Oil is now less expensive than water as West Texas Intermediate (WTI), the U.S. benchmark price for crude oil, was trading at $35.22 a barrel as of December 14th, 2015, about 84 cents a gallon. The national average for a gallon of distilled water is about $1.25.
Simply, 2016 is shaping up to be worse than 2015 for fossil fuel economics. The pressures of oversupply for petroleum markets will be further compounded by the historic United Nations Climate Change Conference in Paris concluding with a 195 nation agreement to reduce greenhouse gas emissions, (finalized on December 12th). For coal, the pending Climate Action Plan proposed by the Obama Administration will place a further and significant burden on existing coal fired power plants and mining operations.
Despite global and domestic politics, basic economic principles are what is placing the most stress on both oil and coal prices. With oil, it is supply and demand. Global supply of oil is assumed to continue to outpace demand well into 2016 by the U.S. Energy Information Administration (EIA) and the International Energy Agency (IEA). For coal, it is the fact that natural gas is less expensive to burn for electricity than coal.
As of the 3rd quarter 2015, global oil production reached 96.9 million barrels per day (bpd) – an increase of 700,000 barrels on average from the previous quarter. OPEC (Organization of Petroleum Exporting Countries) led the over- production surge having added 300,000 bpd since the second quarter reflecting a year to date increase of 3.3 bpd.
In contrast, demand increased just 400,000 bpd average from the second to third quarter of this year to 95.3 million bpd. As of third quarter 2015 data, this reveals an over-supply of 1.6 million barrels per day.
Estimates for 2016 reflect a negative outlook for crude prices as OPEC continues to produce unrestrained. If Iranian crude outputs are added to their numbers with the lifting of economic sanctions, OPEC oversupply additions will be compounded. The IEA estimates that production will begin to pull back in 2016, but only slightly - by about 600,000 barrels a day. This slight decline will largely be due to production declines in U.S. tight shale plays. They further estimate that demand will continue to increase, but by a slower margin then seen in recent years, averaging 96.7 million barrels a day by the fourth quarter of 2016. This will eventually lead to supply once again outpacing demand by the end of 2016, but only by 400,000 barrels.
With inventories at elevated levels, a shift to supply outpacing demand will have limited impact on overall crude prices. The first seven months of 2015 (most recent data) saw total global liquids inventories grow by 2.3 million barrels a day – the highest level of builds through July of any year since 1998. As indicated by the EIA, these “strong inventory builds have put significant downward pressure on near-term crude oil prices.”
EIA estimates that Brent crude oil prices will average $56 with West Texas Intermediate (WTI) averaging $52 in 2016. As of mid-December 2015, WTI was threatening to slide below $35. Moody's investor service is even more bearish in outlook stating a belief that Brent will only hit $43 and WTI will only see $40 average price per barrel in 2016. Moody’s believes that neither benchmark will see $50 again until at least 2017.
Prices, however, are clearly prone to volatility in 2016 as tremendous uncertainties remain which could result in further downward pressure.
Coal’s indicators are less prone to volatility yet negative nonetheless. With 2015 seeing record plant closures due to federal regulations and depressed natural gas prices, that industry can clearly assume that 2016 will not be a year of relief. Natural gas is competitive with coal as an energy source at $4 per million btu. As of mid-December, natural gas was trading below $1.85. With continued elevated levels of domestic natural gas production, EIA assumptions are that natural gas will remain below $3 average Henry Hub spot price in 2016 resulting in a smaller coal energy production market share.
According to a recent Platts report, Central Appalachia (CAPP) coal producers are at the most risk in 2016. In that report, Evan Kurtz, a New York City analyst was frank: "… the vast majority of CAPP thermal [coal used for electricity] mines can't compete with gas at this level. They will hang on as long as they can, but most of CAPP thermal mines will go away."
Coal production dropped roughly 8% in 2015 while utility coal consumption dropped 7%, according to the latest data from Bentek Energy, a unit of Platts. Platts indicates that if natural gas remains below $2.50 million btu, utilities could burn up to 17% less coal next year in favor of the cheaper alternative. Every major coal producing region is down double digits in production with the exception of the massive Powder River Basin of Wyoming and Montana (responsible for over 40% of all coal mined in the United States) being off only 2.4%. Additionally, U.S. exports of thermal coal are down 20% from 2014.
Add to this that 172 new natural gas fired power units are scheduled for construction between 2016 and 2018 versus 5 scheduled coal units and short to mid-term prospects for coal are clearly grim.
But it is external pressures which will give coal the biggest headache in 2016. The Paris Climate Change treaty signed by 195 nations call for significant global reductions in greenhouse gas output. Though greenhouse gas emissions from the burning of petroleum products (transportation and energy) is greater than burning coal, it is coal fired power generation that is the easiest target for emission reductions in developed nations. And that obvious target has already produced a tremendous financial hit as a result of the Paris agreement. Shares of Peabody Energy, the largest coal producer in the United States, dropped by 12.6% alone the day after the announcement. The U.S. Coal index (DSCL) dropped over 2 points from $18.50 to under $16.00. On December 16th of 2015, it sat at $16.16 having fallen from about $95 a year before.
Despite coal seemingly being the main target of the Paris agreement, oil is quietly under fire as well. A spokesman for Morgan Stanley investment firm stated in a recent Fortune Magazine article “there is little doubt that the Paris Agreement creates a long-term challenge to the business model.” In that same article, Fortune points to the biggest problem for the oil and gas industry, those being “stranded assets - oil and gas reserves that companies list as part of their valuation, but that in reality might be worthless, since under the terms of the Paris Agreement those reserves might never be drilled.”
Though the outlook for fossil fuels is grim for 2016, the general consensus of most analysts is that 2016 will see the bottom for petroleum prices. Domestic coal production, consumption, and exports however will likely continue to fall until natural gas prices rise above $4 per mbtu. General estimates are that Natural Gas won’t be trading above that price until at least 2017.