EIA’s December Short-Term Energy Outlook (STEO), released yesterday, forecasts that Brent crude oil prices will average $68 per barrel (bbl) in 2015, with prices up to $5/bbl below the annual average early in the year. The forecast for West Texas Intermediate (WTI) crude oil spot prices averages $63/bbl in 2015. The current values of futures and options contracts show high uncertainty regarding the price outlook. For example, WTI futures contracts for March 2015 delivery traded during the five-day period ending December 4 averaged $67/bbl. Implied volatility averaged 32%, establishing the lower and upper limits of the 95% confidence interval for the market's expectations of WTI prices at the expiration of the March 2015 contract at $51/bbl and $89/bbl, respectively. Last year at this time, WTI for March 2014 delivery averaged $96/bbl and implied volatility averaged 19%, with only a $30/bbl spread between the corresponding lower and upper limits of the 95% confidence interval.
The OVX (an index that measures WTI implied volatility) increased in November and remains near its highest level since 2012. An elevated OVX value implies that market participants expect further large price movements in the near term. There is not sufficient liquidity in the Brent options market to make a similar statistically sound assessment of Brent price uncertainty. However, as volatility across oil markets is generally correlated, it is likely that the probability of large Brent price movements going forward has similarly increased.
North Sea Brent crude oil spot prices settled at $68/bbl on December 5, $48 below the 2014 peak reached in late June and the lowest daily price since May 2010. The declining prices reflect the combination of robust world crude oil supply growth and weak global demand, which have caused global oil inventories to rise (Figure 1). Recent events, including the Organization of the Petroleum Exporting Countries’ (OPEC) decision in late November to maintain its current crude oil production target, have raised expectations that oil supply growth will continue contributing to rising inventories through the first half of 2015.
The lower 2015 price forecast reflects significantly looser global oil market balances over the first half of 2015 compared with last month’s forecast. In the current forecast, EIA expects global liquid fuels supply to average almost 92.8 million bbl/day (bbl/d) in 2015, while global demand is expected to average 92.3 million bbl/d. The increase in inventory growth is more pronounced during the first half of 2015 as a result of lower forecast consumption, based on a reduction in the forecast growth of the global economy, without a drop in forecast supply. EIA expects that global oil inventories will build by almost 0.8 million bbl/d on average during the first half of 2015, up from 0.5 million bbl/d in the previous STEO. In the second half of 2015, production growth slows so inventories build at a lower rate. Overall, the projected global inventory build between 0.4 and 0.5 million bbl/d for the year is relatively unchanged from the previous forecast. This inventory growth comes on top of builds that have averaged 0.5 million bbl/d in 2014. In 2014, inventories have built as global oil consumption growth has fallen well short of expectations, while supply growth has continued apace.
Continuing inventory builds are expected to put further downward pressure on oil prices. EIA expects Brent prices to fall from current levels to average $63/bbl from March through May. EIA expects that a change in market fundamentals will have to come from the supply side because, in the short-term, global demand is very inelastic to changes in price. The $63/bbl March-May Brent price forecast represents the price expected to slow supply growth enough to balance with weaker expected global consumption. The projected price decline is expected to bring the global oil market into rough balance during the second half of 2015, stemming inventory builds. Over the second half of the year, Brent prices are projected to average $72/bbl based on expectations of slower production growth and a firmer market.
EIA’s STEO includes a downward revision to forecast supply growth in U.S. tight oil plays. Because many producers have already made investment and drilling plans for the early part of 2015, the U.S. crude oil production forecast through the first half of 2015 is relatively unchanged from the previous STEO, but growth forecasts for the second half of 2015 have been reduced. With high decline rates, which require high levels of drilling to maintain production, the outlook for U.S. tight oil production is more price-responsive than production in areas within and outside the United States where investment horizons are longer and less drilling is required to maintain production.
