Grading My 2015 Energy Predictions
“It’s tough to make predictions, especially about the future.” ― Yogi Berra
I haven’t looked forward to this post since about mid-year, when it became clear that I wasn’t going to have a repeat of 2014’s perfect record. I recall a year ago wondering whether I would ever have a year the exact opposite of 2014 where I would end up with none of my predictions coming true. While I did a little better than that in 2015, there is no question that the year defied my expectations on many fronts. I did indicate at the time that rising uncertainty in the markets defied easy prediction. That certainly turned out to be true.
The funny thing about predictions is that things are always obvious in hindsight. I rarely have people suggest that any of my predictions are either “no-brainers” or “impossible” when I make them. But when it’s time to grade them, I hear that a lot. “You predicted lower oil prices for 2014. Of course oil prices were bound to fall.” Those are the sorts of comments that tend to be made following six months of oil price collapse hindsight.
The hardest predictions to get right are those that require a certain condition to be true all year long. A lot can happen in a year. Oil prices have skyrocketed and plummeted in the course of a year. One of my predictions was in that category. It was correct for most of the year, but enough eventually happened to prove it false. It was clear to me by mid-2015 that conditions were starting to tilt in that direction, but I don’t make predictions in six-month increments.
The Good, the Bad, and the Ugly
So, with that lead in, here is a rundown of how my predictions for the year fared, as well as an explanation in some cases for why things ended up differently than I thought they would. My predictions were initially made in My 2015 Energy Predictions. Here they are, the good, the bad, and the ugly — in the order I made them.
1. The closing price of West Texas Intermediate (WTI) crude will not fall below $40/bbl in 2015.
This was the one that had the potential to be the first to be falsified. When I made the prediction, oil prices were already in the $40s and dropping fast. This prediction could have proven false within a month of me making it.
Before the end of January, the closing price of WTI fell to $44.12, but then bounced off of that level back to the $50s. It made a couple of runs at $40 before turning upward each time. The price climbed into the $60s by May, and remained there for nearly two months. But then OPEC met again and decided to continue to overproduce its quotas. Crude oil inventories had come down some, but I became concerned for the first time that the continued overproduction could drop the price well below production cost. Shale oil production was falling, but not fast enough.
So prices began to fall again, and in late August WTI finally closed below $40/bbl for three straight sessions, proving me wrong. At that point, the price bounced off a low of $38.22 and climbed back into the upper $40s. I had the unpleasant experience of some people getting nasty about this one. They were playing close attention to the price, because as soon as $40 was breached they were quick to let me have it. Some were happy to let me know that they “knew” the price would drop below $40 — in one case falsely claiming that the price had collapsed because of a collapse in demand.
I had to reiterate why I make predictions. It’s not so I can sound smart. It’s to try to put some framework around what I think is likely to happen over the next year in the energy sector given the current outlook, and how I think that will shape the year. The context around the prediction is more important than the actual prediction. Why did I make the $40 prediction? Primarily because $40/bbl oil isn’t sustainable. For investors, I think $40 oil is a bargain over the long-haul, even if it dips somewhat below that in the interim. Until August, the $40 prediction held for WTI. So even though the prediction was proven wrong, $40/bbl still looked like a pretty solid price floor.
But then another OPEC meeting in December reiterated the overproduction strategy, and WTI broke back below $40/bbl. This time was different than August, as the price would not only remain below $40, but drop into the lower $30s.
If we were grading on a pass/fail system, it is clearly a fail. If we are grading on a curve, then as of August the prediction still provided useful guidance on a $40 floor for oil, but by December what I would have considered a “B” in August had become a “D.” Had prices fallen into the $20s (as many predicted and continue to predict), I would have given myself an “F” on this one. Speaking of “Fs”…
2. West Texas Intermediate (WTI) will average more than $60/bbl on a daily closing basis.
Through Dec. 21, the average closing price of WTI for the year was $48.66. That is 18.9% below the average price I predicted. This was a clear miss.
