No End in Sight

Jim Brown
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Crude prices are at two-year lows and some analysts are calling for even more declines. Equities are approaching -5% on the big caps but the Russell 2000 is already down -12.8%. S&P futures are down -10 late Sunday night with WTI futures down -1.25 to $84.50.

Where will this end? The energy sector has got to be approaching what would be considered a decent inflection point. WTI at $85 and Brent at $89 is a pain threshold for a lot of marginal producers. Even OPEC members with a lifting cost under $20 are hurting because they need high oil prices to support their government budgets. Profit is not the key for them. It is cash flow. Other than Saudi Arabia they can't just pump anther 500,000 bpd to make up the difference. This means they are getting $25 less per barrel today than they did in June. When you pump 1-2 million barrels per day that turns into a lot of money.

Some oil analysts are now predicting prices for WTI as low as $65 with put option open interest increasing at the $77.50 level. This came after Iran said it would sell its oil to Asia at the biggest discount in almost six years in order to match price cuts from Saudi Arabia. Last week Saudi Arabia reduced the price of crude to Asia to the lowest price since December 2008.

The problem they are both facing is a slowdown in China. Oil consumption is slowing and there are competing cargos from Russia and Latin America. Venezuela did a deal with China several years ago to finance drilling in Venezuela. In return China gets the oil at dirt cheap prices. That oil is finally making its way to China at a time where the U.S., Venezuela's biggest buyer, does not need as much as it did in years past.

U.S. production hit 8.875 mbpd last week and a 28 year high. That is the highest production level since March of 1986. Production could hit 9.0 mbpd by yearend and the EIA expects 2015 production to average 9.5 mbpd and the most since 1970. Imports were 7.7 mbpd compared to 10.3 mbpd in October 2008. That 2.6 mbpd difference is going somewhere else today and negatively impacting the market price.

As Saudi Arabia increases its production to offset the lower prices it is hurting everyone in OPEC and they are sure to catch a lot of flack from fellow members. It may not matter to Saudi since the cartel members rarely get along anyway.

Nigeria is already having trouble selling its oil. About half of Nigeria's production for November remains unsold and this is light sweet crude. Normally more than 75% would have already been presold. Angola has already cut their prices and about 85% of their November production has already been sold.

OPEC members may be denying there is a price war but everyone appears to be lowering their prices to insure their oil gets sold.

WTI prices have declined more than 20% from their June peak and Brent is down more than 22%. The -20% level is typically considered a bear market and energy equities are definitely in a bear market.

OPEC is producing more but selling less and that glut has the market worried. OPEC increased production by 402,000 bpd to 30.47 mbpd in September. That is the biggest increase in three years and the highest production in over a year. Most of that came from Libya with average production of 800,000 bpd in September and the highest level in a year. If they put an end to the fighting they could ramp back up to the 1.4 mbpd they had before the civil war.

Russia increased production by +0.7% to 10.61 mbpd and is within 0.3% of a post Soviet record.

The EIA is not too concerned about the drop in oil prices. They released their latest forecast on Thursday claiming WTI will average $94.58 in 2015 and Brent will average $101.67.

Non-OPEC production is expected to increase this year by +3.4% to 55.98 mbpd, up +70,000 bpd from the EIA's last forecast. In 2015 non-OPEC supply is expected to increase +1.2 mbpd from 2014 levels to 57.15 mbpd.

OPEC is expected to produce 29.68 mbpd, a slight decline from September. Excess OPEC capacity is expected to be 2.99 mbpd in 2015 with more than 2.0 mbpd coming from Saudi Arabia.

Global demand is expected to average 91.47 mbpd for 2014 and jump to 92.71 mbpd in 2015.

The EIA expects OECD consumption to decline by -200,000 bpd in 2015 and Japanese consumption to decline by -140,000 bpd. Japan is currently burning some oil to produce electricity until their nuclear plants return to operation.

Unplanned OPEC supply disruptions in September averaged 2.2 mbpd. If that supply from places like Yemen, Syria and Nigeria were to suddenly come back online we would have a huge oil glut and prices really would fall.

Oil Inventories

Crude inventories surged last week by +5.0 million barrels. That was significantly more than the expected increase of 1.7 million barrels. The reason for the spike was a +428,000 bpd increase in imports. Refinery utilization declined from 89.8% to 89.3% and reduced the demand for crude by -135,000 bpd. U.S. production rose +38,000 bpd so all the factors were in place for a rise in inventories.

However, inventories at Cushing declined unexpectedly from 20.5 million to 18.9 million barrels. I suspect that was a blip on the input side rather than a sudden burst of oil withdrawals.

Gasoline inventories rose +1.2 million barrels despite a decline in demand of 15,000 bpd, a drop in imports of 87,000 bpd and a drop in production of 171,000 bpd. How is that possible? Enquiring minds want to know. Inventories are still -4.6% below year ago levels.

Distillate inventories rose slightly by +400,000 barrels compared to a -2.9 million barrel decline last week. Distillate demand crashed unexpectedly with a decline of -619,000 bpd. That is huge and is probably related to the major outage at the Chicago airport with more than 2,500 flights cancelled. Production declined -159,000 bpd and imports were basically flat.

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

Propane inventories rose 1.08 million barrels to 80.65 million. Inventories are at the highest level since October 1998. Demand rose to a four month high from 1,160,000 bpd to 1,400,000 bpd. Propane supplies are not likely to run short this winter. This week is typically the peak inventory level for the season.

Natural gas inventories rose +105 Bcf to 3,205bcf. Inventories are still -10.5% below the five year average at 3,583 Bcf. There are only 3 weeks left in the injection season and at the current rate we may only reach 3,500 Bcf. That is still about 400 Bcf below where we need to be going into the heating season.

The blue line in the chart below shows the current inventory relative to the five year average.

There are two storms in the Atlantic but neither is going to be a threat to the Gulf of Mexico. Gonzalo is tracking for a turn to the north to follow Fay into the open ocean. The hurricane season is rapidly coming to a close without a major storm. Rigs in the Gulf are safe for another year.


The S&P futures are down -9.50 early Monday morning and it appears Monday will be another volatile day in the markets. With the S&P sitting right on its 200-day average we could be in for a breakdown at the open. However, with the bond market closed the trading activity could be subdued. If the Russell 2000 continues lower we can expect the energy sector to follow since quite a few energy stocks are considered small cap. Obviously Exxon, Chevron and Conoco would be the exception but they have been hit hard as well.

Jim Brown

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