Tuesday, January 14, 2014

Gazing Into My 2014 Crystal Ball

Print FriendlyIn last week’s issue, I graded the predictions I made a year ago for 2013. I scored well on oil and gas prices, the Brent-West Texas Intermediate (WTI) differential, and continued growth in US oil production (although it grew even faster than I expected). My only complete miss was that I expected approval for the Keystone XL pipeline.

Today I offer up my predictions, and the reasoning behind them, for 2014. One thing I have learned in making these calls is that they must be specific, and not subject to interpretation at the end of the year.

“The US oil industry will continue to thrive” is far too vague. On the other hand, “The average price of Brent crude will be higher in 2014 than in 2013” is specific and measurable.

So here are my predictions, followed by the reasoning behind each prediction, and in some cases the factors that could work against the predictions.

1. The crude oil export ban will not be lifted in 2014.

The crude oil export ban dates to the The Energy Policy and Conservation Act (EPCA) of 1975, and effectively bans crude oil exports to all countries besides Canada. Before the surge of US oil production over the past few years, refiners invested heavily in equipment that could process crudes that were heavy and sour, and thus deeply discounted relative to light, sweet grades. The current shale oil boom is producing light, sweet crude that isn’t optimal for many US refineries, which is why many refiners would prefer to run imported heavy crudes over domestic light crudes. This reduced demand limits the market for domestic crude producers and depresses domestic crude oil prices relative to global prices. The oil industry’s solution to this is to repeal the export ban so that it could export its premium crude.

There are some formidable obstacles to repealing this ban. Even though Energy Secretary Ernest Moniz has said that the ban should be revisited, there is significant political opposition. Several Democratic senators have voiced opposition because of the potential for increasing fuel prices for US consumers. The public will likely be largely opposed as the issue gains a higher profile. Some will object to the idea of encouraging more oil production in a world of growing carbon dioxide emissions. Others will instinctively balk at the notion of exporting oil while the US is still a large net importer of crude. And given that President Obama has had such a difficult time making a decision on the Keystone XL pipeline as a result of environmental opposition, it is hard to imagine that this proposal will be fast-tracked, as it will also generate significant resistance from environmentalists.

2. Brent and West Texas Intermediate (WTI) crude prices will average less in 2014 than in 2013.

I made this prediction last year as well, with mixed results. Brent crude did trade down, while WTI was up. The same factors remain in place to put downward pressure on crude prices in 2014. Domestically, crude oil production is likely to expand again in 2014 (see prediction 4 below), and given the logistical constraints and insufficient demand growth in the US, prices will be pressured to the downside. There is the possibility of a recovering US economy boosting demand, but it is hard to imagine that demand will grow as quickly as oil production. However, if I am wrong and the crude oil export ban is repealed, then I will likely be wrong about this prediction as well.

Globally, demand has grown faster than new capacity has come online over the past decade. Spare capacity is still tight, but some of the hotspots from the past few years, like Libya, are stabilizing. There is also the possibility of seeing crude oil exports from Iran start to pick back up. This may allow global crude oil capacity to gain a little bit of a cushion this year. However, OPEC is also capable of restricting supplies, and if Iraq heats back up this year and the violence affects Iraqi production then my prediction of lower Brent prices will also likely be wrong.

The variation of predictions among analysts on crude oil prices through the rest of the decade is wide. Ed Morse, the commodities research chief at Citi, expects crude prices to average $80/bbl through 2020. Oswald Clint at Sanford Bernstein projects nearly double that at $158 a barrel in 2020. I expect that short-term fundamentals are going to favor the lower end of that divide, but we will break to the high side by 2020. Global oil production still has some expansion left, but if it slows before 2020 and demand in developing countries continues to grow at the pace of the past decade, crude prices will break to the upside.  

3. The average Henry Hub spot price for natural gas will be higher in 2014 than in 2013.

I also made this prediction last year, and it was correct. Last year it was pretty obvious that crude prices couldn’t sustain 2012’s low average price, but this year the picture is less clear. Long-term, the fundamentals really favor higher gas prices. On a year-to-year basis, it’s going to be heavily influenced by whether we have an exceptionally cold winter (as has been the case thus far this winter).

