Senate Energy & Natural Resources Hearing to Examine the near-term outlook for energy and commodity markets

The Senate Committee on Energy and Natural Resources held a hearing to examine the near-term outlook for energy and commodity markets.  Chairwoman Sen. Murkowski (R-AK) and Ranking Member Sen. Cantwell (D-WA) made opening remarks before the following witnesses testified:

  • The Honorable Adam Sieminski, Administrator, U.S. Energy Administration
  • Antoine Halff, Program Director, Global Oil Markets, Center on Global Energy Policy at Columbia University
  • James Lucier, Managing Director for Capital Alpha Partners, LLC
  • Ethan Zindler, Head of Americas for Bloomberg New Energy Finance
  • Daniel McGroarty, Principal for Carmot Strategic Group


Opening Statements

Sen. Murkowski started the hearing by focusing on the impact the low crude prices had on the Alaskan economy and explaining how this is hurting Alaska in multiple ways.  A large portion of the Alaskan economy is centered around crude oil production because both jobs and the state budget depend on the sector. She added that despite the fact that oil prices are at a historical low, she had recently returned from a trip to Nome where gas prices were still as high as $5/ gallon.

Even though the price of crude is dampening the sector, there are still many steps that can be taken to modernize the nation’s oil policies.  Her bill S. 2012 – The Energy Policy Modernization Act is a step in the right direction for increasing the competitiveness of the nation’s natural resource sector.  This bill has been passed in the committee with a vote of 18-4 (for notes on the hearing markup of this bill click here to see it in the 11th Edition of The Arctic Report) and the bill is on the Senate floor as of January 27, 2016.

Sen. Cantwell (full written statement) followed by highlighting the increases in production of renewable energy in recent years.  She conveyed that these increases were not just from subsidies but from a decrease in production costs as well.  Interest in renewable energy is starting to break into the corporate sector as companies seek to lower pricing volatility and help their public image.

Sen. Cantwell then focused on the positive effects recent legislation has had on the green energy market.  The Clean Power Plan (CPP) will drive aggressive transition towards renewable energy.  More recently, the Omnibus Spending Bill, which passed both the Senate and the House, included long-term extensions for clean energy tax credits.  Bloomberg L.P. estimated that this extension would increase wind energy production by 76% and solar production by 44%.

Sen. Cantwell finished by discussing the benefits that renewable energy has on both the consumers and the job market.  Both solar and wind energy saw increases in employment during a time that other energy markets saw contractions.  Lastly, clean energy provided more options to home owners and businesses when deciding on energy needs.


Witness Panel 1

The witnesses offered varying perspective on different forms of energy and minerals.  While almost all forms of energy were discussed, the focus of the presentations centered on crude oil and its recent recline in price.

In his testimony, Adam Sieminski began by stating that crude oil prices in 2015 ended with Brent and West Texas Intermediate (WTI) below $40/ barrel (b), which is the lowest level since early 2009.  Furthermore, prices have continued decline into the first two weeks of 2016, with prices near $30/b on January 12, 2016.

U.S. crude oil production began to decline the second quarter of 2015, led by reductions in Lower 48 Onshore production.  This is driven by the overall market trend of resilient oil productions, large inventories and weaker than expected demand.

The EIA estimates that the global consumptions of petroleum and other liquids grew by $1.4 million b/d in 2015 and will continue to do so in 2016 and 2017.  While demand is growing it has not kept pace with global petroleum supply and inventories have increased in 2015 and are expected to continue to do so in 2016.  Siemiski does not feel this imbalance can last for an extended period of time.

The decline in non-OPEC production is expected to be offset by the increase in OPEC production.  OPEC production increased by 0.9 million b/d in 2015 and is forecast to increase by 0.5 million b/d in 2016.  This increase is driven by a few distinct events.  Saudi Arabia has abandoned its long held price-defending policy and has not curtailed production in the face of declining global prices.  In 2016 Iran oil is expected to come back online and predicted to contribute about 0.3 million b/d in 2016.

The U.S. petroleum production is forecasted to decline faster than other regions due to the high volume of tight-oil production.  Tight oil is characterized by short investment horizons and fast decline rates.  These two characteristics lead U.S. production to be the most sensitive to changes in oil price.

