Brent Suffering Expiration Blues

Jim Brown
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With the current month Brent contract expiring on Friday we are seeing some selling pressures. WTI and Brent spreads are narrowing but there is no real reason until late this year when the pipelines begin to flow.

Also pushing crude prices lower was another big gain in the dollar to a new six-month high. This dollar strength is killing commodities and it will eventually weigh on earnings for multinational companies. Q1 earnings are going to see a huge earnings drag.

Dollar Chart

Another factor pushing Brent crude lower was a report from OPEC cutting estimates for oil demand growth. The EIA published its own monthly report and also cut the forecast for global oil demand. It is a wonder we did not see crude prices implode. OPEC said oil demand will grow by 840,000 bpd to 89.67 mbpd in 2013.

On Tuesday OPEC said it pumped 30.31 mbpd in February. That was up slightly from 30.24 mbpd in January and it was the highest in three months. Saudi Arabia increased production to 9.12 mbpd, up from 9.08 mbpd in January.

Supporting prices was news from China that implied energy demand rose +4.9% in February. That suggests that a rebounding Chinese economy will continue to increase demand for crude.

Another factor pushing oil prices lower was a +2.6 million barrel gain in crude inventories to 384.0 million. That is only 3.3 million barrels below a 22 year high and we will almost certainly make a new high in the coming weeks. This was the eighth consecutive week of inventory gains. Crude imports rose by 237,000 bpd. U.S. production rose by +66,000 bpd to 7.166 mbpd.

Refinery utilization fell to 81% as the spring maintenance season accelerates. Demand for crude declined -37,000 bpd as a result of the falling utilization.

Gasoline inventories declined by -3.6 million barrels for the fifth consecutive week of declines. As we approach the summer driving season the refiners have to get rid of the winter blends and begin refilling the storage tanks with summer blends. This means gasoline inventories will decline until the system flush is completed. Inventories will then increase as refiners go full bore producing the summer blends. The decline in gasoline inventories would have been a lot worse but imports rose by +122,000 bpd.

Distillate inventories were flat.

Inventory Snapshot

The inventory chart for crude is following the normal seasonal patterns except that levels are +10.5% higher than year ago levels. This is a result of the stronger U.S. production and slow economy. Once the economy finds some traction the demand for crude could increase as much as 2.0 mbpd just to get us back to 2008 levels. That would suck up all the new supply created the last two years. The EIA claims the average U.S. production in 2012 was 6.5 Mbpd. They claim that will rise to 7.3 mbpd in 2013 and 7.9 mbpd in 2014.

U.S. crude demand was 20.8 mbpd in 2005. That fell to 18.6 mbpd in 2012 as a result of fewer people working than in 2005 and better gas mileage on new cars. The average age of a car in the U.S. is 10.6 years suggesting there is a robust replacement cycle in our future if people went back to work. More than 14.4% of the workforce is currently unemployed. Despite the addition of 12 million new workers to the workforce since January 2009 there are fewer people working today than in January 2009.

Crude Oil Inventory Chart

Gasoline inventory seasonal patterns are following the historical range perfectly. We should see declined for the next two months as the storage systems are flushed of winter blends.

Gasoline Inventory Chart

Distillate inventories are also following the seasonal patterns but they are hugging the low end of the range. Heating oil season is over and the end of winter storms should allow airlines and truckers to return to normal demand patterns without the biweekly interruptions.

Distillate Inventory Chart

The EIA Short Term Energy Outlook (STEO) predicted liquids production in the U.S. would increase by 835,000 bpd in 2013. The EIA also predicted the U.S. will exceed Saudi Arabia in total liquids production. Liquids include oil and natural gas liquids or NGLs. This is only a headline and not a material event. Natural gas liquids are not really oil. In some cases they are blended with heavy oil to make a lighter product that can be pumped through pipelines. There are several efforts underway to pump NGLs north to Canada to be mixed with the bitumen produced from the oil sands. This makes it easier to pump that heavy oil south and easier to sell. NGLs are closer to gasoline than oil and in years past before all the computerized cars there were reports of drillers pouring it directly into gas tanks as gasoline. I doubt you would get very far on that concept today.

The EIA predicted OPEC surplus production would rise to 2.8 mbpd in 2013. That is an increase of 800,000 bpd over 2012 but still 200,000 bpd lower than the prior three-year average. OPEC has its depletion problems as well. The EIA expects surplus OPEC capacity to rise to 3.4 mbpd in 2014. That does not include excess capacity in Iran that is embargoed.

The EIA also lowered estimates for Libya because of continuing internal strife and technical challenges in restoring the production lost during the civil war. Security is becoming a serious problem with hundreds of thousands of liberated military weapons now in the hands of local gangs and militias.

Iraq is also a challenge due to security and political fighting between the south and the north. Several major oil companies are abandoning their efforts to rework the fields due to unprofitable contracts in light of increasing security issues and costs associated with sabotage. Iraq bragged they would be at 10 mbpd by 2020 but they will be lucky to get to 5 bpd from their current 3 mbpd.

OPEC Surplus Production Chart

The EIA said there was a global draw on existing inventories of 1.1 mbpd in January and February. Consumption outpaced production but it was related more to a slowdown of excess production by OPEC members and as a result of outages in places like Nigeria and the North Sea that weakened inventory builds. Unplanned outages accounted for 900,000 bpd in February.

The EIA claims global liquid fuels consumption rose +800,000 bpd in 2012 to 89.1 mbpd. They expect that to rise to 90.1 mbpd in 2013 and 91.5 mbpd in 2014. Chinese consumption rose by 360,000 bpd in 2012 and will increase another 450,000 bpd in 2013 and +510,000 bpd in 2015. Average annual demand growth in China was 540,000 bpd from 2004 to 2010. If they continue adding 500,000 bpd per year that will be an increase of 4.0 mbpd by 2020. That is a lot of additional oil demand and that is in addition to demand elsewhere in the world. China is expected to grow auto production from the current 15 million to 20 million per year by 2020.

Natural gas inventories ended February at 2.08 Tcf. That is slightly below year ago levels because of the flurry of winter storms over the last four weeks. That is 0.27 Tcf above the five year average. The EIA expects gas prices to average $3.41 in 2013 but trade between $2.79 and $4.67 based on futures analysis.

Helping with our gas glut problem is a substantial uptick in gas exports to Mexico. In 2010 we exported about 0.9 Bcfpd. That rose to 1.7 Bcfpd in 2012. Gas inventories rose at a slower rate in January and February because of the cold weather. The cold increased the number of "freeze offs" where well output was halted because of super cold weather. Gas production declined -3.5% in Nov/Dec in New Mexico as a result of the freeze offs. As warmer weather arrives all those wells will be back in action and supplies will accelerate.

Active gas rigs fell to 407 last week and a 12 year low. That would seem to indicate lower gas production but the drilling for shale oil has accelerated and shale oil throws off a significant amount of associated gas. Not as much production as a pure gas well but there are a lot more being drilled with 1,341 active oil rigs last week.

The EIA expects U.S. gas production to remain stable in 2013-2014.

Gas Production Chart

Jim Brown

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