But over the next three to five years I expect natural gas prices to rise beyond $5/MMBtu as liquefied natural gas (LNG) projects come online. The first exports from the Lower 48 will most likely happen in 2016 when Cheniere Energy (NYSE: LNG) starts the first two liquefaction trains at the Sabine Pass Liquefaction Project. Two more trains are scheduled to come online in 2017. I think it’s likely that investors will start to bid up the price of gas as these projects move closer to completion. The EPA has also proposed regulations that would effectively preclude new coal-fired power plants from being built in the US, so as older coal-fired power plants are retired, natural gas will pick up some of that capacity.

4. US crude oil production will expand for the sixth straight year.

Crude oil production increased for the fifth straight year in 2013. In fact, after a very strong advance in 2012, crude oil output grew even more in 2013. So even though I know a number of people who are expecting production to slow down soon, so far there are no signs of it happening. US crude oil production is now growing at the fastest pace in US history, and the US has recently accounted for the bulk of the global increase in crude oil production.

Rising production from the shale oil boom may reverse direction by 2020, but it won’t do so in 2014. The US Geological Survey (USGS) more than doubled the reserves estimate in North Dakota’s Williston Basin last year by including the Three Forks Formation that lies underneath the Bakken. Inclusion of Three Forks added an estimated mean resource of 3.73 billion barrels of oil to the estimated 3.65 billion barrels reserve of the Bakken. The Three Forks has already begun to produce oil. Oil production is also expected to continue to increase in the Permian Basin and the Eagle Ford Shale in Texas, and in Colorado’s Denver-Julesburg Basin.    

5. KiOR will declare bankruptcy in 2014.

I really struggled with this one, because there are more than just market forces at play. A major investor could make a unilateral decision to keep the company solvent, and future EPA decisions on biofuel mandates could have a major effect. Either of these events could cause the stock price to surge, but insiders have been unloading their positions since September.  

KiOR (Nasdaq: KIOR) is one of three advanced biofuel companies that venture capitalist Vinod Khosla took public in 2011. The other two were Amyris (Nasdaq: AMRS) and Gevo (Nasdaq: GEVO). Each of these companies has seen its share price drop sharply since the IPO. While KiOR is one of the few companies to have produced advanced biofuel for sale, the volumes have consistently come in below company guidance, and I expect production costs to remain above the sales price for the foreseeable future.

On May 9, nearly halfway through Q2 of last year, KiOR CEO Fred Cannon stated, “We expect that total fuel production during the second quarter will range between 300,000 and 500,000 gallons, keeping us on track to fall within our projected production range of 3 million to 5 million gallons for 2013.” The actual amount of product shipped for the quarter came in at only 75,000 gallons. When the actual volume was announced, the share price plummeted and investor lawsuits were filed. In August Cannon lowered guidance: “We expect our full year production levels will be in the 1 million to 2 million gallon range.” Another statement in November was considerably weaker when he said, “We believe that our full year production levels will exceed 1 million gallons.” The actual production number for the year was reported to be 894,000 gallons — lower than even the reduced guidances and about 7 percent of the stated capacity of the plant. Investors can’t be very confident in future projections given last year’s track record.

The share price is now down about 90 percent from the IPO price, and KiOR’s plant in Mississippi has shut down to work on improvements and save money. The company has said it will need $10 million to invest in the plant and $22 million for research and development for the year. The market still values the company at $170 million, which is 10 percent of the level in 2011 when I argued that KiOR was grossly overvalued.

But the reason I am stepping out on a limb with this prediction is that someone could just write a check to keep funding operations. Vinod Khosla is not only a major shareholder, he has been loaning the company money. He may choose to continue doing this. Bill Gates made a token investment in October 2013, with another potential investment contingent on KiOR getting additional financing.  

If you caught last week’s episode of 60 Minutes, you would have seen Vinod Khosla talking up the marvels of KiOR’s technology, and you would have seen me discussing why the advanced biofuel field is so challenging. After Khosla’s previous Range Fuels venture had a high-profile failure, he knows his reputation in the energy arena is on the line. For that reason, he will do everything he can to keep the company running in 2014, but he is likely going to have to pull out his checkbook or convince someone else to do so in order to keep KiOR solvent this year.


Beyond these five predictions, I think there are a number of other likely developments. I would like to see the MLP Parity Act pass Congress, which would permit more renewable energy projects to qualify for MLP status, but it doesn’t seem likely that the bill will pass. I believe that there will be at least a partial and retroactive reinstatement of the production tax credit (PTC) for wind power that expired at the end of 2013, as well as some reinstatement of the $1/gallon blender’s credit for biodiesel.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

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