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Predicting the Price of Oil Is Almost as Hard as Perfecting Nuclear Fusion

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Oil and gas analysts look as if they have it easy. The prices of energy commodities are simple to track on futures exchanges that react immediately to changes in sentiment. Armadas of government researchers release supply-and-demand data every week. There are even drones flying over oil storage units in Oklahoma, broadcasting just how high the lids are—a sign of demand. For those willing to pay up, fancier tools are available, too. Using traffic stats and credit-card trackers, data brokers can see how much it cost you to fill up at the local Sunoco yesterday, predict when you’ll be back for the next tank, and determine whether you bought a Snickers on your way out.

And yet, forecasting prices is remarkably difficult, even at a time when oil and gas producers are better than ever at broadcasting and sticking to their drilling plans.

Take this past year. On Dec. 31, 2021, analysts said that Brent crude, the international benchmark, would average $73 per barrel in 2022. Instead, Brent has averaged $101. Similarly, West Texas Intermediate, the U.S. benchmark, has averaged $95— $25 above Wall Street’s forecast.

Next year, Wall Street banks are predicting that oil prices will rise from current levels around $75 per barrel to $100 or even higher. In a recession scenario, however, there’s precedent for petroleum to fall precipitously, perhaps as low as $50. In a bet between $50 and $100, we’d lean toward the high side. But it’s worth considering why such a wide range is even possible, and why energy analysts might not have it so easy, after all.

One major problem is that energy markets operate on multiple timelines at once. Yes, it’s easy to see how much gasoline is sold every week. But it was much harder to predict when Vladimir Putin’s 20-year grudge against the North Atlantic Treaty Organization would boil over, leading him to invade Ukraine. Now, 10% of the world’s oil and even more of its natural gas are hostage to his whims.

Other timelines changed this past year, too, scrambling predictions. Hydrogen, a clean-burning gas that has been too expensive for widespread use, suddenly became economically viable—largely because it gets benchmarked against the price of natural gas, which has soared. The Inflation Reduction Act in the U.S. directed large subsidies at the industry, too. Hydrogen was expected to start powering industrial plants and trucks in a decade or so. Now, companies are investing tens of billions in it, on the expectation that it can gain traction well before 2030. The European Union expects it to account for as much as 20% of its power by 2050, and considers renewable hydrogen a key element in its plan to move away from Russian energy.

A third timeline was accelerated just this past week. Nuclear fusion, the reaction that powers the sun, reached a milestone in a government lab in California that seemed straight out of The Jetsons. Scientists at the Lawrence Livermore National Laboratory zapped a small fuel pellet with 192 lasers, creating pressure and heat that mimicked the conditions inside a star, or a nuclear weapon exploding. Temperatures rose to more than five million degrees Fahrenheit, and the explosion caused two hydrogen atoms to fuse into helium.

Fusion has happened before, but what made the latest experiment unique was that the amount of energy produced exceeded that needed to power the lasers. Scientists call that ignition. Like fission, the atom-splitting process that now powers nuclear plants, fusion promises to produce carbon-free energy. But it’s much more powerful than fission, and isn’t expected to produce nuclear waste. Zapping one glass of deuterium, a kind of hydrogen found in water, could theoretically produce the same amount of energy as 10 million pounds of coal, Morgan Stanley analyst Edward Stanley wrote in a client note.

Michl Binderbauer has been working toward this moment since the 1990s, when he was studying fusion at the University of California, Irvine. Over 20 years ago, he co-founded TAE Technologies, aiming to build a nuclear fusion company that could provide clean energy. At the time, it seemed unrealistic. “Some people thought maybe I was a delusional dreamer,” he said. Fusion seemed theoretically possible back when Albert Einstein discovered that E=mc2. When scientists began studying it in earnest in the 1950s, optimists predicted that they were 20 years away from a breakthrough. When 20 years came and went, the timeline was pushed out another 20 years. And so on, until it became a running joke among nuclear engineers (a surprisingly funny group). Scientists at the Livermore Lab still think they’re decades away from harnessing the reaction to produce a steady stream of clean energy.

But Binderbauer is betting on a shorter runway to launch.

“I think, as humans, we shouldn’t question anymore whether we’re going to have fusion,” he says. “It’s a question of when, and when is measured not in decades. It’s measured in probably five years. Somewhere within a decade, I believe, the private sector will have its first power plant running.”

