MARKETS:

Glut of U.S. oil is depressing, confusing prices

Oil and gas won't be hard to find in North America this year, but to many market analysts, optimism will be.

They, and those in the fossil-fuel business, had hoped for a hastier path to the higher prices that give the industry a healthy return on investment. Instead, early forecasts for 2013 suggest that gas will struggle above the $3 per thousand cubic feet mark, while the U.S. oil benchmark will continue to lag the global price.

Meanwhile, U.S. consumers will pocket the benefits, through lower power bills and gasoline costs.

On oil, one of the more bearish predictions has been made by analysts at Raymond James, who see the threat of a global oversupply of oil -- and see surging U.S. production as the main culprit.

Add that to production from Iraq, Canada, Australia, Russia and Brazil, and global supply will rise four times faster than demand, they wrote earlier this week.

"The elephant in the room is 'Where is all this crude going to go?'" the analysts said. For 2013, they pegged the American benchmark, West Texas Intermediate, at $65 per barrel; they expect Brent, the benchmark more associated with global prices, to reach $85 per barrel.

They aren't the only ones to forecast a global market suffused with oil. The larger trends are well-known to analysts: Economic growth is shaky in the United States and worse in Europe. Oil demand, once determined by the rich countries and the United States in particular, is increasingly connected to emerging markets.

"With U.S. gasoline demand in secular decline, the effect is that China now sets global oil prices, which supports the idea of a sustainable $110+/bbl [Brent] with a peak $130/bbl as the new paradigm," analysts at Deutsche Bank said earlier this week.

One question is whether U.S. producers can enjoy those kinds of prices -- or whether they will be stuck with the lower WTI benchmark. Much of the growth in U.S. production is in remote areas, such as North Dakota, that lack the infrastructure for the resources to escape to the highest-bidding markets.

That bodes well for consumers, at least. This week, the Energy Information Administration said it expects gasoline prices to drop from an average of $3.63 per gallon last year to $3.44 per gallon this year (EnergyWire, Jan. 9).

For producers, the path looks less comfortable. They are coming off a year in which natural-gas prices stooped unexpectedly low, forcing many to shift to oil and natural-gas liquids, sometimes at a burdensome cost.

Still, credit-ratings agency Fitch Ratings has said that it expects the sector to muddle through, overall. Most are "reasonably well situated to handle a one- to two-year dip in crude oil prices," it said in a report last month.

For natural gas prices, 'what do we consider normal?'

As for natural gas, analysts see an industry that has taken its foot off the pedal but can't slow down fast enough to get favorable prices.

Even though the total number of rigs has fallen to half the number that started 2012, EIA said, gas output is projected to rise again this year.

And warm weather, which takes much of the blame for last year's gas oversupply, could become a repeat offender.

So far, this winter appears warmer than usual -- just like last winter, when the balmy weather forced natural gas into storage instead of furnaces -- said Frank Brock, senior energy market specialist at ICF International.

Brock said last winter was so warm, there wasn't even a comparable year to plug into his computer model.

"This is perplexing a whole bunch of clients ... what do we consider normal?" he said. "There's a chance that the market can be lulled into this sense that ... it's never going to be cold again," which would also suppress natural gas prices.

Still, the broadly held view is that natural gas prices have escaped their trough: a sub-$2 level not seen since last spring. EIA projects natural gas spot prices to average $3.74 per million British thermal units this year, a figure that would rate at the high end among Wall Street analysts.

The increase may slow the torrid gains natural gas made in the power sector last year, largely at coal's expense. Natural gas plants were routinely dispatched before coal plants, sometimes even hyper-efficient units.

"At the low prices like we saw in 2012, our gas units will run as much as possible," Tammy Ridout, a spokeswoman for American Electric Power Co. Inc., said of the utility's business in its seven Eastern states. "The more natural gas prices rise above $3, the more of our efficient coal generation will dispatch before some gas generation in the East."

This year, as gas surpasses the $3 mark, many expect coal to grab back some of its old share.

But even though market observers all believe gas prices will eventually rise to the level drillers want, they know this isn't the year.

Greg Hopper, managing director in Black & Veatch's Management Consulting Division, said gas prices won't reach the $5 or $6 level until next decade. He doesn't expect to see sustained performance at the $4 mark until the end of next year. "The issue there is we need demand," he said.

What could provide that demand? Natural gas exports require federal approval and construction of plants. There are large industrial facilities, like gas-to-liquids plants, that would also take years to build. Some hope natural gas vehicles can provide demand, but most believe they face severe market challenges.

"The fact is, it's power generation that's going to drive the bus," Hopper said. The critical development would be early next decade, if the United States approves a carbon policy and forces futher coal retirements. "We can't find supports for $4, $5, $6 prices on any sustained basis before that."

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