such as Europe’s financial crisis and conflicts with Iran and other regions, make long-range forecasts hard to pin down.
“The black swans are flocking together,” says Phil Flynn, senior energy analyst at PFGBest. “There are so many black swans out there, they’ve become the new white swans. That’s the problem going into 2012 — we’re going to need a new term. There are so many issues that really could have an impact on oil prices.”
Flynn points out that a number of geopolitical hotspots or the ongoing European debt crisis could create a black swan type of event.
Other factors affecting the outlook for oil and natural gas products include the possible weakening of demand from China and India, the continuing possibility of an economic downturn in North America and expanding supplies, particularly for natural gas.
Natural gas working inventories ended November 2011 at a record high for that date. According to the U.S. Energy Information Administration (EIA), they are about 1% above a year earlier. Projected Henry Hub natural gas spot prices averaging $4.02 per million British thermal units (MMBtu) in 2011 were 37¢ per MMBtu lower than the 2010 average and the EIA expects that spot prices will continue to decline in 2012, averaging $3.70 (see “Feeling gassy,” below).
“The potential huge supplies of natural gas from shale formations will keep any price rallies in check in 2012,” says Mike Zarembski, manager of futures trading at optionsXpress. He adds that weather events such as hurricanes in the Gulf of Mexico that previously would send natural gas prices soaring have become a smaller factor in gas prices because inland gas supplies have increased their share of the market since 2008.
“Oil prices look to remain volatile in 2012, especially with tensions remaining high with Iran and the potential for further attacks on the oil infrastructure in Nigeria,” Zarembski says. “Natural gas prices should remain subdued unless we start to see much stronger industrial demand to absorb the huge gas surpluses we should have at the start of 2012.”
Global supply and demand conditions for oil ended 2011 in balance, according to Patricia Mohr, economics and commodity market specialist for Scotiabank Group. She noted that OPEC, at a December meeting, agreed to maintain output near current levels, slightly higher than projected demand, and scheduled another meeting in June. Mohr says WTI oil prices should average $95-$100 per barrel in 2012 compared to $95 in 2011 and $79.53 in 2010.
Other analysts and traders forecast average prices as high as $110 for the coming year, but most noted that fluctuations far above or below those ranges could be possible in such scenarios as a breakup of the European Union or a military conflict around the Strait of Hormuz, which links the Gulf of Oman and the Persian Gulf.
What many see as receding prospects for a recession affecting North America also will come into play. “Oil prices are going to be most related to economic growth,” says Keith Springer, president of Springer Financial Advisors. “If it looks like we’re coming out of recession and we have a true recovery, you’ll see higher oil prices. If not, you’ll see lower prices. We’re getting to the point where we’re due to come out of the recession. We’re either going to double dip or recover.”
But Springer says the world’s economy and demand levels will be more critical to energy prices in the coming year. “It’s going to be the whole world’s economy and not just the U.S.,” he says. “The U.S. has tremendous demand, but China has tremendous demand, too. I don’t believe that [the U.S. is central]. There is enough supply and we’re finding supply all the time. Oil spikes when [a] recovery is expected.”
Europe’s banking and government debt crisis also will weigh heavily on the outlook, Springer and other energy market watchers agree. “Europe is going to be more of a mess. Unless Germany starts printing money or lets the ECB [European Central Bank] do it, they’re going to continue to deteriorate,” Springer says. If the ECB does engage in some form of quantitative easing, Europe will strengthen. “But I expect more turmoil and a lowering of growth prospects,” he adds.
Declining prospects for the euro currency also could feed strength in the U.S. dollar and keep a lid on oil prices. “Unless we see a total collapse of the value of the euro, any gains in the value of the USD might be more muted in 2012 and should have a very minor impact [on] determining energy prices,” Zarembski says.
Dominick Chirichella, founder of the Energy Management Institute, notes that the European situation also will have an impact on the direction of the U.S. dollar in the next six months. “Europe will make it and thus I see some USD weakness going forward [that will be] supportive for oil prices,” he says.
Along with the economic exposure of Europe, he also says demand exposure in China from what is looking like a slowing economy could have an impact on the global oil outlook. “China is the main oil demand growth engine and any impact from China is far greater than the EU and the U.S., “ Chirichella says. He adds that China and India constitute “the most important region of the world insofar as oil demand growth is concerned. Both governments will be able to orchestrate a soft landing and thus get their economies growing. The result will be decent oil demand growth from both of them.”
Oil prices now appear to be focused more on potential supply issues than slack industrial demand resulting from economic trends. “How else could one explain WTI futures trading over $100 per barrel if the market was concerned about a potential recession?” Zarembski says. “If a major European recession [were] to occur, then we may see some weakness in oil prices, particularly Brent. However, the market does not seem to be anticipating a major recessionary environment (see “Driven by supply,” below).”
A narrowing of the North American-focused WTI oil price discount off more Europe-focused Brent oil has followed the recent ending of conflict in Libya and developments in rail and pipeline shipping to link mid-continent North American oil supplies to the U.S. Gulf coast, Mohr notes. After climbing to $30 per barrel that discount narrowed to $10 per barrel, by early December (see “Crude spread narrows,” below).
Factors in this narrowing, according to Mohr, include a decline in oil inventories at Cushing, Okla., the pricing point for the Nymex contract; increasing rail shipments of Bakken light crude oil between Dickenson, N.D. and St. James, La., which diverts crude from the Cushing hub; and the announcement of plans to reverse flow in the Seaway Crude Pipeline System from Cushing to Houston beginning the second quarter of this year.
“The situation in Cushing with the reversing of the Seaway pipeline going from the Gulf Coast to Cushing and now going back to the Gulf eventually could take away some of that bottleneck we’ve seen, especially with those large supplies coming down from Canada and North Dakota,” Zarembski says. “It’s definitely going to change the dynamics of the WTI futures contract for sure.”
Pipeline shipping of gasoline products from the Gulf Coast to the East Coast also is replacing production of an increasing numbers of refineries that have been closed by low profit margins, Zarembski says. “The East Coast is going to rely more on pipeline shipments to get the products because they can’t rely on the refiners anymore to produce,” he says. “The potential (quantity of production taken out) could be quite substantial. It seems like nobody out there on the coast is making any kind of money.”
While recent trends toward lower U.S. domestic gasoline usage are expected to continue in early 2012, disruption in the gasoline markets in the past year also was impacted by the uprising in Libya throughout much of the year as well as flooding on the Mississippi River during the early part of 2011. “Last year was a strange year for gasoline,” Flynn says, who notes that consumers have seen the greatest percentage of their income go to gasoline in 30 years as Libyan production taken off the table combined with faltering North Sea production is contributing to a global tightening of supplies and the emergence of the United States as a gasoline exporter.
Refining problems in Europe, including the struggle by Petroplus Holdings AG to maintain crude oil supplies after lenders froze its credit lines, also are contributing to below normal heating oil inventories in Europe and the United States, Chirichella says. “We could see [heating oil] being the main price leader in the oil complex, at least for the first half of 2012.”
Along with heating oil and gasoline, the refining problems also are hitting middle distillate and diesel fuel supplies, Zarembski says. “Recently the refiners have been focusing on the gasoline segment of the market,” he says. “They’re getting more per barrel for gasoline than the middle distillates. Cleaner diesel requirements in New York state also are contributing to uncertainty about supplies in the coming year.”
While Zarembski’s outlook could mean higher prices in the U.S. Northeast, the overall outlook on energy includes so many potential stumbling blocks to a smooth supply/demand flow that perhaps Flynn is right in his initial assessment: Black swans could be the norm in 2012.