Hopefully everyone is well-rested and ready to tackle the new year with a renewed sense of optimism and enthusiasm – wait, what? The markets are crashing? China is imploding? Canadian dollar reaching millennial lows? Oil still cratering? Natural gas continuing to test lows? George Soros is profiting?

 

What is an investor/market/industry participant to make of all this? Is there no one who can make sense of this chaos, be a shining beacon in the fog of confusion, lead us to safety?

 

Well fret not, for in the time-honoured tradition of all lazy writers, please find below the annual, first of the year “Fearless Forecast” upon which you should base all your business and investing decisions (after first signing a waiver).

 

Seriously though, given the range of forecasts, any one is probably as good as the next. My approach is a blend of two of my favourite games. The first is horseshoes, where you can get points for being close and the second is, of course, baseball, where even if you are successful a third of the time you are a near unanimous first ballot Hall of Famer (Yay Ken Griffey Jr. – lifetime batting average of 0.284).

 

So without further ado and in no particular order, please find the the fearless forecast wherein rather than trotting out the usual roster of data points, we have instead selected what we believe to be some of the more important themes for the oil patch for the year and make bold predictions about these. Or something like that.

 

Oil Market

It’s hard to decide what part of the oil market is most important – is it supply? Demand? Price? All three have tremendous interplay, and one won’t move without the other moving, but really it all starts with the difference between production and consumption, currently sitting at about 1.0 to 1.5 million barrels of oil a day and to repair the price, this surplus needs to go.

 

US production has been pretty resilient during the past year, with production numbers staying fairly consistent, but this can’t last. The number of rigs idled in the last year is staggering (1,000 and counting!) and no amount of efficiency can compensate for that. We expect that US production should come off at least another 500,000 barrels a day by the end of 2016 if not more as a result of significantly reduced activity levels, constrained capex and natural declines. Other non-OPEC, non-Russian production should come off a similar amount as capex declines across the world.

 

As it regards Russia and OPEC, assuming each of these are producing at or near capacity as part of the market share defense and Iran is able to add its 500,000 barrels in short order (a stretch), and that demand growth forecasts of 1.0 to 1.5 million barrels hold true, then at some point during the year, the over-supply situation should correct (i.e. the demand growth eats up the surplus and the declines in non OPEC offset the additional Iranian barrels). Given the unique ability of the market to over-compensate, there is also a strong possibility for the supply glut to rapidly become a crunch, the dangers of which have already been pointed out by none other than OPEC.

 

Putting supply/demand to the side though, the theme of the year in the oil market is going to be the impact of global instability, which has been largely absent for a while. And nowhere is this more in focus than the ongoing battle for pre-eminence in the Middle East between Shia dominated Iran and Sunni Saudi Arabia.

 

While not a shooting war, the conflict is fundamental and real and should be concerning to any global observer. From proxy wars in Syria and Yemen to open oil-based economic conflict and political/religious gamesmanship, the outcome of this Sunni/Shia conflagration will have lasting consequences globally. While not impacting oil production currently, the longer low prices eat into these countries’ budgets, the more tenuous their governments are and the more unrest there is, the more they will be inclined to create more conflict to detract attention. This needs to be watched.

 

All of this affects price. The current price is about $34 for WTI. My no-conflict year end price is $60. Average price for the year probably in the $45 range which implies a rally in the second half of the year.

 

Natural Gas

The natural gas market is different than the oil market in that it is continental in nature rather than global, however the same oversupply situation exists for gas as it does for oil. With record amounts of gas in storage and weak winter weather, markets are beset by a perfect storm. That said, the same reductions in capex that are occurring in the tight oil world are also occurring in the gas market and the decline in rig count is already having a major impact in some of the shale gas plays with overall US natural gas production declining on a month over month basis, even in the prolific Marcellus region.

 

Newly opened LNG facilities in the US should help take away some of the surplus gas as will increased US exports into Mexico, but at the end of the day, natural gas is a seasonal market in North America and right now it’s wobbly. Any rally in natural gas is several quarters away.

 

Price wise, natural gas is trading at $2.35 per MCF, year-end expectation is $3.50, average price for the year is $2.75.