When he started, Binderbauer didn’t know when success might come. “We see the summit now, that moment coming out of the clouds,” he says.

To be sure, the clouds are still pretty thick. Binderbauer needs to safely recreate an experiment that took place in a lab the size of Fenway Park and cost more than $3 billion to get started. He’s trying to do it using magnets instead of lasers, and fit it into a reasonable-size building about the size of a modern nuclear reactor. What’s more, he’ll need to keep the reaction going indefinitely, instead of the one time it happened at Livermore. And any power that comes out of the plant will need to cost about as much as electricity does today.

In some ways, The Jetsons is more realistic than his goal. Jane Jetson’s daily life in 2062 includes video calls and robot vacuums, two things that exist, for better or worse, today.

Binderbauer isn’t alone in his dream world, however. TAE has impressive backers investing real money. Google owner
Alphabet
(ticker: GOOGL) and
Chevron
(CVX) were part of a $250 million funding round this year. And that was before the Livermore news. The calls are now pouring in from investors, says Binderbauer. For the average investor, it’s obviously hard to bet on nuclear fusion, because there aren’t any pure-play public companies and there’s no deuterium futures market yet. But it’s worth keeping an eye on the developments.

“If you’re heavy into oil and gas and carbon-emitting generation assets, you’re going to have to ask yourself, ‘Can I afford to not have a hedge?’ ” Binderbauer says.

Oil and gas investors probably shouldn’t stay up nights worrying about nuclear fusion. There are enough other issues to stress out about.

The setup for 2023 had looked extremely bullish just a few weeks ago. Europe’s ban on Russian oil shipments, and its price cap on exports to other countries, looked likely to force Russian oil completely out of the market, causing buyers to pay up for the limited global supply remaining. On the demand side, China has begun to loosen its Covid restrictions, which should jump-start oil and gas use there.

Those factors are why almost all Wall Street analysts predict that oil will average more than $90 a barrel next year, with some expecting prices to sit comfortably above $100. The average 2023 estimate for Brent crude is $95. But the futures curve is telling a different story, forecasting oil at $80 in the middle of next year. Front-month Brent futures are at $79. Recession fears are outweighing supply shocks. Or, as analysts have become fond of saying, Powell has become more important than Putin.

With economies around the globe slowing, energy demand is falling at a faster rate than analysts had expected. Oil is building up in storage tanks throughout the world at a time of year when inventories usually fall, according to Tudor Pickering Holt analyst Matt Murphy. China’s Covid plan remains a mystery. Meanwhile, Russia appears to have diverted most of its sanctioned oil to China and India. In fact, the net result of the sanctions on Russia could be bearish for oil, not the bullish disruption that analysts had predicted.

“Unless China comes back strongly, it feels to me like this price cap has a gravitational pull downward on oil prices,” says Daniel Yergin, vice chairman of S&P Global and a historian of oil markets.

A recession could knock prices even lower. Nicholas Colas, co-founder of DataTrek Research, writes that oil has tended to fall 40% to 50% in recent recessions. With West Texas Intermediate crude on track to average $95 per barrel this year, that would mean prices could fall to $57 or even lower in 2023.

It’s hard to imagine they will, however. There are too many tripwires on the way down. The Organization of the Petroleum Exporting Countries stepped in when oil prices were above $80 to cut production and stabilize prices. OPEC may have to cut even more in the new year. Its members’ incentive to act will only grow as the price slips.

The U.S. also has an incentive to keep prices from falling too much. That might seem strange after a year in which President Joe Biden repeatedly tried to force gasoline prices down and sold an unprecedented amount of oil from the Strategic Petroleum Reserve, or SPR. But Biden also has said that the U.S. will use the reserve to keep prices from crashing, because the government wants to make sure that producers are incentivized to drill.

On Friday, the Energy Department said it would start buying back crude, putting out bids for oil to be delivered in February. It’s part of a plan to “give producers the assurance to make investments today, knowing that the price they receive when they sell to the SPR will be locked in place.”

The first purchase is just three million barrels, less than 1% of the total remaining barrels in the reserve, but it points to an evolution of the national energy strategy that should put a base under oil prices. After 50% gains for energy stocks in 2022, the ceiling won’t be nearly as high in 2023. But the floor looks increasingly solid.

Write to Avi Salzman at avi.salzman@barrons.com

Credit: marketwatch.com

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