Energy Directions, Inc.

Oil & Natural Gas Prices How Did We Get Here and Where Are We Headed? Michael D. Smolinski April 23, 2015

Figure 1 Oil & Gas Price Comparison (Src: Oil Price-Platt’s Oilgram and WSJ; Gas Price-WSJ) $/bbl

$/mmBtu

Energy Directions analyzes the economy, energy markets and predicts the direction of energy prices and the stock market. Our lives are inundated by what people are saying. We find examining what people are doing, evident in all the data available, and contrasting it with what they are saying adds much value. First and foremost, we provide pictures of what people are doing. Second, we provide our thoughts as to what is taking place and why. Third, we provide our predictions. We view $75 per barrel for WTI and $3.50 for Henry Hub natural gas as what these prices average during 2015.

April 23, 2015

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Figure 2 Average U.S. Refinery Acquisition Price Of Foreign Crude (Src: U.S. Department of Energy data) Dollars per barrel

We have lived through a number of oil-price sell offs. Many view this time as a UShaped drop that has yet to bottom. We see a V that is now rising nicely. This crude-oil price is updated only to October. We believe it bottomed at $44.93 in January and predict back up to $80 by August. We saw a seasonal drop in demand, said Sell-Oil in August and oil-stocks in September. We upgraded to Buy in October, too early. We went to Overweight Strong Buy December 18. Too early for most but perfect for some.

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Figure 3 Monthly World Crude Oil Production (Src: U.S. Department of Energy data) Million barrels per day

Billion barrels per year

We see oil prices determined by supply and demand. The first OPEC price shock changed $4.08 per barrel in 1973 to $13 in 74 and gave us the 1974 Crash. The second OPEC price shock took $14.50 in 77 to $39 in 81 and gave us the early 1980s recession. Crude oil supply unable to move above 75 mmbd in 2004 gave us $140+ and Crash 2008. We find demand tends to be the big source of surprise so understanding it is Energy Direction’s major focus. Demand data is poor, old and much must be discerned. We gauge infrastructure and the weather as we watch the economy flow.

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Figure 4 S&P 500 Stock Index (Src: Standard & Poor) Index

The two OPEC price shocks kept the S&P 500 from rising above 140 until 1983. Lift off was helped by oil supply rising nicely and the cost of WTI crude dropping from $30 per barrel in 1985 to $11 in 1986 and averaging $19 from 1986 through 1999. Too little oil kept it from rising above 1,600 until 2013. We credit “DrillBaby-Drill” success for 2,100 and more UP to go. Most believe the problem is The Have’s and the Have Nots which we conclude is wrong. We find it is the Do’s and The Do-Nots. Far too many Not Doing is the problem. Technology, helping the herd of those Doing Do-more/grow-more is driving UP.

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Figure 5 Canada and U.S. Monthly Crude Oil Production (Src: U.S. Department of Energy data) Million barrels per day

Many believe that interest rates extra low have driven stock prices to record highs. We credit most the oil industry; incredible technology in the hands of gifted, talented, hardworking people achieving much that is fueling UP. The right people, technology and the Free-Market system are working best in Canada and the U.S., using prices to signal what is needed and where.

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Figure 6 Monthly World Crude Oil Production and the world less Canada and the United States (Src: U.S. Department of Energy data) Million barrels per day

World crude-oil production rising again is fueling all those gainfully Participating at a lower cost and increasing the number who live prosperity-producing, “transportation-and-hotwater” life styles.

However, more wouldn’t be prospering more were it not for how things work/Freedom Ringing in the U.S. and Canada.

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Figure 7 Monthly Alaska and Venezuelan Crude Oil Production (Src: U.S. Department of Energy data) Million barrels per day

Production in all the places where rulers ruling dictate have too little cash feeding the oil-producing bees needed to offset depletion, grow production and fuel more. Keeping UP going needs much cash, especially given how much is diverted to keep rulers ruling. We view $80 as what is needed to keep fueling UP.

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Figure 8 U.S. Oil Refinery Runs – Four-weeks and Fifty-two-weeks moving averages (Src: Calculated from Department of Energy data) Million barrels per day

Most oil focus on crude oil is another example of how poorly understood the economy and energy markets are. Oil products are what produces prosperity and more oil refining capacity is needed. We conclude that oil producers here will fare much better encouraging oilrefining expansion here, rather than relying on exporting crude oil Over There. We rate crude-oil, oilfocused E&P, Drilling and Oil Service and Oil Refining overweight Strong Buy.

