OIL PRICES: $34 - $40
North Sea Brent crude oil prices averaged $32/barrel (b) in February, a $1/b increase from January.
Brent crude oil prices are forecast to average $34/b in 2016 and $40/b in 2017, $3/b and $10/b lower than forecast in last month's STEO, respectively. The lower forecast prices reflect oil production that has been more resilient than expected in a low-price environment and lower expectations for forecast oil demand growth.
Forecast West Texas Intermediate (WTI) crude oil prices are expected to average the same as Brent in 2016 and 2017. However, the current values of futures and options contracts suggest high uncertainty in the price outlook. For example, EIA's forecast for the average WTI price in June 2016 of $35/b should be considered in the context of recent Nymex contract values for June 2016 delivery (Market Prices and Uncertainty Report) suggesting that the market expects WTI prices to range from $24/b to $58/b (at the 95% confidence interval).
U.S. crude oil production averaged an estimated 9.4 million barrels per day (b/d) in 2015, and it is forecast to average 8.7 million b/d in 2016 and 8.2 million b/d in 2017. EIA estimates that crude oil production in February averaged 9.1 million b/d, which was 80,000 b/d below the January level.
Natural gas working inventories were 2,536 billion cubic feet (Bcf) on February 26, 46% higher than during the same week last year and 36% higher than the previous five-year average (2011-15) for that week. EIA forecasts that inventories will end the winter heating season (March 31) at 2,288 Bcf, which would be 54% above the level at the same time last year. Henry Hub spot prices are forecast to average $2.25/million British thermal units (MMBtu) in 2016 and $3.02/MMBtu in 2017, compared with an average of $2.63/MMBtu in 2015.
Natural gas is expected to fuel the largest share of electricity generation in 2016 at 33%, compared with 32% for coal. This would be the first time that natural gas provides more electricity generation than coal on an annual average basis. In 2017, natural gas and coal are both forecast to fuel 32% of electricity generation. For renewables, the forecast share of total electricity generation supplied by hydropower rises from 6% in 2016 to 7% in 2017, and the forecast share for other renewables increases from 8% in 2016 to 9% in 2017.
Prices: The North Sea Brent front month futures price rose $2.83 per barrel (b) from February 1 to settle at $37.07/b on March 3 (Figure 1). The West Texas Intermediate (WTI) front month futures price rose $2.95/b and settled at $34.57 over the same period.
Crude oil prices began to increase during the second half of February in response to potential future supply reductions and better economic data in the United States. Discussion of a potential plan to freeze production at January levels among leading Organization of Petroleum Exporting Countries (OPEC) and non-OPEC oil producers may have contributed to some covering of short positions ahead of a long weekend in U.S. markets. Such a plan, if adopted, could help support prices but recent statements suggest that such collaboration is not imminent. On the demand side, a larger-than-expected rise in both U.S. industrial production and existing home sales in January along with continued gains in U.S. employment supported crude and equity markets.
The rise in front month crude oil prices toward the end of February was largely responsible for the decline in the price discount of near-term contracts to further-dated ones (contango) in the Brent market. The Brent 1st-13th spread decreased $1.76/b since February 1 to settle at -$5.78/b on March 3 (Figure 2). The contango in the WTI 1st-13th spread declined $2.38/b over the same period to -$7.43/b. After the front month WTI contract reached a price discount of $12.01/b to the contract for delivery one year out on February 11, the contango began to decline despite U.S. crude oil inventories reaching a record high as of February 26. A rebound in gasoline consumption in February, along with declines in U.S. crude oil production and reductions in the number of U.S. oil rigs to the lowest level since 2009, may have lessened market participants' fears that storage capacity limits may be reached in the near future.
Crude oil prices on the U.S. Gulf Coast strengthened over other domestic crudes and Brent crude prices in February. The Louisiana Light Sweet (LLS)-WTI spread increased 95 cents/b from February 1 to settle at $2.15/b on March 3 (Figure 3). Gross inputs to refineries in PADD 3 rose 0.1 million b/d from January to February, compared to a decline of 1.1 million b/d on average over the last five years. Higher LLS prices may have encouraged crude movements into the U.S. Gulf Coast, as crude stocks rose in PADD 3 ) by 11.4 million barrels since January compared to an increase of 2.4 million in PADD 2. The Brent-LLS spread declined $1.07/b from February 1 to settle at 35 cents/b on March 3. With LLS at parity to Brent, the U.S. Gulf Coast may see an increase in crude imports in the coming weeks.
