By The Energy Information Administration –
Higher OPEC oil output during the second quarter has so far failed to dampen upward price pressure as West Texas Intermediate (WTI) prices reached the mid $40’s per barrel level in early August. With rising consumption and little global surplus production capacity, near-term prices remain volatile and sensitive to news relating to possible reductions in oil production. Some reduction in prices is likely if increased production continues to flow and inventories build. However, short of a serious slow down in demand during the coming months, the floor for prices probably remains above $30 for the foreseeable future. The current world oil prices may not entirely reflect pure economic fundamentals of the world oil supply market because the Iraqi war and the Russian government’s actions on its major oil company have increased world-wide perceptions that the supply of oil during the short-term is more vulnerable to disruption than normal and may have added a premium to what otherwise might be a lower world crude oil price.
U.S. gasoline prices, while down from their May highs of more than $2 per gallon, have been stuck in the high $1.80’s to low $1.90’s per gallon for 6 or 7 weeks. Higher crude oil prices could create some late-summer gasoline price increases but gasoline inventories are now at the top of the normal range and spot prices have shown some weakness despite elevated crude oil costs. Average pump prices for regular gasoline are expected to drift toward the lower $1.80’s per gallon by fall.
Natural gas prices retreated in early August as storage levels remained on a normal track and summer demand levels appeared manageable. However, with the economy continuing to expand and supply growth sluggish at best, prices at the Henry Hub (which averaged about 5.83 per mcf during the first week of August) are expected to rise above $6 per thousand cubic feet (mcf) by fall.
Looking ahead to the next heating season, emerging fuel cost profiles for the fall and winter suggest that increases in average consumer heating fuel prices from the 2003-2004 heating season are likely. Under baseline weather conditions, demand for fuel is likely to increase in the Midwest and drop in the Northeast (particularly in the first quarter). Weather patterns will drive the eventual outcome, but higher overall heating expenditures are likely this winter unless above-normal temperatures prevail.
U.S. Summer Gasoline Update
Pump prices for gasoline have varied since the third week of June between the upper $1.80’s and low $1.90’s per gallon and on August 9, 2004, stood at $1.88 per gallon, about 18 cents per gallon below the historical weekly high of $2.06 per gallon (regular) on May 24 of this year. Some seasonal reductions in pump prices are expected after Labor Day, but currently high crude oil costs as well as projected costs in the upper $30’s per barrel through 2005 suggest significant reductions in average gasoline prices are unlikely anytime soon. On the other hand, spot prices for gasoline have weakened recently as gasoline inventories have shifted to the top of the normal range from the low end of the range one month ago. This development may accelerate price declines in the near term, but U.S. average pump prices for regular gasoline are not likely to fall below the low $1.80’s this year unless world oil markets ease substantially.
For the summer (second and third quarters), regular gasoline prices are now expected to average $1.92 per gallon, 36 cents per gallon above the 2003 average. For all of 2004, regular gasoline prices are expected to average $1.83 per gallon, about 27 cents per gallon above the 2003 average. In 2005, assuming that crude oil prices (WTI) average nearly $38 per barrel, motor gasoline prices are projected to average about $1.87 per gallon, mainly because the first quarter 2005 average is likely to far surpass the $1.65 per gallon seen in first quarter 2004.
Oil Market Developments
U.S. spot prices for crude oil (West Texas Intermediate) have climbed above the $40 per barrel level in early August, despite increases in output by key OPEC producers such as Saudi Arabia. The projected average WTI price for the third quarter 2004 is now almost $41 per barrel, about $4 per barrel higher than in the previous Outlook.
Total OPEC crude oil production in July was 29.8 million barrels per day, 0.5 million barrels per day higher than June levels (revised upwards from the last Outlook), and only about 0.5 million barrels per day below total OPEC crude oil production capacity. Currently, world oil surplus production capacity is near its lowest point of the past 3 decades, providing little cushion in the event of unexpected oil market disruptions. Price spikes are still quite possible given the uncertainties surrounding terrorism, Iraq, Nigeria, the political situation in Venezuela, and the Russian government’s relationship with its largest oil producer, Yukos. Yukos production accounts for about 1.7 million barrels per day of Russian production.
Although the current high levels of OPEC production are expected to push WTI prices below $40 per barrel on average by the fourth quarter 2004, a sustained sharp decline in crude oil prices is unlikely during 2005 because world oil demand is expected to continue its strong growth, keeping petroleum inventories tight. The overall level of petroleum inventories both in the United States and in the rest of the industrialized world remains relatively low, particularly when looked at in the context of rapidly increasing global oil demand. In fact, growth in global oil demand is expected to exceed 2 million barrels per day (about 2.6 percent) during 2004 and 2005.