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Figure 9 U.S. Oil Refinery Runs – Four-weeks moving average and current weeks (Src: Calculated from Department of Energy data) Million barrels per day

We find that the peak in world oil demand has switched from the northern hemisphere’s winter peak to it’s summer peak. Crude oil processing peaked in July. Falling for Fall maintenance had us downgrade crude oil to Sell in August and Sell oil stocks in September. Seeing runs here bottom in October had us upgrade back to Buy then. Oil prices continuing to fall indicates that runs continued to decline Over There. Unplanned outages changing year-over-year (YOY) increase to no gain also reduced crude-oil demand and increased downward crude –oil price pressure .

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Figure 10 U.S. Commercial Crude Oil Inventory (Src: Department of Energy) Million barrels

U.S. crude oil inventory rising sharply has been the big bearish news item each week pressuring oil prices and stock prices lower. The drop in refinery runs is one reason for the inventory increase. The other is oil producers insisting they not cut production, when asked to by Saudi Arabia at the Organization’s Thanksgiving-Day meeting. This inventory has changed from 6.5 mmb less than the year before the Thanksgiving week to 56.6 more now. A 0.809 mmbd production cut would have U.S. inventory the same as last year now. Refinery runs need to recover to catch UP.

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Figure 11 Monthly Saudi Arabia Crude Oil Production vs OPEC Crude Oil Production (Src: U.S. Department of Energy data) Million barrels per day

The 2009, V-shaped oil-price recovery was helped by Million barrels per day OPEC cutting production 2.9 mmbd, from 33.1 in July of 2008 to 30.5 in January 2009. Saudi Arabia accounted for 1.6 of the 2.8. Production was reduced to winter 2010/11 and 2012/13 troughs. However, OPEC production has increased heading to the winter2014/15 world crude-oil demand trough. With no producers willing to cut production, Saudi Arabia hasn’t cut either. Instead, what isn’t needed has gone into U.S. inventory (the place with the most capacity) and is in ships moving slower or not at all. However, prices rising are signaling the seasonal switch, from less needed to more.

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Figure 12 Monthly Iran, Iraq and Saudi Arabia Crude Oil Production (Src: U.S. Department of Energy data) Million barrels per day

While many believe that Saudi Arabia views U.S. oilshale producers as the problem and has driven oil prices down to knock them out, we believe they learned back in the early 1980s not to reduce supply on their own. Saudi Arabia cut production from above 10.0 mmbd in 1982 to below 2.5 in 1985, to keep crude oil prices above $30. Looking ahead to crude demand dropping with the end of the 1985/86 winter, it asked for assistance. None granted had it change to pursuing market share. Oil prices collapsed and averaged $19 per barrel through 1999 as supply recovered and fueled many more much more UP.

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Figure 13 Regular unleaded gasoline price Gulf Coast, cargo, spot (Src: Platt’s Oilgram data) Cents per gallon

$’s per barrel

World oil demand now peaking with the northern hemisphere summer driving season had gasoline prices lead the price decline with the Gulf Coast market (where most gasoline is produced) leading down first and foremost. This time $1.176 per gallon the Monday of Christmas week was the low. 78.1 cents per gallon was the Crash 2008 low, the day before Christmas. Vacation shutdowns for Christmas and New Year minimizes the ability to move gasoline out of the Gulf Coast—maximizing downward pressure then. Bottoming higher now despite no production cuts indicates a firmer market.

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Figure 14 Average regular unleaded spot market gasoline price comparison (Src: Calculated from Platt’s Oilgram data) Cents per gallon

$’s per barrel

Shipping out of the Gulf hindered kept the East Coast price notably higher until mid January. Gulf supply moving elsewhere is evident in the Gulf Coast price now above $1.60 per gallon. Disruptions limiting shipping out of the refining system had the West Coast summer high the highest, above $3.20 per gallon. Disruptions keeping gasoline in the West Coast system had its pricedrop-low the lowest, in mid January.

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Figure 15 U.S. Distillate Oil Inventory (Src: Department of Energy) Million barrels

We credit supply of distillate oil kept in the oil refining system, helped by workers on vacation, for distillate oil inventory surging from Thanksgiving into the New Year. Most, interpreting prices collapsing and inventory rising so much as indicating demand/the -economy weakening , reduced expectations further. They see a U-shaped price recovery that has yet to bottom. Our crediting the rise to disruptions as well as mildweather dominating since Thanksgiving, see the notable inventory drop underway continuing, against last year’s drop done.

