Tuesday, August 18, 2015

Growth Economics in the Energy Sector

The oil markets today are heavily embattled with the sentiment over Chinese market and moves to buy into cheap oil positions. As of the first hour of market opening on Tuesday, the WTI spot price inches 0.14% lower with more losses on the Brent end down 0.78%. Most of the bearish pressure comes from the Chinese stock index opening with 6% losses, but overall low prices in the market are stocking up bullish confidence in a slight reversal. ETFs follow the same pattern as the jaded market holds on to a neutral day. Technical traders will be looking at indicators for signals of a support price where profits will come from a bounce. In the end, it's all cyclical with a tinge of randomness, but a saturated market will keep any rebounds in check.Speculation in the near future will be inhibited by the pressure of supply and demand numbers that come out in EIA reports tomorrow. The good news is, all it will take for WTI price increases is negative rig utilization data. I would bet on one or two positive trading days to end the week if that is the case.


Nevertheless, the world still looks on to the Chinese economy. Despite the inevitable (but slow) end of the supply glut, global demand growth needs to continue growing in order to meet production. The chart above from the Energy Information Administration lists world production and consumption with stock change and balance. The spread between the blue and black lines (production and consumption respectively) represents the glut attributed to the fracking growth. Midway through 2014 a sudden jump in the "implied" crude stock sent prices into the ground. But projections are bullish. The EIA sees stocks significantly dropping in the latter half of the year even with the summer demand past us. A majority of the reduction will come from U.S. oil companies cutting spending in upstream operations while capitalizing on cheap crude by hedging low prices for large downstream margins. It is important to note that the changes in crude stock and production have been non-OPEC changes, so they have not been purposefully organized to manipulate prices.Unlike cartel conditions which seek to maintain market control, non-OPEC producers are unwilling to produce at lower than full capacity when margins are profitable. In my opinion, most oil investors forget that these companies operate under the free market, and in turn, their speculation becomes sour when the high prices we know so well don't return. There is no conspiracy, no altered projections, the markets are really just that saturated. As the years go on, analysts and traders who knew OPEC will have to adjust to the fact that green energy is in and the winners of the future energy markets will not consist of crude oil firms. Therefore, I would adjust demand and stock change projections in the late periods of 2016, but production levels will most likely stay the same as full capacity fracking in the United States will offset tapering ventures in the North Sea. At the same time, we must consider the type of market that will dominate the energy sector in the future. The petroleum industry is an established international system that has multinational players with large cash reserves. A high barrier of entry will prohibit any new entrants in the petroleum extraction industry. Upstream oil services will be about cash flow, increasing revenue and income, and perfecting a low P/E ratio. The only way to do this is by perfecting economies of scale where costs are minimized and reserves are efficiently used. On the other hand, energy growth outside of crude oil and other conventional unrenewable resources will require new entrants with streamlined approaches to research and development. The tech generation will define the energy revolution. The change must be made before or at peak oil.So in the future of oil fundamentals will go one of two ways. Either supply will catch up with demand and prices will skyrocket as we remain addicted to petrol that is almost gone, or demand will catch up with supply with prices dropping to almost nothing rendering the black gold worthless as the energy sector moves away from fossil fuels as energy sources. Both scenarios require more analysis and preparation, but as the EIA's hazy 2016 projections depict, the future is hard to predict.

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