Extreme volatility and downward pressure brought the price of crude, as tracked by the United States Oil Fund LP ETF (NYSE Arca: USO), down more than 40% during the last six months of 2015. WTI crude fell 37.4% for the full year.
At the same time, we've seen remarkable economic and technological developments in the price, availability, and usage of alternative and renewable energy sources like solar, wind, geothermal, and even nuclear.
Oil still tends to dictate terms for energy prices across the board - not because it's the driving force it used to be for actual energy usage, but from the way it's traded.
This complicated relationship can make the overall energy picture cloudy and tough for regular investors to navigate. And that can add up to lost profits and opportunities.
So here's the clarity you need to make money in oil and energy investing in 2016...
Crude maintains its outsize role in a shifting energy matrix because of the way futures contracts are traded. The extremely high liquidity of crude futures translates into what is still the single largest source of profits (and volatility) in the energy market.
That positioning turns the oil situation into a ready-made central focus for the 30-second daily sound bites in the media. Oil is still portrayed as the driving force for the entire energy sector.
But... that portrayal is wearing thin. We have already benefitted from positive moves among renewables, energy efficiency providers, new fuels, and even alternative power producers - all of which testifies to the expanding opportunities available for some nice moves in other energy companies moving forward.
Nonetheless, given the visibility afforded oil and the likelihood that such a position will remain for a bit, these are the important elements I am seeing in oil prices for 2016.
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First, Saudi Arabia will be loosening the Organization of Petroleum Exporting Countries' (OPEC) strategy to maintain and increase production levels. This has been the element depressing prices since Thanksgiving 2014, when OPEC took the decision to protect market share by maintaining volume, thereby reducing prices.
OPEC members have been forced into increasing sales to garner revenue, an approach that has added to the international oil glut and driven prices down even more. Several member-states are now in open opposition to the Saudi policy - with Venezuela, Nigeria, Libya, Iran, and Ecuador leading the charge to cut production and allow prices to rise.
Second, Riyadh has signaled that they would support a joint move with other non-cartel producing companies to "stabilize" the international market. That is a certain indication that calls for rapport with the likes of Russia and even the United States are now moving forward. With a face-saving caveat, the Saudis will lessen the "hold the line" on production and allow a reprieve.
That brings us to the situation in the United States. Here, unconventional (shale and tight) oil has been regarded as the major change in worldwide production levels - and one of the two main targets of the Saudis (the other target is keeping cheaper, better-graded Russian oil out of the Asian market).
But the American energy machine is more resilient than the Saudis gambled on...
You see, better drilling techniques and new, more efficient field operations have allowed companies to survive cascading prices. Forward capital expenditure (capex) commitments - especially for more expensive deeper, fracked, horizontal drilling - have been slashed, along with mothballing major Arctic and Gulf of Mexico offshore projects. Rig usage has also declined significantly.
But production from current wells has continued more robustly than expected, adding to the surplus even as future projects are cut.
Two matters here are rapidly approaching to change this and increase prices: a drop-off in well production and a debt crunch that will be burying more producers - and increasing the mergers and acquisitions cycle.
As far as well production drop-off goes, keep in mind that an average shale or tight oil well (where most of the new oil has been originating) provides most of its volume in the first 18 months, with secondary and enhanced oil recovery techniques (SOR and EOR) used to reduce the rapidity of the decline curve.
We are now well into the impending normal extraction rate declines from the latest deep wells, with the cost of SOR and EOR becoming too prohibitive in the low pricing environment. This will translate into a reduction of surpluses in the American market.
On the debt side, the problem is even more acute. Energy debt occupies the worst segment of the high-risk (i.e., "junk") bond market. This paper has experienced a significant rise in interest requirements and is once again accelerating.
The debt encumbrance is unsustainable for many companies who are now looking to roll over existing debt and an appreciable rise in cost - if replacement debt can be found at all. The average debt may well require more than 15% of a yield premium above junk bonds in general.
A rising number of producers will disappear, be acquired, or merge with larger competitors. Reducing the number of players will serve to reduce overall volume as well, as surviving companies use acquired reserves in the ground as a way to buttress share price, but defer more of the actual extraction awaiting higher market prices.
Finally, the combination of derivative moves on futures contracts (a practice once again heating up) and heavy ongoing short plays have distorted the actual price of oil. While "paper barrels" have always had an influence on oil prices for delivery ("wet barrels"), that influence has grown well beyond any market justification.
At the end of November 2015, I estimated the actual market value for a barrel of oil to be $50 in New York (West Texas Intermediate benchmark crude) and $54 in London (Dated Brent).
As the price stabilizes and the profit potential for running derivatives lessens while shorts need to be covered, the price will begin to rise toward actual market value. Both the paper price and the actual price should advance further with an overemphasis toward the upside emerging.
So what does this all mean? We are not racing back to $100 a barrel oil. Absent the outlier of a geopolitical event that impacts supply, more subdued rises are in order. But we certainly do not need triple-digit oil to make some nice investment returns, especially in a sector that has been so oversold.
Therefore, my current reads are as follows: By July 1, 2016 (beginning of the third quarter), WTI should be at $66, Brent at $70; by Oct. 1 (beginning of the fourth quarter), WTI at $68, Brent at $72; and by Jan. 1, 2017, WTI should finally breach $70 a barrel, with Brent reaching $75.
In all of this, it is interesting to observe that international demand continues to expand. This crunch has been all about the supply side of the equation.
I'll be tracking these changes in the oil market closely. I'm already developing some potentially lucrative profit plays that should pay off handsomely, even in this unusually turbulent and distorted market.
But oil is by no means the only opportunity for us in 2016... The renewables and alternatives segment, which usually takes it square on the chin during a protracted oil bear, is heating up nicely as technology and price converge to make these sources profitable.
To access my 2016 forecast for renewables, click here.
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Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, emerging market economic development, and market risk assessment.
He serves as an advisor to the U.S., Russian, Kazakh, Bahamian, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces.
Moors directs the Energy Policy Research Group at Duquesne University. His six books and hundreds of publications, presentations, and workshops have appeared in 44 countries.