 

Canadian Dollar

The Canadian dollar is trading near its lows for the 2000’s and in many ways deservedly so. The dollar follows the price of oil and is also facing the headwinds of an extremely strong US dollar and a relatively weak Canadian economy. Depending on where the Fed goes with rates through Q1, the Canadian dollar will be volatile. If the oil market recovers on a price basis as anticipated above and the US/Canada rate differential tightens a bit, it is fair to expect a rebound in the Canadian dollar, probably to the $0.75 range and over the long term to an $0.80 to $0.85 range. In the short term, if you are planning a US spring break, this is the level you likely have to live with for a while.

 

Merger and Acquisition Activity

While 2015 was slower for M&A activity in the oil patch than was anticipated (a 73% decline from 2014 according to one market research firm), the gloves are off for 2016, which is expected to be very active both in the service sector and the E&P space as companies grapple with the impact of low prices. This includes both distressed M&A as over-levered companies will be doing deals with better capitalized competitors and corporate consolidation transactions. There is a significant amount of dry-powder on the sidelines including some of the majors and new, private-equity backed consolidators.

 

While E&P transactions get all the glory, we are seeing increased activity in the service sector and expect that to pick up over the year as well.

 

Western Canada Activity Levels

Far smarter people than I have already published their forecasts for the year and it is hard to argue with any of them, so rather than specific numbers of rigs working and utilization numbers, let’s look at it from a thematic perspective. 2016 is going to be a train wreck and there is no sugar-coating that, but at least we have had ample warning that it is coming.

 

Last year still had legacy spending from the previous fiscal year so activity levels were artificially elevated prior to breakup in April of 2015. 2016 could easily be half of what 2015 was and that is saying something. On the bright side (such as it is), if you survive breakup in 2016 and make it through to the next fiscal planning period, it is highly likely that you will have higher utilization going forward as a) the price rally should finally have started, expanding budgets and b) the prior period should have resulted in many competitors falling by the wayside.

 

US Presidential Election

From where we currently sit, it is hard to predict anything but a Clinton presidency in November 2016. While a lot can change in the next 11 months, the Republican field appears hopelessly divided and the continued presence of Donald Drumpf and his appeal to a rabid partisan base can only further alienate the 5%-10% centrist/independent voters who are the ones who actually decide the election in the US.

 

If pressed, my call is that the Clinton ticket will defeat a Marco Rubio led GOP ticket and it may not even be close. The vice-presidential angle is harder to peg, but I will go out on a limb and say O’Malley for the Dems and Kasich for the GOP.

 

Republicans wanting to retake the White House are going to have to wait for the Drumpf led self-immolation to subside and elect President Paul Ryan in 2020.

 

Infrastructure Projects

You heard it here first. In 2016, three major infrastructure projects will get the nod in Canada. The TransMountain and Energy East pipeline projects and one major LNG project in BC (no, no call on which one. OK – Shell!).

 

Super Bowl

The fix is in and it will be Denver over Seattle in Super Bowl 50. Call it Peyton’s revenge if you like, but that is the pick and I feel horrible about picking Seattle as an Arizona Cardinals season ticket holder, but of the current hot teams in the NFL, Seattle is by far the scariest and they are getting healthy at the right time. On the AFC side it is hard to see who among the playoff teams can match the Denver defense in Denver and with Peyton only having to perform as a game manager the odds are in their favour. On the odd chance the Vikings pull it out this weekend against the Seahawks, my replacement pick is Arizona.

 

Stock Picks

Just for fun, here are three E&P and three service companies that I am following, wish I owned, or may own, for various reasons. Mainly following on the above being a gradual turnaround in energy markets, infrastructure and Western Canadian survival. Note that this does not constitute investment advice, and if you saw my portfolio you would know why. I will set up two equal weight tracking portfolios and compare the results of this basket against their respective sectors on at least a quarterly basis throughout the year.

• Suncor. The Canada oil play. Integrated. Financial flexibility. Regardless of whether they accomplish their takeover of COS, still a good play.
• Peyto Exploration. Low cost gas producer. Well run. Operates under the radar in some of the more prolific areas in Western Canada. Stands to gain significantly from LNG.
• EOG Resources. The smartest guys in the room for tight oil (Enron pun absolutely intended). Low cost, manageable leverage, best in class assets.
• Mullen Group. Always a smart play for the Alberta and Western Canadian oilpatch. A management team and corporate legacy that has been through pretty much every cycle since the discovery of oil in Turner Valley and they get it.
• Halliburton. Global diversification with significant assets overseas where most of the current spend is being done.
• TransCanada. The infrastructure play. If you believe that Energy East is going to be built, you need to own TransCanada. If you believe LNG is going to happen, TransCanada will be building the natural gas pipeline.

