June 22, 2018

June 22, 2018

22nd June 2018

Oil Drilling Activity

Onshore US drilling activity decreased by 3 with a total active count of 1032 rigs; those targeting oil decreased 1 with the total at 862. Across the three major unconventional oil basins, the oil rig count decreased by 2 to 602, with Permian down 2, Eagle Ford up 1 and Williston down 1. US rig growth (all rigs in the red this week) has hit a flat spot with zero adds the past five weeks. Pipeline and service industry constrains are starting to show its impact on rig activity.

The expansion in US production last week was also flat; halting its average weekly increase of 32,000 barrels per day for the 1H 2018. US production stands at 10.9 million barrels a day.

Source: EIA Weekly Update, BHGE Rig Count and GCA Analysis

Although not yet official, OPEC reached a deal; the headline increase is 1 million barrels per day but, because of supply constraints in some OPEC countries, only ~600,000 barrels per day is expected to be added to the market - roughly in-line with market expectations.

Natural Gas – LNG change happens slowly

Over the last few months, GCA has been working with a number of clients in the LNG space to help them understand some of the current trends in the sector, three of them being the emergence of new pricing mechanisms, lifting the restrictions imposed by traditional LNG contract structures, and new markets.  This week brings news on all three trends.

The Platts Japan Korea Marker (JKM) has become one of the better-established indices for spot prices in Asia, and has been increasingly used for swaps and other derivatives.  The index is compiled by collecting pricing data from a variety of sources, however, any price index is always subject to the “chicken and egg” syndrome, where it needs to be sufficiently transparent and reliable for it to be trusted; but to become trusted, it also needs to be based on information from as many sources as possible.  News that a number of companies including Vitol, Trafigura, BP and Itochu are now making transparent bids for LNG cargoes will add reliability and credibility to the JKM index, which has already benefitted from a tenfold increase in JKM based swaps, to the equivalent of over 3 million tonnes per month.

In a move that follows the successful challenge by Japan, Korea and China to the widespread LNG destination clauses, the EU has now decided to mount a challenge to get such clauses deemed anti-competitive, with respect to Europe’s supply contracts with Qatargas.  Using the argument that these clauses, common in a number of more traditional LNG contracts, create barriers to the free flow of natural gas between European States, the EU is carrying out what has been called a “fast track” investigation.  Whether or not they reach the same conclusions as their Asian legal counterparts remains to be seen, but pressure is mounting to liberalize the LNG market to enable a more commercial footing to become established, encouraging trading, shipping efficiencies and, of course, price arbitrage between markets.

Thirdly, with LNG for bunkering beginning to take off prior to the IMO Sulphur restrictions that will come in 2020, two ship brokers, one London based and the other Tokyo based, will join the SEA/LNG trade alliance of more than 35 organizations, which are collaborating to grow the market.  GCA has predicted that as much as 35 MTPA of LNG could be used for marine fuel by the 2030s, and there are a growing number of LNG suppliers looking to participate, with a growing fleet of LNG bunkering vessels ranging from small barges, to smaller scale LNG carriers of more than 20,000 cubic meters.

It seems change is unfolding for the LNG sector, and it is worth considering Hemingway’s quote from The Sun Also Rises, with the LNG industry in mind.  The gist of it is that change happens more slowly than people think, and then it happens much faster than you would have thought.  Change has been on the cards for LNG for some decades, now perhaps is the time it is suddenly upon us.

Crude Oil – Demand (not OPEC) to balance markets?

A sharp rise in prices normally leads to a slowdown in consumption growth, especially in the advanced economies, but the slowdown is more apparent in retrospect than at the time. By the time a slowdown shows up in official statistics, it will already be too late, and prices will probably have risen too high to be sustainable.

In 2006-2008 and again in 2011-2014, surging oil prices resulted in a slowdown in consumption growth in the advanced economies. In both cases, the oil market was eventually forced back to balance, but not before prices had overshot on the upside, creating conditions for the subsequent collapse.

Sources: EIA Data and GCA Analysis

Attention is focused this week on Vienna, where ministers from the Organization of the Petroleum Exporting Countries and its allies decide whether to increase their output. However, the direction of prices over the next year will be more influenced by less visible developments in the major oil-consuming countries, especially the United States, Europe, China and India.

The oil market’s production capability appears fairly fixed for the rest of 2018 and into 2019. Spare capacity is already low and will shrink further as OPEC boosts its output, leaving the market without much capacity to absorb supply disruptions. US oil production is expected to rise by 1.4 million barrels per day in 2018 and another 1.1 million barrels per day in 2019 but may not be able to rise much faster because of pipeline bottlenecks until end of 2H 2019.

With available production capacity fairly fixed in the short-term, oil market balancing will depend on consumer reactions to higher prices. Rebalancing may need to come from the demand side, where prices will have to rise high enough to moderate consumption growth.

Global consumption has increased by an average of 1.7 million barrels per day for the last three years, accelerating from an average of 1.1 million barrels per day in the three previous years. Slower growth in consumption could certainly have to play a significant role in pushing the oil market back towards balance.

Weekly Recap

Drilling Activity

Source: BHGE Rotary Rig Count

Total US rig count (including the Gulf of Mexico) stands at 1052, down 7 this week. The horizontal rig count stands at 9320 down 2 this week. US rig growth has trended flat for the last 5 weeks.

Compared to a November 2014 figure of 1,876 active rigs, the current level is above 50% of the 2014 high. The rig market is tighter than it appears because many older rigs have been scrapped, cannibalized for spare parts, or are simply unsuitable for drilling the very long wells now favored by shale producers.

Crude Oil Price

Brent, the global benchmark for oil, was unchanged at US$75.07 a barrel, again this week.

WTI crude rose US$1.10 to US$67.72 a barrel, up 1.65% on the week.

US Crude Oil Supply and Demand

Sources: EIA Weekly Update and GCA Analysis

US crude oil refinery inputs averaged 17.7 million barrels per day, with refineries at 96.7% of their operating capacity last week. This is 196,000 barrels per day more than the previous week’s average.

US gasoline demand over the past four weeks was 9.5 million barrels, down 0.9% from a year ago. Total commercial petroleum inventories increased by 0.2 million barrels last week.

US crude imports averaged 8.2 million barrels per day last week, up by 143,000 barrels per day from the previous week. Over the last four weeks, crude oil imports averaged 8.1 million barrels per day, 0.3% more than the same four-week period last year.

US crude exports averaged 2.374 million barrels per day last week, an increase of 344,000 barrels per day from the previous week. Over the last four weeks, crude oil exports averaged 2.074 million barrels per day, 167.7% more than the same four-week period last year.

Crude oil inventories decreased 5.9 million barrels from the previous week. The crude stored at Cushing (the main price point for WTI) decreased 1.3 million barrels; total stored is 32.6 million barrels (~36% utilization).

Authors

June 22, 2018

P Kevin Galvin

Principal Advisor, Field Development Planning - kevin.galvin@gaffney-cline.com
June 22, 2018

Nick Fulford

Global Head of Gas and LNG - nick.fulford@gaffney-cline.com

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