U.S. petroleum demand will likely average 20.43 million barrels per day this year, a 1.9 percent increase from the 2003 average. Similar growth (2.1 percent) is expected for 2005. This upward trend is led mostly by transportation fuels, including healthy increases of 4.3 percent in 2004 and 3.4 percent in 2005 in jet fuel demand. As expected, gasoline demand growth continues to slow compared with the robust growth rates seen during the first half of the year. Year-over-year growth in the second half of 2004 is expected to average about 1.3 percent (the first half saw an average rate of about 2.3 percent). As consumers adjust to higher prices (averaging in the $1.80’s per gallon in 2004 and 2005), more or less normal rates of growth (about 2 percent or so) should reappear and keep pressure on the U.S. gasoline market for at least another year.
U.S. petroleum demand is expected to grow about 800,000 barrels per day (4 percent) from 2003-2005. This increase continues to be met through higher net imports. Net imports this year are expected to average 11.67 million barrels per day, 57 percent of total domestic oil demand. About three-fourths of the 400,000 barrels per day of demand growth anticipated for 2005 is expected to come from imports of either crude oil or products. U.S. refinery capacity utilization is expected to increase next year, possibly to the highest average rate seen since 1998 (95 percent).
Natural Gas Outlook
Natural gas spot prices (at the Henry Hub) moved below $6 per thousand cubic feet (mcf) in early August as storage levels continued to track well within the normal range and summer demand remained at manageable levels. Prices are likely to average well above $6 per mcf for the fall and winter. Annual net new supply of natural gas (production plus net imports) fell by about 1 trillion cubic feet (4.5 percent) between 2001 and 2003, with drops in both domestic production and net imports contributing to the downturn (annual exports to Mexico grew by about 300 billion cubic feet over that period). Despite high rates of drilling for natural gas in North America, only marginal improvement in the supply picture is likely through 2005 (less than 1 percent from domestic production and modest increases in liquefied natural gas imports). Therefore, natural gas spot prices are expected to remain high. Henry Hub prices averaged $5.80 per thousand cubic feet in 2003 and are expected to average $6.21 in 2004 and $6.60 in 2005. These projected prices are somewhat higher than those reported in the previous Outlook due largely to upward revisions for the crude oil price projection and the macroeconomic growth forecast for 2005.
In 2004, natural gas demand is expected to increase by about 0.4 percent, a weaker annual growth rate than projected in last month’s report. Next year demand growth is expected to average only 0.7 percent. Recent data indicate that coal use for power generation was stronger than previously estimated during the spring and therefore has likely been higher this summer than suggested in our earlier projections, reducing somewhat the need for natural gas for power generation. Meanwhile, new data show that natural gas for residential and commercial demand was overestimated in our previous Outlook and thus the current projections have been adjusted downward.
In addition to higher prices, the reduction in available natural gas supplies over the last few years has led to a reduction in the overall intensity of natural gas use in the industrial sector. An index of industrial output by traditionally gas-intensive industries declined by about 3.6 percent between 1999 and 2003. Total natural gas use in the industrial sector declined by 13.3 percent over the same period. Thus, overall gas intensity fell by about 10 percent over the period. A variety of industry adjustments caused this reduction, including fuel switching, conservation and cutbacks in operations in some industries more sensitive to gas costs than others. It is expected that similar adjustments will continue in the future and that industrial natural gas intensity will continue to decline. Industrial gas demand is expected to grow by about 0.5 percent this year and 0.1 percent in 2005.
Natural gas in underground storage (working basis) totaled an estimated 2,391 billion cubic feet at the end of July, about 4 percent above the 5-year average and approximately 12 percent above year-ago levels. Storage is expected to approach 3,200 billion cubic feet by the end of October, a level that would be considered in the upper end of the normal range.
Electricity and Coal Outlook
Electricity demand in 2004 is expected to increase by 1.8 percent this year and by another 2.1 percent next year. With continued growth in the economy in the 3- to 4-percent range, electricity demand will likely grow about 2 percent annually. Electricity demand in third quarter 2004 is likely to be essentially flat compared with third quarter 2003 because cooling demand is projected to be down for the quarter. This contrasts with solid growth in the second quarter when cooling degree-days were up sharply and spring electricity demand was surprisingly strong.
Coal demand in the electric power sector is expected to show steady gains this year and next (1.4 percent and 1.5 percent, respectively). High spot prices for coal reflect the impact of growing demand but have not discouraged increases in overall power sector use. U.S. coal productionis expected to grow by 2.3 percent in 2004.
Hydroelectric power output is now expected to post a small decline in 2004 as recent data indicate a particularly low second quarter. It is assumed that hydroelectric output reaches normal levels by early 2005. Some of the pressure on fossil fuel demand in the power sector that otherwise might have appeared next year would be avoided if hydroelectric availability does improve. This would offset the expected flattening out of nuclear power output next year while demand for power continues to grow.
Source: The Energy Information Administration
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