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Figure 16 U.S. Distillate Oil Demand – Four-week Moving Average and the recent weeks (Src: Department of Energy (DOE) data and calculated from DOE data) Million barrels per day

Shipments out of the oil refining system (which is what demand is) disrupted is most evident in the wide, week-to-week swings of distillate oil demand (bold dot). New-Year’s week was extra low. That and cold-airincursion #2 set up a big rebound that has the four weeks average now (bold line) up nicely indicating lower-cost stimulating. These distillate oil demand data also highlights fuel switching, from heating oil having demand peak in December 7 years ago, to troughing in January last year and the year before.

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Figure 17 Average Gulf Coast Spot Cargo Distillate Oil Price (Src: Calculated from Platt’s Oilgram data) $’s per gallon

$’s per barrel

Thanksgiving to mid January dominated by mild had this Gulf-Coast spot distillate price trough January 15 at $1.443 per gallon. Cold-air incursion #3 continuing tugged it up to $1.878 March 3. $1.520 is this drop’s end-ofwinter low. $1.087 was the 2008 Crash’s end-of-winter low March 5, 2009. This market is much firmer than the 2008/09 market.

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Figure 18 Number of seasonally-adjusted people employed in America, total nonfarm from the Establishment (CES) Survey (Src: U.S. Department of Labor, Labor Stats) Million

Recessions are about people loosing jobs. However, all those going/doing/being without increase pent-up demand. Meeting it drives subsequent expansions UP. Watching the physical factors we follow is why we have been bullish on the overall stock market and economy. UP for the U.S. this time is extra slow. Recovering from the recession trough to the prior peak took 21 months for 1990, 18 for 2000 but 51 months this time at 171,000 a month. The 1981 recovery took 11 months at 258,000 a month. Now is finally in more-newjobs territory. A V-shaped oil-price recovery occurred in 2009 despite job losses continuing.

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Figure 19 U.S. Private New Housing Starts in Permit-Issuing Places, Seasonally Adjusted and at Annual Rates (Src: Dept of Commerce (DOC) and calculated from DOC data) Millions of Units

Real estate has had an extended decline this time. We credit it to the effort to have everyone participate in the prior UP. Millions losing jobs with Crash 2008, unable to pay mortgages, made this drop deeper and activity extra low. Nevertheless, a Vshaped oil-price recovery occurred in 2009. Housing starts still down at where prior expansions began underpins our assessment: much more UP to go here and Over There; where decline happening the past couple of years has increased pent-up demand there too.

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Figure 20 U.S. Employment-Population Ratio, 16-19 years of age, teenagers ; 12-months moving average of the actual data, from the Current Population (CPS) Survey (Src: U.S. Census Bureau for the Department of Labor) Percent of teenagers with a job

Extra-slow growth here this time, in the number participating in gainfulemployment-Doing, is evident in much. The percentage of teenagers with jobs peaked in 2000 and collapsed in 2007. Sports highlights the importance of learning-andexperience curves, for becoming gainful producers and participating in moving on and UP. Job growth tardy and slow=moving up learningand-experience-curves slow=upward-mobility for the masses slow. However, it also has an extra-large pool in place to learn what works, do it more—what doesn’t do it less and join in prospering.

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Winter 2013/14 cold tugged the Henry Hub spot price above $7 for 6 days. It tugged the Marcellus spot price up above $5 and its January/February average was $4.031. Summer mild deflated, November cold tugged up but most of winter mild deflated more. Figure 21A Daily Henry Hub Spot Market Natural Gas Price vs the Marcellus Spot Market Natural Gas Price (Src: Wall Street Journal) $/mmBtu

April 23, 2015

While the Marcellus spot price averaged $1.390 the first three months of 2015, the high price in the Northeast averaged $22.96 with a $125 high. Many dollars are signaling: “Add more transportation to already-there, behind-pipe demand.” Figure 21B Highest Appalachia/Northeast Spot Natural Gas Price (Src: Natural Gas Intelligence) $/mmBtu

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The Henry Hub spot price has averaged $2.871 the first three months of 2015. It reflects minimal need for natural gas from inventory here and the drawdown ending early, the refill starting early. Figure 22A Producing Region Weekly Natural Gas Inventory (Src: U.S. Energy Information Administration) Billion cubic feet

April 23, 2015

Little gas has been needed from inventory out West. It is a sharp contrast to last winter’s extra-large draw. Most producers living in these two regions has helped keep prices and price expectations low. Figure 22B Consuming Region West Weekly Natural Gas Inventory (Src: U.S. Energy Information Administration) Billion cubic feet

