Looking back on the energy markets: 2014 in review
For the energy markets, 2014 felt eerily like a repeat of 2008. Crude oil prices peaked in June 2008 at $145 per barrel, spurring predictions of $200 oil and concerns of supply shortages (remember the peak oil theory?). By the time the Beijing Olympics opened in late summer, prices took a sharp turn and began to free-fall, hitting a low $35 in just 8 months, an unprecedented decline of 75% that no one saw coming.
Perhaps more surprisingly was how fast prices rebounded. Economies around the world forced interest rates to near zero, sending all markets soaring. By the summer of 2009, crude oil was back above $70 and well on its way back to surpass the $100 threshold in no time.
Fast forward to 2014. Although it looks and feels the same, the underlying issues are much different. Russia's invasion of the Ukraine and on-going problems in the Middle-East kept price above $100 for much of the first half of the year. But the Chinese economy, the main engine of growth for past decade, failed to rebound despite all efforts by its government. By the summer, energy agencies around the world began to warn of slowing demand from emerging markets. But US oil production continued to grow steadily through the year, at a record pace. A strengthening US dollar causing all commodities, including crude oil, to declined proportionately in the second half of the year. By December, OPEC put the nail in the coffin, confirming that crude oil markets were seriously oversupplied. Most importantly, Saudi Arabia refused to cut production and instead pointed the finger at the United States. Crude oil closed out the year a full 50% lower than the highs of June.
So where do we go from here? Well, in order to know where we're going, we must understand where we came from. Here's a look back to what happened in 2014.
COMMODITIES - CRUDE OIL PRICES
Crude oil prices peaked in July and started a downward slide for the remainder of the year. By the end of 2014:
- West Texas Intermediate (WTI) declined 46%, or 50% from the peak of late-June,
- North Sea Brent Crude declined 48%, or 50% from the peak of late-June,
- Western Canadian Select (WCS) declined 36% in US dollar terms, or 56% from the peak of late June. If measured in Canadian dollar terms, WCS fell 30% in 2014; 53% from the highs of late June.
West Texas Intermediate ended the year just under $54/barrel, the lowest since the spring of 2009. North Sea Brent, which is still trading about $5/barrel more than WTI, closed below the critical support level of $60 and ended the year at $57/barrel. Crude oil prices have declined for 6 straight months and have failed to find a bottom so far.
The heavy oil discount (defined as the difference between WTI and WCS) was relatively stable in 2014, ranging between $15 and $22/barrel for much of the year. Differentials were much better than 2013 where WCS sold for up to $39/barrel cheaper than WTI and the discounts varied greatly through the year.
So why the narrower differentials in 2014? Probably because more and more crude is being transported by rail, addressing the serious pipeline constraints for the Canadian crude oil market. Although this is good news for Canadian heavy oil producers, a discount of $16 per barrel on a US benchmark price of $55 per barrel represents a 30% rebate for US refineries. At lower crude prices, margins for profit are much tighter for Canadian oil producers. Any further narrowing of this discount would be very welcomed in 2015, but highly unlikely in the current environment.
US DOMESTIC CRUDE OIL PRODUCTION
At the start of 2014, the US produced 8.0 million barrels per day of crude oil. By the end of 2014, production ballooned to 9.1 million barrels per day, an increase of 13% or 1.1 million barrels per day of extra output. 2014 saw one of the largest growth rates for oil production in US history.
CANADIAN OIL EXPORTS TO THE UNITED STATES
The United States increased its import of Canadian crude oil by about 8% this year. This number has been steadily climbing in the past decade. In 2011, the US imported 2 million barrels/day of Canadian crude oil. By the end of 2014, this number is expected to average close to 3 million barrels per day, representing an increase of 50% in only 4 years. Despite falling oil prices, this number is expected to keep growing through 2015.
CANADIAN AND US ENERGY SECTOR PERFORMANCE
US and Canadian energy stocks faired much better than the underlying crude oil price. US stocks in particular, have held up quite well.
- Canadian energy stocks declined an average of 18% since the start of 2014 and 34% from the highs of the summer.
- US energy stocks declined 11% since the start of 2014 and 22% from the highs of the summer.
- Canadian oil sands specific stocks were down 25% since the start of 2014 and down 39% from the highs of the summer.
CANADIAN OIL SANDS STOCKS
Not all Canadian energy stocks suffered badly in 2014. The best performing oil sands majors on the TSX included:
- Suncor Energy (SU): Up 1% from the start of 2014 but down 21% from the highs of the summer.
- Imperial Oil (IMO): Up 8% from the start of 2014 but down 13% from the highs of the summer.
- Canadian Natural Resources (CNQ): Up 2% from the start of 2014 but down 26% from the highs of the summer.
All three companies benefit from having more a diversified production portfolio (oil sands, conventional and off-shore). Imperial's exceptional performance was likely due to 70% of its stock being held by Exxon Mobil.
By comparison, some medium-sized oil sands players didn't fare as well in 2014:
- Husky Energy (HSE): Down 15% from the start of 2014 and down 24% from the highs of the summer.
- Cenovus Energy (CVE): Down 18% from the start of 2014 and down 29% from the highs of the summer.
- Canadian Oil Sands (COS): Down 44% from the start of 2014 and down 56% from the highs of the summer.
Canadian Oil Sands is the least diversified player, having only the Syncrude mine in its portfolio. The company is one of the highest cost producer in the oil patch and was hit hard by the dividend cut late in the year.
US ENERGY MAJORS
Canadian energy stocks outperformed their US counterparts for the first half of 2014. However, US energy stocks corrected less after the crude oil decline and have performed exceptionally in the second half of the year.
- Exxon Mobil (XOM): Down 6% for the year and 10% from the highs of the summer.
- Chevron (CVX): Down 7% for the year and 15% from the highs of the summer.
- ConocoPhillips (COP): Up 2% since the start of 2014 but down 20% from the highs of the summer.
Looking back at previous crude oil market collapses in the 80s, 90s and 2008, integrated energy majors perform surprisingly well. Large integrated companies make money on the crack spread (the difference between the oil price and the price of refined products) and are therefore the least affected by falling crude oil prices. They also have sufficient cash flow to ride out low prices and maintain business as usual, including dividend pay-outs.
PIPELINE AND INFRASTRUCTURE PLAYS
So who were the big winners in 2014? Not surprisingly, energy infrastructure, pipelines and rail companies. Growing North American oil and gas production increases the need for storage and transportation. Some of the best performers on the TSX:
- TransCanada (TRP): Gained 22% for the year but down 5% from the highs of the summer.
- Enbridge (ENG): Gained 32% from the start of the year and down only 1% from the summer highs.
- Pembina Pipelines (PPL): Gained 17% for the year but down 19% from the summer highs.
Currencies were also also big movers in 2014.
- Canadian Dollar: Down 8% for the year and also down 8% form the summer highs.
- US Dollar Index: Gained 13% since the start of the year and 15% from the lows of late spring.
So why should traders care about the US dollar? Because all commodities are denominated in US dollars; as the dollar strengthens, the price of the commodity falls. The CRB Commodities Index, which is a basket of hard and soft commodities, including oil, fell 18% in 2014 and 27% since the highs of summer. It would be safe to assume about half of the crude oil slide can be attributed to the strengthening dollar, while the other half is probably due to oversupply.