One OPEC indicator that does not fit with the current price environment is its surplus capacity.  This is currently below 2.5 million b/d, which historically has been an indicator of strong oil market conditions.  Given the high levels of global inventory Sieminski felt this data point was not significant.

Sieminski stated that while futures are a bad predictor of future oil prices, they do suggest an increased amount of uncertainty within the crude oil market.  Sieminski did not elaborate in detail on the root causes of this uncertainty, but noted that the crude market is changing significantly.

He then touched on the natural gas market.  He is a bit more bullish about this market than the crude oil.  He felt that that the dual effect of increased demand and flat production would cause the price to increase through 2016 and 2017.

The increased demand for natural gas has been led by the industrial sector and Mexico.  The industrial sector is forecast to increase consumption by 3.5% in 2016.  This increase in consumption is not believed to be demand driven but rather an economic reaction to the lower cost of natural gas.  Mexican demand for natural gas has increased with the nation’s growing electrical power sector.  This demand has led the EIA to predict U.S natural gas exports will increase by 0.7 bcf/d in 2016 and 1.4bcf/d in 2017.

Some of the increase in the industrial sector and Mexico export demand is forecast to be offset by a decrease in the consumption for power generation.  This decrease in consumption is caused by the substitution of green energies for natural gas.

In Antoine Halff’s testimony, he focused solely on crude oil and discussed at great length the changing crude market.

Halff noted at the beginning of his presentation that he does not feel the crude oil glut has run its course, but some of the early market responses to low oil prices are being seen.  These responses are most noticeable in the Oil Company’s reduction of capital spending, and in the increase of U.S. oil imports.  Halff stated that oil will ostensibly recovery from its current low but cautioned that even when it does this will not return the market to status quo because shale oil has permanently changed the crude oil environment.

At its core, the introduction of shale oil has changed the economic incentives for crude oil production.  Historically, OPEC and other large producers had the ability defend oil price by reducing production.  This price defense was possible because new developments were dependent on long-term investment, significant initial costs and favorable geological findings.  These three factors caused oil production to be highly inelastic, or unresponsive to oil price changes.

The advent of shale oil increased the elasticity of production, weakening the ability to defend price.  Shale oil has many characteristics that cause it to be more sensitive to oil price changes.  Halff felt that this sensitivity caused shale oil to be a “swing producer” adding and removing production as market incentives allow.  This elasticity has reduced if not removed the ability for large producers to defend price.  Cuts in production are seen as subsidizing fracking rather than defending price.  This simple economic change is at the heart of the “new oil market.”

The two characteristics of the “new oil market” are increased production, and increased volatility.  The increased elasticity of production when contrasted with Hoteling’s Law suggests that the revenue optimization formula for large producers has change.  Large producers are no longer defending price but defending market share.  This change in policy has led to a race to the top, or bottom when looking at oil price.

The increased volatility comes from the fact that shale has a much shorter production horizon.  Halff states, “The very rise of the shale oil industry, with its unique cost structure and short business cycle, undermines longer-term investment in high-cost conventional supply. The ability of the shale industry to ramp back production in a rebound is untested, however, and the market might find out when prices finally recover that its capacity has been durably degraded.”  If, however, shale is able to act as a swing producer the crude price bands might be narrowed.

Lastly, Halff discussed the medium term forecast of crude oil price.  Halff felt that a mixture of low project investment, political uncertainty and market over reactions, might lead to a rebound in price.  This rebound, however, would be mitigated by sluggish increase in crude oil demand over the next few years.

James Lucier testified on the power markets, as well as the power industry.  He discussed that much like other commodities, electric prices were at historically low levels.  These low prices are within a historically stable range and good for the consumer in the short term, but they have negative long-term implications.

He gave a broad overview of the state of power markets.  First, inflation-adjusted retail power prices are at a historically low level, but they are also consistent with a historically stable range.  This illustrates that the system and the industry have generally served consumers well by maintaining low and stable prices over a considerable period of time.

The second point he made was that wholesale power prices are similarly at a ten-year low, which shows service to consumers and also reflects low interest rates and low natural gas prices, which cannot be taken for granted.  These are possible design flaws in the market that may not be sustainable.