 

Prices as at January 8, 2016 (December 31, 2015)

• The price of oil ended the week down, after a modest amount of volatility.
  • Storage posted a large surprise decrease, but finished product inventories remain high
  • Production was up marginally
  • Markets are selling the storage story and China fears
  • The rig count decreased
  • OPEC
• Natural gas gained ground during the week, as cool weather in the Northeast led to increased demand.

• WTI Crude: $33.05 ($37.04)
• Nymex Gas: $2.493 ($2.337)
• US/Canadian Dollar: $0.7074 ($ 0.7233) (Thank you US Fed!)

 

Highlights

• As at January 1, 2016, US crude oil supplies were at 482.3 million barrels, a decrease of 5.1 million barrels from the previous week and 99.9 million barrels ahead of last year. Continued high levels of imports are contributing to stubbornly high inventories.
• The number of days oil supply in storage was 29.1, ahead of last year’s 23.4.
• Production was up to 9.219 million barrels per day. Production last year at the same time was 9,129 million barrels per day. Based on the numbers and a result of stubborn production levels, it is likely that negative year over year production growth in the U.S. will be delayed to later in Q1. The marginal increase in production this week came from lower 48.
• As at January 1, 2016, US natural gas in storage was 3,643 billion cubic feet (Bcf), which is 17% above the 5-year average and about 15% higher than last year’s level, following an implied net withdrawal of 117 Bcf during the report week.
• Overall U.S. natural gas consumption increased by 17.0% for the period led by residential consumption which rose 33% on cold weather
• Oil rig count at January 8 was down to 516 from 536 the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States were down to 148 from 162.
  • Rig count at January 1, 2015 was 328
• As of January 4, the Canadian rig count was at 142 (19% utilization), 86 Alberta (16%), 30 BC (38%), 25 Saskatchewan (21%), 1 Manitoba (6%)). Utilization for the same week last year was about 44%.
• US split of Oil vs Gas rigs is 78%/22%, in Canada the split is 43%/57%

 

Drillbits

• TransCanada filed a lawsuit against the US Federal government in Texas alleging that President Barack Obama exceeded his constituitional authority when he denied the permit for the Keystone XL project. The Company is also planning to file a challenge under the North American Free Trade Agreement (NAFTA) seeking damages of up to $15 billion from the US Givernment alleging that the denial of the project was arbitrary and unjustified and thus contravened this agreement.
• Saudi Arabia announced its intention to conduct a partial IPO of business units of or the main holding company for Saudi Aramco, the world’s largest integrated oil and gas company. The reasons behind this would seem to be a combination of wanting to plug a budgetary gap due to low oil prices, an accelerated modernization of the economy and a desire to increase the market cap of the local stock exchange. Given low oil prices, the timing appears to be somewhat confusing, if not downright baffling given that the same contribtuion to the kingdom’s coffers could likely be accomplished by cutting back production by 5%.
• Drumpf Watch – So it appears that the Donald has decided two things.
  • First, Ted Cruz is a threat and he’s Canadian – while it’s hard to do a birther thing to someone for whom it is public domain he was born elsewhere, the reaction is consistent with the Drumpf credo of if something seems to be in the way, best to try and blow it up.
  • Second, Drumpf has set his sights on the Clinton’s, more specifically Bill Clinton and his various “indiscretions” and purported mistreatment of women. While the whole glass house analogy is important here, I think it is important for Drumpf to consider this – Bill and Hillary Clinton have been in the public eye since he was governor in Arkansas in the 1980’s and spent eight years as the first couple of the United States. Through that time they have survived a concerted assault from the media and the Republican party, scandals, tragedy, wars, you name it. I am no ardent supporter of the Clinton dynasty, but they are supposed to be intimidated by a knuckle breathing loud mouth with bad hair? I don’t see it, best to actually win your own nomination Mr. Drumpf before you start taking on the opposition.