Déjà vu … All Over Again

Déjà vu … All Over Again

21st August 2015

While oil price headed down further this week, apparently spooked by U.S. storage and refining numbers, the onshore rig count continued its (4-week) slow rise, increasing by 5 and now standing at 854.  That is down 1,022 (54%) from a November 2014 high of 1,876, but up 24 (3%) from its June 2015 low.

Imported crude jumped this week by 465,000 barrels per day, lower oil price encouraging traders to increase crude in storage.  Additionally, the BP Whiting refinery outage is redirecting Canada imports into the Cushing, Oklahoma storage hub while under repair.

U.S. Drilling Activity.....

Rig count remained essentially flat (up 1) this week; however, rigs targeting oil decreased by 10 last week.  With the continued drop in oil price, operators are adjusting their drilling activities toward gas.

Across the three major unconventional oil basins, rigs decreased by 5, with the Eagle Ford down 6, Permian down 2, and Williston up 3 week-on-week.  Rig activity over the past week included the increase of 1 horizontal rig.

The rigs targeting oil in offshore Gulf of Mexico has decreased by 5 last week.

Oil Price…..

The “green shoots” of oil price recovery seen in Q2 have been hit by a really heavy frost these past few weeks, returning to the lows seen in early January and still threatening to go lower still.

Since June 30 Brent has given up nearly US$20 per barrel, with even the long-dated prices having declined US$10 per barrel.  

Source: GCA Analysis

The crude price fell sharply on the EIA inventory numbers.  Analysts had been predicting a stock draw but appear to have got the sign wrong, and the build of 2.6 million barrels spooked the market.  While stock draws are important at this time of the year, perhaps the refinery outages had not been taken into consideration.  Either way, it does not look like good news and a price starting with a 3 now looks pretty inevitable (at the time of this writing, it was only 25 cents away).

U.S. Supply and Demand…..

Total U.S. oil stocks remain above their five-year highs while U.S. oil production continued to decline slowly.  While price continued downward, oil inventories reversed their trend with an increase last week of 2.6 million barrels, including an addition of 0.8 million barrels to stocks at the Nymex delivery point of Cushing, Oklahoma.

U.S. crude oil refinery inputs averaged 16.8 million barrels per day, 254,000 barrels per day less than the previous week’s average.  Refineries continued to operate at 95.1% of their operating capacity.

BP’s 405,000 barrel-a-day Whiting refinery, 20 miles southeast of Chicago, is running at minimal rates and its big crude unit could be shut at least a month for repairs.  Oil from Canada’s oil sands, normally delivered to Whiting, is being redirected into the Cushing, Oklahoma storage hub.

At least six other Midwest refineries have scheduled maintenance to begin over the next two months, including Marathon Petroleum Corp.’s unit in Catlettsburg, Kentucky.  Whiting itself, already missing 235,000 barrels a day of capacity, is scheduled to shut a second crude unit in September.

U.S. crude imports averaged 8.0 million barrels per day, up by 465,000 barrels per day from the previous week.  Over the past four weeks, crude oil imports have averaged 7.6 million barrels per day, 0.9% below the same four-week period last year.

Source: EIA Weekly Update and GCA Analysis

Global Production News....

Amid high uncertainty in the global oil market, the EIA has lowered crude oil price forecasts in the Short-Term Energy Outlook (STEO), expecting West Texas Intermediate (WTI) crude oil prices to average US$49 per barrel in 2015 and US$54/Bbl in 2016, US$6/Bbl and US$8/Bbl lower than forecast in last month's STEO, respectively.  Concerns over the pace of economic growth in emerging markets, continuing (albeit slowing) supply growth, increases in global liquids inventories, and the possibility of increasing volumes of Iranian crude oil entering the market contributed to the changed forecast.

At the fundamental level, supply and demand need to be rebalanced and the main problem is over-supply of shale oil from the U.S. and of OPEC crude production depending upon which way the problem is viewed.  The recent price action has been brutal on producers but seemingly not yet brutal enough to remove the oversupply from the system, or to cause a further withdrawal of rigs from the U.S. market although the reason for that is probably “lag” in the system.  Increased demand has helped but production increases in 2015 have outpaced the increase in demand and, therefore, a risk of substantially lower price in the months ahead looks possible.

The relief from overproduction pressure expected this year has not materialized; both OPEC and other large oil exporters are extracting crude at ever-increasing rates in a battle for market share. U.S. shale production has shown a surprising resilience throughout the oil price collapse, as producers have chosen to continue operating (covered by hedges or focusing on core areas) rather than scale back extraction.  With refineries set to go into maintenance mode soon, market oversupply will become even more pronounced and may well add additional downward pressure on price.

GCA Analysis…..

It would be a mistake simply to try to tie the price outcome for crude in 2015 and 2016 to economic breakeven for U.S. shale operators.  These two categories have very little relevance for each other at any given point in time; the largest factor being that U.S. shale accounts for a very small percentage of the global crude supply.  Continental Resources is a good case in point.  The company substantially curtailed its spending in 2015 but still plans to spend US$2.7 billion this year, despite the fact that well price realizations in the Bakken dropped well below US$40 and analysis estimate WTI price of US$65-US$70 per barrel is required to sustain production flat over a long period.  Additionally, analysis currently estimates that a WTI price of US$75 per barrel could be required to sustain meaningful production growth in the Bakken.

As assets are redistributed and consolidated and industry productivity continues to improve, it would be reasonable to expect the industry economic break-even price to continue to move down within a few years.  

In the U.S., the oil rig count is 54% lower than it was in November 2014 but this decrease has done very little to bring the global crude market into balance.  While OPEC consists of twelve nations, its policies are divided between those who like to see a reduction in output to boost prices, and those led by Saudi Arabia, who in November 2014 made it clear that they wished to retain their market share, abandoning their role to stabilize production in times of oversupply.  OPEC (Saudi Arabia) has firmly stated that their production will remain at over 30 million barrels per day regardless of the price of oil.

Production resilience from the United States, Russia and other non-OPEC countries has further exacerbated the global supply glut, and will undoubtedly be a headwind for oil price recovery in the near term.  Non-OPEC production is forecast (by IEA) to add 1.1 million barrels per day in 2015, resulting in an average output of 58.1 million barrels per day, bring more crude to an already oversupplied market.  

Source: EIA and IEA August 2015 Update and GCA Analysis 

The Iran nuclear deal, sluggish demand from China and the return of the strong dollar continue to weigh on the price of crude oil and show little evidence of relenting anytime in the near future.  So far it has been a blessing for the pockets of consumers but a curse for the energy sector.  While only time will tell what trajectory the price of crude oil follows, it would be irrational to ignore the bearish catalysis that have ravaged this beaten down commodity.

In the short term, the oil market is in the doldrums and projects are being delayed or cancelled, left, right and center.  That will mean that, outside North America, oil production capacity will (should!) decline even faster.  With the growth taken out of the U.S. shale producers and new projects in Canada’s oil sand being put on the back burner, the fundamentals required for demand to start exceeding world oil production capacity are there – once the extent of Iran returning to the market is better understood.  Right now, the focus remains on the demand side; what will it take for growth to resume in Europe and, more significantly, what is going to happen to Chinese demand?

Authors

Déjà vu … All Over Again

P Kevin Galvin

Principal Advisor, Field Development Planning - kevin.galvin@gaffney-cline.com
Déjà vu … All Over Again

Bob George

Regional Director: Americas - bob.george@gaffney-cline.com

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