He added that in a regulated utility space, corporate management faces a conundrum about how to maintain or increase earnings to satisfy shareholders at a time when power demand remains flat or nearly flat “as far as the eye can see, which is well into the foreseeable future.”

The fourth point Lucier made was that in the merchant power space, generators are hard pressed to show a return on equity that would justify new investment in a competitive markets that serve two-thirds of the U.S. population.  A step change downward in natural gas prices since 2008, which we will credit to the Shale Revolution, is part of the story, but so also are troublesome issues with price formation in the energy markets and the development of appropriate pricing mechanisms for reliability and ancillary services.  As generators struggle, states understandably seek out-of-market solutions without waiting for the markets and the market operators to adjust, sending mixed signals to the capital markets and ultimately helping no one.

The last point Lucier made was that as the demands of the EPA’s CPP will drive the greatest investment cycle ever in the history of the U.S. power industry as existing baseload power plants retire, with natural gas pressure all the way.

These low prices have made it so developers and investors are struggling to show a return on investment.  The poor investment market has led to under investment in the power industry.  If prices fail to adjust in the short term this will lead to under investment and in the long term has potential to cause to power outages, pricing volatility and supply short falls.

Lucier recommended that the committee focus on ways to make the power industry more competitive.  The fact that the power grid system is characterized large fixed capital investment and long payback periods cause it to be significantly under-invested in low price environments.

The next thing Lucier focused on was the uncertainty in the power market.  In 2015 prices fell by 27%-37% year over year.  This price decline has prompted Regional Transmission Organization’s and Independent System Operators to review the pricing policies to provide greater reliability and less significant price swings.  The uncertainty extended beyond price to the legal and regulatory outlook as well.  Ongoing litigation includes a case being review by the Supreme Court, which deals with “demand response and state level capacity procurement.”  The outcome of this case might alter the supply-demand relationship in energy and capacity markets.

Some states have begun to take action to increase entry into power generation markets.  These states include Ohio, Illinois, and Maryland.  Most of the action focuses on contracts and regulations that affect power plants.

In Ethan Zindler’s testimony, he focused on renewable energy.  Due to a confluence of economics and policy actions this is an exciting time for renewable energies.  This interest in renewables is highlighted by the fact that in 2015, investments in clean energies reached an all-time high of $315 billion.

New projects are increasing at higher rate than new investments, which suggest that the cost of clean energy is dropping.  In 2015 half of added energy capacity was in the form of renewable energy.  Furthermore, this increase in renewable energy consumption/investment occurred during a time when the price of the substitute (coal and crude oil) was decreasing.

The trend towards clean energy is having a notable impact on CO2 emissions and now the U.S. emissions are the lowest they have been since 1990.  The decrease in CO2 emitted is coming from both increased renewable resources and increased efficiencies in existing energy productions.  This trend in decreased emissions is forecasted to increase with strong political backing and improving technology.

Daniel McGroarty testified on the near term outlook of commodity markets with a focus on hard-rock commodities.  He stated the near term outlook could be summed up in a single word: bleak.

McGroarty noted that commodity cycles are not a novel occurrence and as supply and demand fluctuate so do the underlying prices of the commodities.  In the recent year headlines have been dominated by the news of declining oil prices, McGroarty felt it was worth mentioning that prices for the five key industrial minerals are down as well.  In the last five years aluminum is down 36%, lead 35%, zinc 40%, copper 55% and nickel 64%.

While it is reasonable to assume these prices will rebound as supply and demand respond to the new price environment McGroarty cautioned that the risks of this glut for America are dire.  United States production of critical minerals and metals has continued to decrease.  In 1980 the U.S was 100% depended on 11 critical metals and minerals, that number has spike to 47 in 2014.  The implication of this dependence on foreign nations is not only economically troublesome but have significant impacts on the nation’s national defense.

McGroarty felt that certain policy actions were steps in the right directions.  These policies included Senator Murkowski’s American Mineral Security Act, and the White House’s Material Genome Initiative.  Both of these are aimed at increasing mineral production within the U.S.

In addition to policy actions McGroarty felt that we should further encourage recycling of rare metals.  This reclamation is referred to as “urban mining” and could potentially be a win-win for both the economy and the environment.  He stressed however that this action alone could not replace the necessity for new mineral production.