$700 Million Well

Jim Brown
 
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If oil is as plentiful as many writers would have you believe then why is Exxon spending $700 million on one well?

Obviously we know the answer. Oil is not as plentiful as everyone believes because nearly all the majors reported production declines as the depletion monster continues to eat away at their existing fields. I wrote about this a couple weeks ago but an article I saw this weekend rekindled my interest.

On Saturday Exxon began drilling the Universitetskaya project in the Arctic Ocean. This is a joint project with Russia's Rosneft and the first of 40 such wells that will be drilled by 2018. This effort by Exxon is not impacted by the sanctions since the contracts were signed a couple years ago.

Oil and Gas exports from Russia bring in about $300 billion a year or one-third of Russia's budget. They currently produce just over 9 million barrels per day of oil but production is declining. They have to expand their horizons to locations where they have never looked before.

The seismic data from the Arctic Ocean where these wells are going to be drilled indicate a geologic structure the size of Moscow that could contain as many as 9 billion barrels of oil. Just drilling these deepwater wells in a very inhospitable climate is only the first challenge. If the wells are successful the next struggle will be to build production platforms where waves can reach 100 ft and temperatures -40 degrees with icebergs as frequent visitors. There is no sunshine in November through January.

The West Alpha rig was leased from SeaDrill (SDRL) and is currently 72 miles off the coast of the island of Novaya Zemlya. The island has a population of 2,716. Originally it was populated by indigenous people that existed on fishing, hunting, trapping, reindeer herding, polar bear and seal hunting. In 1943 it was a Nazi seaplane base for spying on Allied ships en route to Siberia. The population was resettled on the mainland in the 1950s when Russia commandeered the island as a military base for interceptor aircraft and for logistical support for a nearby nuclear test area. In October 1961 it was the site of the Tsar Bomba test. That was the largest nuclear weapon ever detonated. Over its history as a test site 224 nuclear weapons were detonated on Novaya Zemlya. The last test was in 1990. I am surprised there is any island left after that many tests.

The fact it was a nuclear test site goes to show how remote the island is and why any oil production from that region is going to involve significant challenges. This also illustrates what great lengths the oil companies are willing to undertake to find undiscovered oil. All the discovered oil is depleting at roughly 7% per year so companies like Exxon have to find huge fields in order to slow their production declines.

It remains to be seen if Exxon will be successful. Shell tried to drill north of Alaska two years ago and gave up. The weather conditions and icebergs made it commercially impossible. Even if they had found oil they would have had the same challenge in getting it to market.

To further illustrate the absurd lengths Exxon is pursuing, how many onshore wells could Exxon drill for $700 million? Also, this is just the first of 40 planned wells so multiply out the eventual cost. Exxon could buy the entire Gulf of Mexico for the money they are spending on the Arctic. At least the weather would be easier to manage.

Oil Inventories

Oil inventories declined -1.8 million barrels to 365.6 million. This was slightly more than the -1.5 million estimate. Crude imports declined -181,000 bpd and production rose by 10,000 bpd. The decline in inventory levels would have been worse but refinery demand declined by -158,000 bpd.

We are reaching the point on the calendar where demand is going to slow. The Labor Day holiday is the last driving weekend before Thanksgiving. Once past Labor Day the refiners will begin shutting down processes for maintenance and demand for oil will decline.

Refinery utilization declined from 93.5% to 92.4% but anything over 90% is still strong. Product supplied rose to a 2014 high at 20.34 mbpd. This is probably a result of the high utilization for the prior two weeks finally being accounted for in inventory.

Cushing inventories rose slightly to 18.0 million barrels. Cushing inventories have fallen -22.7 million barrels (-56%) since January. This is the lowest level since 2008 and for this time of year since 2004.

Gasoline inventories declined by 4.4 million barrels and the first decline in five weeks. As we approach Labor Day we should see gasoline levels drop as it is pushed out to the retail market in time for the driving demand. Once past Labor Day inventory levels will decline quickly as refiners, storage and pipeline operators begin to flush the summer blends through the system before the refiners begin making the winter blends.

Gasoline imports declined by -167,000 bpd and production rose by +422,000 bpd. However gasoline demand rose to the high of the summer at 9.36 mbpd. Gasoline inventories are already 4.4% below year ago levels.

Distillate inventories declined by -1.8 million barrels as production dropped -182,000 bpd. Imports were nearly unchanged at +13,000 bpd. After Labor Day homeowners will start topping off their heating oil tanks in preparation for the winter.

In the graphic below green represents a recent high and yellow a recent low.





Propane inventories are soaring. Inventories rose +1.3 million to 68.48 million barrels and nearing the top of the five-year average range. This is +10.8% higher than the same period in 2013. After the propane shortage last winter it appears managers are stocking up as fast as possible.

If you need propane for the winter now is the time to buy it. Demand has risen for the last three weeks. Prices are going up after Labor Day.


Natural gas inventories rose +82 Bcf to 2,389 Bcf last week. Gas inventories are still 18.4% below year ago levels and 20.3% below the five year average. However, with 80+ Bcf additions over the next 12 weeks that would add nearly another 1 Tcf to supplies and bring the ratios back into balance ahead of the heating season that begins on November 1st.

The continued mild summer weather in most parts of the country is preventing utility companies from consuming huge amounts of gas. This is allowing supplies to build rapidly.

Summer weather did arrive to some parts of the country and prices ticked up slightly. If we continue to see these large builds the price will have a tough time moving over $4 again.

Where I live in Colorado the low tonight is expected to be 41 degrees. We have only had 5 days this summer with temperatures over 80 and 1 day over 90 and those intraday spikes were brief. I think we skipped summer this year.


Inventories of gas in storage rose more than 1 Tcf since mid-April for the fastest gain in more than 11 years.


Market

The S&P futures are up +2 points late Sunday night so we could start the week off with a bounce. However, that is down from the +6 points earlier in the session. I would be careful about new long positions until we see how the market digests the Friday short squeeze. This is still August and the worst month of the year BUT expiration week is the best week in August.

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Jim Brown

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