EIA expects Brent crude to fall next year, but outlook still constructive

2013.02.04 - EIA Brent EstimateEnlarge GraphA US government agency called the Energy Information Administration (EIA) believes that for 2014 compared to 2013, Brent crude oil prices will fall while WTI prices will rise slightly. If the EIA’s outlook is correct, this would generally be a negative for international oil companies’ profits (names such as ExxonMobil, Chevron, and ConocoPhillips) and a positive for domestic oil companies’ (names such as Chesapeake Energy) profits for 2014 compared to 2013. This is because Brent is more representative of oil prices received internationally while WTI is more representative of oil prices received domestically. However, the overall outlook still calls for relatively high oil prices, under which environment most companies can operate quite profitably.

On January 8, the EIA released its latest Short-Term Energy Outlook, a report detailing the agency’s analysis on energy prices and trends. In it, the EIA noted that it expects Brent crude to fall this year and next year. Brent crude averaged $111.65/barrel in 2012. The EIA believes that Brent will average $105.17/barrel in 2013 and $99.25/barrel in 2014.

In the report the agency noted that the expected drop in price is as a result of an increase in expected supply of oil. The incremental production is expected to come from non-OPEC countries such as the US, which has been experiencing a recent surge in oil production. This also implies that the agency expects the increase in supply to be greater than the necessary increase in demand for oil prices to increase or remain the same.

Lower Brent crude oil prices as the EIA anticipates would be a slight negative from a year-over-year basis for oil companies such as ExxonMobil (XOM), Chevron (CVX), and ConocoPhilips (COP) that have vast international oil production operations. However overall, these commodity prices still allow most producers to operate quite profitably.

It also should be noted that the EIA expects West Texas Intermediate (WTI) crude prices to average $89.54/barrel in 2013 and $91.00/barrel in 2014 (see chart below). This would be a positive for domestic players such as Chesapeake Energy (CHK) which receive prices on oil more closely linked to WTI than Brent.

Enlarge Graph

Despite the drop in Brent crude (the international benchmark in crude), the agency expects the US benchmark of WTI to rise in 2014 compared to 2013. This is because the EIA expects more transportation capacity to be constructed in the US to allow domestic oil to more easily and cheaply move to international markets, therefore closing the price difference between international crude and domestic crude. The chart below shows the predicted difference between Brent crude and WTI crude.

Enlarge Graph

Note that commodity price forecasts are highly uncertain. This is due to several reasons such as inherently high volatility in commodity prices and the inability to predict certain happenings (such as geopolitical events, natural disasters, etc.) that could cause sudden and severe price movements.

A fall in Brent prices as the EIA predicts would be a negative sign for the margins of international producers such as ExxonMobil (XOM), Chevron (CVX), and ConocoPhilips (COP) for the years 2013 and 2014 as compared to 2012. However, note that the price outlook is still at levels where these companies can operate quite profitably. Additionally, the EIA predicts that WTI will close the gap to Brent over the next two years, which is a positive for domestic producers such as Chesapeake Energy (CHK). Investors in the companies such as those mentioned above, or those involved in energy ETFs such as the Energy Select Sector SPDR Fund (XLE) may find it informative to monitor the EIA outlook in prices, which is updated monthly.