5 possible surprises that could impact the energy market in 2016

Thomson Reuters

Many energy analysts like to make predictions at the end of the year for the coming year. Instead, I'll point to five possible surprises in energy--surprises because few people expect them to happen.

I am not predicting that any of the following will happen, only that there is an outside chance that one or more will occur. Naturally, these surprises would move markets and policy debates in unexpected directions.

1. Crude oil ends 2016 below $30 per barrel

With oil hovering in the mid-$30 range it doesn't seem implausible that at some point in the not-to-distant future, crude oil will dip below $30 per barrel, if only briefly. What would surprise most people is if the crude oil price finished next year below $30 per barrel. The conventional wisdom is that cheap oil is giving a boost to the economy that will lift worldwide economic growth and thus demand for oil. There is also a belief that high-cost producers will simply have to stop drilling new money-losing wells after more than a year of financial Armageddon in the oil markets. This will bring down supply just as economic growth is rising, sending prices much higher as the year progresses.

The alternate view is that oil in the mid-$30 range is a reflection of an economy that has been weakening since the middle of 2014 and foreshadows a worldwide recession which should hit in full force by the end of 2016. In addition, with Iran almost certain to add to the current oversupply as sanctions are lifted and with the continued determination of OPEC to destroy the viability of tight oil deposits in the United States, the oil price could surprise on the downside, even testing $20 per barrel.

2. US natural gas production declines

Despite persistent low U.S. natural gas prices, U.S. production has continued to grow. Most of the growth has been coming from two places: the Marcellus Shale where ample deposits continued to be economical in the range of $3 to $4 per thousand cubic feet (mcf) and Texas where furious fracking for oil locked in deep shale deposits also produced associated natural gas without concern for the price of that gas.

With oil drilling across the United States in precipitous decline because of low oil prices, we won't see nearly as much new natural gas associated with oil drilling as we saw in 2014 and 2015. With natural gas now hovering around $2, even the very sweetest of the sweet spots in the Marcellus are unlikely to be profitable to exploit.

Having said all this, U.S. natural gas production growth has continually defied predictions that it would dip in the face of low prices. Part of this had to do with desperate drillers carrying heavy debt loads who had to produce gas at any price in order to pay interest on that debt.

3. Several approved US liquefied natural gas (LNG) export projects are postponed or abandoned

One of the memes of the so-called shale gas revolution was that the United States would produce far more natural gas than it consumes and that that would open the way for liquefied natural gas exports to other energy-hungry countries. Two things went wrong. First, U.S. production, while growing, has not exceeded U.S. consumption. Despite the highest natural gas production in history, the United States had net imports of natural gas of about 3 percent of its consumption so far this year.

Second, with the price of landed LNG around the world between $6 and $7, LNG exports from the United States are currently uncompetitive. Even with U.S. natural gas at $2, when the cost of liquefying and transporting gas--about $6 per mcf--is added to the American price, landed LNG prices would have to rise to about $8 just for American suppliers to break even. And, of course, just breaking even is not a proposition investors are very much interested in.

Now, some of the export projects have already undoubtedly received commitments from buyers to take U.S. LNG under long-term contracts, usually priced at Henry Hub plus a certain amount for liquefying and transporting the gas (plus something to reward investors, of course). If those contracts are in place, then the builders of the LNG export projects don't care what U.S. prices are. They make money no matter what. And, it doesn't matter whether they export so much LNG that the United States is forced to IMPORT more from Canada via pipelines or possibly in the form on LNG itself.

Whether buyers make out under such an arrangement will all depend on how world spot LNG prices unfold over the next couple of decades. Undoubtedly, many of those with long-term contracts today would be better off buying in the spot market. But, of course, when prices are high, they have no protection.

What we'll find out this year is which projects have contracts from buyers and which do not. The ones that do not yet have such contracts will almost certainly be postponed or abandoned. For those that proceed, investors who are not careful to understand how much of the capacity of the project has been taken up by long-term contracts and how much will be sold on the spot market may be in for rude surprises if they are too exposed to the spot market and that market remains soft.