Energy and non-energy commodities: Since the beginning of 2016, energy commodity prices fell relative to nonenergy commodity prices. As of March 3, the energy component of the S&P Goldman Sachs Commodity Index (GSCI) declined 12% from January 4 (Figure 4) The precious metals and industrial metals components of the S&P GSCI rose 16% and 7%, respectively, while the grains component remained stable and the softs components (coffee, sugar, cocoa and cotton) declined 5% over the same period. Prices of different commodity groups typically move together when the main driver of commodity markets is global economic growth. When price movements diverge, it indicates there are market-specific or supply-side issues also affecting these commodities. Precious metals, specifically, tend to respond more to the risk of future economic growth and are also affected by volatility in foreign exchange markets. For energy commodities, increased crude oil production and rising crude and product inventory levels have contributed to the decline in prices so far in 2016. Commodities included in the industrial metals, grains, and softs components have responded primarily to changes in exports and production levels within their individual markets this year.
Crude oil trading volume and open interest: A measure of trading activity and liquidity of futures contracts is the average turnover ratio, calculated by the total monthly trading volume divided by the average monthly open interest in all futures contracts. The average turnover ratio for all WTI futures contracts reached a record high of 14 per day in February, and the average turnover ratio for all Brent futures contracts was 8 per day in February (Figure 5). Trading activity often increases when volatility rises. Historical volatility in the WTI front month futures contract was much higher than the historical volatility in the Brent front month futures contract recently, from a difference of near zero in November 2015 to a difference of over 9 percentage points in February. This divergence in volatility may have contributed to the recent rise in the turnover ratio for WTI futures contracts. In addition, in early 2015, open interest in Brent futures contracts surpassed the open interest in WTI futures contracts for the first time. Higher open interest without a corresponding increase in trading volume kept the turnover ratio for Brent futures contracts lower than that of WTI since 2015.
Volatility: The implied volatility for both Brent and WTI front month futures contracts declined since February 1 by 16 and 14 percentage points, respectively, to settle at 50.4% and 51.6%, respectively, on March 3 (Figure 6). Despite the decline in implied volatility, both Brent and WTI had the highest average implied volatility in February since 2009, as uncertainty grew about potential changes to future global crude oil production growth.
Market-Derived Probabilities: The June 2016 WTI futures contract averaged $36.98/b for the five trading days ending March 3 and has a 17% probability of exceeding $45/b at expiration. The same contract for the five trading days ending February 1 had a 19% probability of exceeding $45/b (Figure 7).
Prices: Although U.S. working natural gas inventories declined in February, the withdrawals from storage were less than the five-year average for this time of year. Inventories were 666 billion cubic feet (Bcf) above the five-year average for the week ending February 26, and prices moved lower in response (Figure 13). The front month contract for delivery of natural gas at Henry Hub, Louisiana, settled at $1.64 per million British thermal units (MMBtu) on March 3, a decline of 51 cents/MMBtu from February 1. Natural gas futures prices are at the lowest levels since December 1998.
Hydrocarbon Gas Liquids (HGL) Prices: Despite both crude oil and natural gas prices decreasing, the HGL market is showing some price strength. The ratio of the HGL composite price index (an average price of propane, butane, isobutene, ethane, and pentanes plus, weighted by production) to both WTI and natural gas increased since the start of the year. The ratio of the HGL composite price to natural gas rose from 1.15 to 1.68 from February 1 to March 3 and the ratio to WTI peaked at 0.55 on February 11 (Figure 14). Recent price increases in propane and pentanes plus markets were the main drivers and make up 45% of the HGL composite price. Increased export capacity for HGL combined with strong international demand may be providing price support.
Volatility: With the winter heating season coming to an end, natural gas volatility began its seasonal decline. Historical volatility declined 16 percentage points from February 1 to 51% on March 3, while implied volatility rose 9 percentage points to 56% over the same period (Figure 15).
Market-Derived Probabilities: The June 2016 Henry Hub futures contract averaged $1.91/MMBtu for the five trading days ending March 3 and has an 8% probability of exceeding $2.50/MMBtu at expiration. The same contract for the five trading days ending February 1 had a 34% probability of exceeding $2.50/MMBtu (Figure 16).
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