3. The average Henry Hub spot price for natural gas will be below $3.50/MMBtu in 2015.
Here is one that I did get right, and one that looks obvious in hindsight. I did identify it as the prediction in which I had the most confidence. The average closing Henry Hub price for natural gas in 2014 was $4.37 per million British thermal units (MMBtu). It would have been a bigger “no-brainer” to simply predict that 2015 prices would be lower, so I got a bit more aggressive with this prediction. Not aggressive enough, perhaps, as year-to-date the average closing price has been $2.64/MMBtu. A much bolder prediction — and one I briefly considered before concluding that it was too risky — was the price would fall below $2.00/MMBtu. That in fact happened briefly in October, and then again in December, when the price fell well below that mark all the way to $1.66/MMBtu.
The collapse in natural gas prices, just as the oil price collapse, is partly the result of the surge in U.S. shale output. But, in contrast to the global market for crude, U.S. natural prices still mostly reflect domestic supply and demand factors. The shale boom, combined with a couple of mild winters and summers, has resulted in the highest natural gas inventories on record. The long-term outlook for natural gas producers is still good, but the short term looks like it will continue to be painful.
4. U.S. crude oil production growth will probably slow, but will still expand for the seventh straight year.
This was another correct prediction, on both counts. U.S. crude oil production did slow, but did expand for the seventh straight year. In 2014, production averaged 8.7 million bpd, an increase of 1.2 million bpd over 2013 (which represented an increase of 1 million bpd over 2012.) This year through September, U.S. production has averaged 9.4 million bpd — an increase of 700,000 bpd over 2014. However, year-end production was below 9.2 million bpd after peaking at 9.6 million bpd in April. The average production numbers for 2015 won’t be finalized until early 2016, but based on the average through September and the year-end numbers, the 2015 average should come in at 9.3 or 9.4 million bpd.
5. The Energy Select Sector SPDR ETF (XLE) will rise at least 10% in 2015.
I consider this to be my worst miss. It was driven by both the collapse in oil prices and the collapse in natural gas prices. The problem with some of my predictions was they were interrelated. Failure of one led to failure of others.
In this case, the XLE had a total return in 2015 of -24.7%, and is now down 31.7% over the past two years. Historically, such a sharp decline leads to a rebound, but given the difficult intermediate outlook for oil and gas prices, an extended rally may still be months away.
6. BP will be bought out or merged in 2015.
I called this “my most aggressive, wild card prediction for 2015.” Speculating on a deal within a year was what made it the riskiest.
I made this prediction primarily to call attention to how grossly undervalued BP (NYE: BP) was relative to all of the other supermajors. This was true even if one assumed the worst case financial outcomes for BP related to the Deepwater Horizon oil spill in the Gulf of Mexico. I pointed out that there were only a handful of suitors that could pull this off, but that the value of BP’s reserves was compelling given the market value of the company. A company like Shell (NYSE: RDS-A) or ExxonMobil (NYSE: XOM) could find oil reserves on BP’s books at a much lower cost that of their own exploration efforts.
In fact, several sources reported that before Shell announced its $70 billion acquisition of BG Group (London: BG) earlier in the year, it seriously considered bidding for BP. Bloomberg also reported that “BP executives are concerned the company is vulnerable to an opportunistic bid” — with ExxonMobil and Chevron mentioned as the most likely pursuers. BP reportedly stepped up internal reviews of takeover scenarios and simulations of defense strategies against a hostile takeover, but acknowledged it would have limited options if ExxonMobil came knocking.
In July BP agreed to pay $18.7 billion over 18 years to settle the federal and state claims and fines over the Gulf spill, pushing the total tab for the disaster to nearly $54 billion. In October the Obama administration said it had finalized the terms of the settlement, which would actually be $20.8 billion. This removes a major uncertainty for potential BP suitors, but there are still hurdles in place. One of these is a small “poison pill” built into the settlement that could force a suitor to accelerate two-thirds of the payout to the government should they attempt to acquire BP. This is just another defensive measure BP has put in place, but it wouldn’t be a huge deterrent given that the overall acquisition price would be north of $100 billion.
For the year, BP’s share price outperformed Shell and Chevron. In fact, for most of the year it outperformed all of the other supermajors. And while it is still a compelling value in my view, BP closed 2015 without being acquired or merged. Hence, this prediction proved wrong, but I still expect a deal to happen at some point.
This was by far my worst annual predictions performance in a long time. I take little consolation from the fact that I had lots of company this year for missing the mark on the energy sector. I do believe the sector is largely oversold, and I expect better results in 2016. Next week I will outline my predictions for 2016.
Link to Original Article: Grading My 2015 Energy Predictions