Inventory Decline No Help for Prices

Jim Brown
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Another weekly decline in crude inventories did not provide support for crude prices and WTI fell -$1.12 to $104. Even with the security issues overseas the July ramp was too far too fast and investors are taking profits.

Egypt's military said Wednesday that "mediation has failed" and a crackdown against two major protest sites is inevitable. After nearly two weeks of talks the various sides remain very far apart and the potential for a disaster is very high.

If the military attempts to clear the protest sites of Morsi supporters there will be bloodshed and it could be very bad. If there is a massacre it could turn the country's Muslim Brotherhood into an army of terrorists striking back at the government in every way possible. This could impact oil production and shipments. The Suez Canal is not expected to be interrupted but you never know in a civil war how far and how aggressive the weaker side will react.

The Muslim Brotherhood is the weaker side in this conflict but supporters still number in the millions out of the Egyptian population of 83 million. We know from history that civil and religious wars in that part of the world can be especially bloody.

The worries over Egypt and the closure of the 21 embassies failed to provide support for crude. We are moving into the period where the driving season ends and crude demand and prices decline.

Crude inventories fell -1.3 million barrels to 363.3 million. That is still +6% over year ago levels and +11% above the five-year average. The -27 million barrel decline in the prior four weeks was a record drop for that time frame. Based on the historical norms we should see a continued inventory decline into early September.

EIA Crude Inventory History Chart

The primary reason for the inventory decline last week was a -254,000 bpd decline in imports and a -72,000 bpd drop in refinery demand. Refinery utilization fell from 91.3% to 90.9% as refineries go into cruise control for the month of August.

The inventories at Cushing plunged again from 42.1 million to 39.9 million and the lowest level since March 23rd, 2012. This is due almost entirely to the methods of alternate shipment being used by producers in the Midwest and Southern shale fields. From 2005-2010 more than 96% of oil delivered to refiners came by pipeline and ships. This dropped to 93% in 2012 and is still dropping.

Barge traffic has increased because of rail and truck deliveries to river barges and the barge makes the final trip to the refineries. Barge traffic is cheaper per mile than truck or rail so rather than truck oil all the way to the refinery they truck it to the closest barge facility to the shale field. The EIA assigns the transportation method to whichever method is used in the last 100 miles to the refinery. In reality the majority of oil delivered overland to refineries traveled the first 500 miles by truck or rail.

When the new pipelines to the coast from Cushing and the various shale areas are completed we could see oil in storage at Cushing decline significantly to something in the 25-30 million barrel range.

Gasoline inventories rose by only +100,000 barrels after rising +800,000 in the prior week. Demand increased slightly by +99,000 bpd to 9.25 mbpd. That was only 50,000 bpd below the high for the last eight weeks. Inventories are 8.5% over year ago levels.

Distillate inventories rose by +500,000 barrels thanks to a drop in demand of -103,000 bpd or -721,000 barrels for the week.

(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. The number of active gas rigs at 349 is an 18 year low. Oil rigs at 1,412 is an eight-month high. Crude oil at 397.6 mb is the highest since 1931.)

Inventory Snapshot

Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

The decline in the inventory at Cushing has had a dramatic impact on the WTI-Brent spread. After collapsing from more than $20 early in 2013 to zero a couple weeks ago it has stabilized at about $3 in favor of Brent. The refiners buying the cheap WTI crude and selling the refined gasoline at Brent prices were making a killing. Now they are forced to pay roughly the same price for oil as the coastal refiners and the profit margins have evaporated.

Gasoline prices are in freefall after spiking to the early year highs in mid July. Gasoline futures could fall back to $2.70 in the weeks ahead and bring retail gasoline prices back to $3.25 or less. This time the Rocky Mountain refiners will not have the benefit of the cheap Bakken oil and gas prices will remain elevated.

Gasoline Futures Chart

There were several earnings reports today including Continental Resources (CLR). The company reported earnings of $1.33 that beat estimates by 8 cents. Revenue rose +70.5% to $892.2 million and also beat estimates. Q2 production was 12.3 million Boe or 135,700 bpd of which 71% was crude oil. Bakken production totaled 88,000 bpd. Production from the South Central Oklahoma Oil Province (SCOOP) rose +23% to 17,550 bpd. Proved reserves increased +17% to 922 million Boe. Shares lost 50 cents on the news.

Devon Energy (DVN) reported a 43% increase in earnings to $1.21 compared to estimates of 95 cents. Total production rose +19,000 boepd to 698,000 Boepd. Oil production was 160,000 bpd. Devon said it was having good success in the Woodford shale, which is located underneath the Mississippi Lime acreage. They are also going to drill more Permain Basin wells to capitalize on the high oil content. Shares of Devon rose +88 cents.

EOG Resources (EOG) reported an 81% increase in earnings after the close on Tuesday to $2.10 and beat estimates of $1.76. Revenue rose +32% to $3.84 billion compared to estimates of $3.53 billion. Production rose +5% to 46.0 million Boe. Average daily production for crude oil and condensate was 214,400 bpd, a +35% gain. NGLs rose 16% to 64,700 bpd. Natural gas production declined -14.8% to 1,361 million cubic feet per day. The average price received for crude increased +8.4% to $103.19 per barrel. EOG is the only company I can remember that posted a gain in the selling price for Q2. EOG projected its full year production to be 208.0 million barrels or 219,600 bpd, up from the prior range of 193,000-211,200 bpd. Shares of EOG have been on fire ahead of earnings on rumors they were going to announce strong production.

EOG Chart

W & T Offshore (WTI) reported earnings on the opposite side of the ledger. Production volumes increased +14% to 45.3 MBoepd. That was split 40% oil, 12% NGLs and 48% gas. They had to defer 3.2 Bcf of gas during the quarter because of operational problems. They completed one offshore well with four more in the drilling/completion phases. They completed nine wells in the Permian. After the quarter ended they completed the Ship Shoal 349 A-14 well with a peak rate of 3,588 bpd of oil and 6.3 MMcf of gas. They experienced downtime at 10 different fields and were forced to curtail production because of third party pipeline outages. Several wells continue to be offline and he company lowered its production outlook for the year from 17.0-18.7 MMBoe to 16.9-17.7 MMBoe. Shares declined -9% on the news.

McDermott International (MDR) reported earnings on Monday and they were a disaster. McDermott reported a massive drop in earnings from a 22 cent profit in the year ago quarter to a loss of 63 cents in Q2. Revenues fell -28% to $647 million. Project backlogs declined -$200 million to $5.1 billion. The company tried to explain away the huge miss saying a lot of projects have been completed over the last several quarters and are no longer active. The company was promptly downgraded by several brokers. McDermott also announced the Chief Operating Officer or COO would be retiring almost immediately. As the token scapegoat John McCormack will leave "sometime" in Q4 and the search for a replacement has begun. The company needed somebody to blame for the -25% decline in the stock since February with three consecutive post earnings declines. Shares declined another -25% this week.

McDermott Chart


The anticipated market weakness has arrived. With earnings fading and no economic reports of note this week the market is left to focus on the potential for tapering QE. The S&P posted its first three day decline in two months but rebounded off strong support at 1685. This was expected to be the first real test of the decline with critical support at 1680. We could see a short rebound from here but longer term I think the seasonal August weakness will continue.

Nobody knows if this year will follow the seasonal patterns for an August decline but I would want to err on the side of caution rather than load up with long positions on the first dip.

Crude prices typically decline in August-September and then rebound in the fall as winter heating oil demand increases. Investors should wait for the normal end of summer weakness to add long positions.

Jim Brown

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