Rising China, Falling Dollar

Jim Brown
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Crude prices rose slightly on Friday as a result of better than expected economics in China and the sharp drop in the dollar as a result of the budget agreement.

WTI closed at $101 and Brent right at $110 after China reported its GDP rose from 7.5% to 7.8% and snapping two quarters of declines. China reported oil imports rose to a record 25.61 million metric tons in September. That is roughly 187.72 million barrels or 6.26 million bpd. The barrels per day estimate is approximate because different grades of crude oil have different weights. A metric ton has approximately 7.33 barrels of oil.

Rising demand in China is confirmation the economy is actually growing. China's demand is expected to exceed 10.7 mbpd by 2020 and 12.5 mbpd by 2022. China and Asia in general are the main drivers for demand growth in the world today. The developed countries including the USA and Europe are seeing minimal demand growth and are well under demand level peaks in 2008.

The short term budget agreement caused a sharp drop in the dollar because it means we are going to repeat this fight in January. The damage done to the U.S. economy in October and the potential for damage again in January means the Fed is not going to be cutting QE any time soon. The continued purchase of $85 billion a month in treasuries and mortgage backed securities will keep pressure on the dollar until the taper talk heats up again in the March-June timeframe.

That means commodities prices in dollars should see their prices supported. With China's economy picking up again that will also increase demand for commodities. Coal producers Peabody Energy and Walter Energy have both said that Asian demand is increasing.

Europe is showing signs of improvement but after a false start in August the numbers for the Eurozone faltered in September and October could also be erratic because of the U.S. budget battle. That uncertainty probably kept some spending decisions on hold.

WTI prices also ticked slightly higher after a gas main break in Canada slowed production at four oil-sands producers. The Kearl oil-sands project and CNQ's Horizon upgrader halted output. The Syncrude upgrader stopped shipping product and Suncor's Fort McMurray plant reduced output.

A TransCanada (TRP) gas pipeline ruptured and caused an outage not only to the electrical generation facilities feeding the plants but also to customers in Alberta. The Suncor power plant saw output drop to 319 megawatts from the normal 700 MW.

The 36 inch gas pipeline is still closed as Transcanada tries to understand why it ruptures. A 24 inch pipeline that is part of the Transcanada system was quickly brought back online and is now feeding the power plants on a reduced pressure basis.

Most people don't realize how fragile out entire energy ecosystem is. A couple outages at critical points could cause a cascade failure all across North America. It takes monster gas pipelines to feed gas power plants. Those plants fuel refineries that make gasoline and diesel. With only a 3-5 day supply of fuel in the retail system a coordinated terrorist attack on several of those pipelines could cause major problems that could last for weeks.

Railroads are another weak spot in the energy ecosystem. We have seen crude shipped by rail increase dramatically along with the increased production from the shale oil fields. The train wreck in Quebec that killed 47 people is causing a major revision in regulations in the USA. New rules on brakes and on the strength of tanker cars are being devised. The U.S. DOT is working on rules to increase the strength of rail cars and make them less prone to leakage and rupture in the case of a crash.

Trains are expected to move more than 2.0 mbpd in 2014, up from 175,000 bpd just a few years ago. The remoteness of the shale fields and the lack of pipelines is forcing producers to install rail loading centers and refiners are buying thousands of tanker cars so they can buy oil cheap at the source and then ship it by rail to their various refiners.

Rail shipments from Canada are expected to quadruple by the end of 2014 from the current 224,000 bpd to more than 1.0 mbpd. The move is to increase access to the oil sands oil. Shipping oil by pipeline limits the direction and the number of buyers. Shipping oil by rail allows anyone to buy it regardless of geographic location.

Baker McKenzie said the amount of crude shipped from the Bakken is also expected to rise +400% in 2014 with the oil going to the east and west coasts.

Oil at the source in North Dakota is about 15% cheaper than oil delivered to Cushing Oklahoma. Starting in early 2011 the rail shipping began taking off. Prices are now rising for those producers because of the extra access. Refiners in California or the North East were previously forced to pay Brent prices for water borne crude delivered to their coastal refineries. Now they are buying crude 10-15% cheaper than WTI and much cheaper than Brent. While there are some transportation costs involved the end result is a greater profit margin.

Continental Resources (CLR) is the most active driller in the Bakken and they are now shipping 75% of their crude by rail.

The boom in rail shipments forced the cancellation of the Kinder Morgan Freedom pipeline back in May. The pipeline was going to connect the West Texas oil fields to California refineries. They could not get enough long term contracts to make the project commercially viable thanks to the boom in rail traffic.

The runaway train accident in Quebec will change the parameters for shipping crude by rail in the U.S. but the benefits are still too strong to prevent the continued increase in volume.

This will help when the new Cline Shale field begins production. The Cline Shale is north of the Midland Wolfcamp and east of the Wolfberry. This is about 300 miles north of the Eagle Ford. The Cline Shale is exciting to producers because there are multiple layers similar to the Williston Basin (Bakken).

The Eagle Ford has a producing layer about 150-300 feet thick. The Cline Shale has about 1300-1500 feet of potential production in the Wolfcamp and Cline layers. That is the equivalent of multiple Eagle Ford fields stacked on top of each other.

Chevron has leased over 700,000 acres in the Eagle Ford with 150,000 in the Cline. Other landholders include Devon Energy with 389,000 acres in the Cline and Apache with 520,000 Cline acres. Devon is planning 30 pilot wells this year and Apache will drill 28 test wells.

The various exploration companies will spend hundreds of millions of dollars on determining the geology of the play and how best to produce it. They can't just punch a hold similar to a Bakken well or an Eagle Ford well. They have to sample the various layers and determine porosity, flow rates, how the rock will fracture, how many laterals and at what length, plus many other well characteristics. After their pilot programs are completed they will develop a model well and then launch into their first development phase. The models will be adjusted as they gain more experience in the play. They will eventually be able to determine where the sweet spots are and that tells them what areas to drill first.

It may be a couple years before the Cline Shale news begins to dominate the shale space but geologists are hopeful it may eventually produce more than the Eagle Ford. The Cline Shale play covers more than 10,000 square miles with an estimated 3.6 million barrels of recoverable oil per square mile. Geologists are saying there could be more than 30 billion barrels of recoverable oil.

Map from TheClineShale.com


The Nasdaq and Russell 2000 rallied to close at new highs on Friday. The Dow is still lagging but managed a +1% gain for the week.

Earnings are now the focus for investors and despite several high profile misses the majority of companies have exceeded estimates. If this trend continues we could see the markets continue to move higher into November. The wild card is the mutual fund fiscal year end on Oct 31st. They will have to balance their desire to take profits with the desire to have winners in their portfolio for the year-end statements.

Crude prices continue to remain stable with WTI showing solid support at $101 and Brent holding on to the $110 level. While the majority of factors suggest prices should be declining the solid support suggests the next move could be higher as winter demand picks up.

Jim Brown

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