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However, the East has had a big inventory draw. 519 Bcf on April 10, 2015 is lower than every year since 2004 except last year. However, 519 being 209 more than 310 last year is helping most conclude that natural gas supply is more than enough. Figure 23A Consuming Region East Weekly Natural Gas Inventory as of the 10th of April (Src: Calculated from U.S. EIA data) Billion cubic feet

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Rapid gas production growth, inventory high and prices low have most concluding that gas demand is weak and will continue to be so, gas supply is strong and will continue to be so. We conclude The Climate mild is hiding strong demand growth. Figure 23B National Oceanic And Atmospheric Administration (NOAA) National Climate Data Center; National Temperature Maps

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The tug of demand was clearly evident in November; particularly in the parts of the country fed from Louisiana’s Henry Hub. The Henry Hub spot price was tugged up to $4.410 November 20 and the Marcellus price up to $3.50 November 11. Figure 24A National Oceanic And Atmospheric Administration (NOAA) National Climate Data Center; National Temperature Maps

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The Climate Changing in March, back to minimizing gas demand is evident in the Henry Hub price dropping to $2.610 March 30 and the Marcellus price dropping to $1.24 March 2nd. Figure 24B National Oceanic And Atmospheric Administration (NOAA) National Climate Data Center; National Temperature Maps

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November cold is confirmed by electric generation setting a new record high. December and January notably lower than prior years confirms The Climate mild, not the economy weakening. Figure 25A U.S. Monthly Electricity Generation (Src: Calculated from U.S. Department of Energy data) Billion kilowatt hours per day

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The notable reduction taking place in the use of the old, high-wear-and-tear coal-fired power plants we helped sell more than 40 years ago is a major part of our bullish natural gas outlook. Figure 25B U.S. Monthly Coal-Fired Electricity Generation (Src: Calculated from U.S. Department of Energy data) Billion kilowatt hours per day

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Markets signaling the need and providing the resources to transport more gas to existing power plants had natural gas generate a new record-high quantity of electricity in January, despite notably less electricity needed because The Climate was milder. Figure 26A U.S. Monthly Natural Gas Fired Electricity Generation (Src: Calculated from U.S. Department of Energy data) Billion kilowatt hours per day

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Coal has generated most of the electricity in your lifetime and continues to be the nation’s major source. 5.061 Bkwh/d was generated by coal in 2010. Replacing half that with natural gas at 7.5 Bcf per Bkwh requires 19 Bcf/d more gas at the burner tip. Figure 26B U.S. Monthly Electricity Generation 12-months moving averages at an annualized rate (Src: Calculated from U.S. Department of Energy data) Billion kilowatt hours per day

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Figure 27

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Summer 2014 mild and northeast gas production rising rapidly deflated Dominion South natural gas for May 2015 delivery from $3.50 to $2.50. More production and mild deflated to $1.50. More production and winter ending have it down at $1.44 Figure 28A

Mild in mid January and low expectations has also deflated Dominion South for January 2018 delivery. However, this price double the May 2015 price reflects prices signaling need to increase access to the demand that has been hindered. Figure 28B

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Figure 30 U.S. Annual Natural Gas Demand (Src: Calculated from U.S. Department of Energy data) Bcf per day

Tcf per year

Despite much said about no jobs here, natural-gas demand at the trough of Crash 2008 exceeded the trough of the early 1980s crash. That trough was followed by a natural-gasfueled industrial renaissance. Hundreds of million around the world need much more infrastructure to live goodtransportation/hot-water lifestyles. We predict natural gas will be exported in many products & services rather than the U.S. exporting ideas, jobs and just nat gas. Plenty of natural gas and much gas-fired electric generation in place has us looking for the much more gas that new technology can produce meeting our need for electricity; including replacing coal and nuclear.

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Outlook • We see gainful-bartering-activity growing, producing prosperity, upward-mobility-of-the-masses and increasing value (stock prices) at a consensus-beating pace. It is led by technological advances and the number participating in gainfully bartering increasing. • We are bullish on oil refining—much more is needed. • We see extenuating factors exaggerating the seasonal, oil-cost drop but setting up 2015 to be an outstanding energy-investing year with now an exceptional buy-oil-extra-low opportunity. • We predict that being invested in North America natural gas production is a big, bullish surprise in the coming weeks/months. • We watch to see if those willing to use terrorizing-aggression will be thwarted? Or will fairly-free-oil-flow-over-there be restricted?

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Michael Smolinski President, Energy Directions, Inc. President, National Association of Petroleum Investment Analysts (NAPIA) 212 West Emerson Street Melrose, MA 02176 781-979-9415 [email protected]

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