With WTI crude oil prices expected to average $58/bbl in the second quarter of 2015, netback prices at the wellhead in certain domestic areas could fall into the low $40/bbl range. EIA expects 2015 drilling activity to decline due to less-attractive economic returns in some areas of both emerging and mature oil production regions. Many companies will redirect investment away from marginal exploration and research drilling and into core areas of major tight oil plays. However, projected oil prices remain high enough to support development drilling activity in the Bakken, Eagle Ford, Niobrara, and Permian Basin, which contribute the majority of U.S. oil production growth. EIA expects U.S. crude oil production to average 9.3 million bbl/d in 2015, up 0.7 million bbl/d from 2014, but down from expected growth of 0.9 million bbl/d in last month’s STEO. However, all of the decrease in forecast production growth comes in the second half of the year. EIA revised production growth downward by 140,000 bbl/d and 270,000 bbl/d in the third and fourth quarters, respectively, compared with the previous forecast. However, this forecast remains particularly sensitive to actual prices available at the wellhead and drilling economics that vary across regions and operators.
EIA does not expect significant reductions from OPEC producers as, consistent with OPEC’s announcement, Saudi Arabia has indicated its intention to maintain its export market share rather than cut production to keep prices higher. In the past, Saudi Arabia has often temporarily cut its production to accommodate supply growth elsewhere or weaker global demand, or increasing its output level to make up for a supply shortfall. Saudi Arabia's production is still expected to decline in next year compared with its current 9.6 million bbl/d level, but is forecast to be maintained above 9.0 million bbl/d throughout 2015.
With price volatility high and markets in flux, small changes to fundamentals or perceptions can cause prices to shift rapidly. Several factors could cause oil prices to deviate significantly from current projections. Chief among these is the responsiveness of supply to the lower price environment. Despite OPEC’s recent decision to leave its crude oil production target at 30 million bbl/d, if crude oil prices continue to fall, Saudi Arabia and others could choose to cut production in order to tighten market balances. The level of crude oil production outages could also vary from forecast levels for a wide range of producers, including OPEC members Libya, Iraq, Iran, Nigeria, and Venezuela. Additionally, the price and lag time required to cause a reduction in forecast non-OPEC supply growth, particularly U.S. tight oil, could be longer or shorter than expected. The degree to which non-OPEC supply growth is affected by lower oil prices will also affect market balances and prices. Finally, consumption could turn out to be more responsive to lower oil prices than anticipated. How these factors evolve over the next several months will shape the market both in 2015 and beyond.
Average U.S. gasoline and diesel fuel prices decrease
The U.S. average price for regular gasoline fell 10 cents from the previous week to $2.68 per gallon as of December 8, 2014, 59 cents lower than the same time last year. This is the lowest U.S. average price since February 22, 2010, and the first time since October 4, 2010 that all five regions of the U.S. have average gasoline prices below $3 per gallon. The Midwest price decreased 13 cents to $2.59 per gallon, and the Rocky Mountain price followed with a decrease of 12 cents to $2.74 per gallon. The Gulf Coast price declined nine cents to $2.44 per gallon. The East Coast and West Coast both decreased eight cents, to $2.74 per gallon and $2.94 per gallon, respectively.
U.S. average diesel fuel prices declined seven cents this week to $3.54 per gallon, down 34 cents from this time last year. The West Coast price decreased 10 cents to $3.59 per gallon, while the Midwest declined eight cents to $3.62 per gallon. The Gulf Coast and Rocky Mountains were both down seven cents, to $3.43 per gallon and $3.66 per gallon, respectively. The East Coast price decreased five cents to $3.46 per gallon.
Propane inventories fall
U.S. propane stocks decreased by 0.3 million barrels last week to 79.2 million barrels as of December 5, 2014, 26.5 million barrels (50.4%) higher than a year ago. East Coast inventories decreased by 0.5 million barrels and Rocky Mountain/West Coast inventories decreased by 0.1 million barrels. Gulf Coast inventories increased by 0.3 million barrels while Midwest inventories remained unchanged. Propylene non-fuel-use inventories represented 4.0% of total propane inventories.