Buy Some Gasoline

Jim Brown
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With the price of oil headed back towards $80 and the national average for gasoline at $2.99 and falling about a penny a day it is time to buy more fuel.

While I am joking to some extent that is exactly what happens when fuel prices fall. For every 10% decline in oil prices there is a +0.15% rise in global consumption according to Goldman Sachs. The recent decline in prices should increase global consumption by about 500,000 bpd according to Goldman estimates. Since the oil market is currently oversupplied by about 1.0 million bpd that extra consumption will solve about half of the supply problem.

Everyone is blaming the decline in prices on Saudi Arabia but it is not really their fault. They did increase production to 9.7 mbpd in September but that was only 100,000 bpd over August levels. The problem has multiple faces. Libyan production rebounded from 150,000 bpd to more than 800,000 bpd because of an agreement with the rebels to open up the export terminals they held. Iraq increased its production from the southern region as efforts taken over the last several years with private companies begins to pay off. Iraq is now producing more than 3.1 mbpd. Iran is producing and selling every barrel they can because they know the sanctions are coming back hard on November 24th when no agreement is reached on the nuclear problem. I think it is safe to assume they are black marketing about 1.0 mbpd in excess of their allowed sales of 1.25 mbpd. Iran needs $153.40 per barrel to break even on their budget. Needless to say that is not going to happen without a nuke going off somewhere in the Persian Gulf.

Add in the 30 year high in production in the U.S., which is moving ever closer to 9.0 mbpd in the coming weeks. That compares to only 3.93 mbpd in September 2008. That represents a gain of more than 5 mbpd in the last five years. That is an astounding amount of increased oil production and one reason why OPEC may want to keep prices lower for a few months to choke off additional development.

Russia needs $100 a barrel to cover their budget and they are the second largest producer in the world. I would not be surprised to learn that President Obama made some kind of deal with Saudi Arabia to temporarily lower the price of oil to punish Russia for annexing Crimea and continuing to cause strife in the Ukraine. Saudi Arabia depends on the U.S. for protection and the safety of the Persian Gulf. While Saudi would lose a lot of money if prices remain low they can always make up that loss by producing more barrels. Saudi Arabia has the hammer when it comes to oil prices.

One point worth mentioning is that shale oil fields deplete very rapidly. According to the EIA we lose -1.8 mbpd in existing production every year in the USA. Drillers have to drill enough new wells to find and produce another 1.8 mbpd every year just to stay even. If the low prices slowed new drilling even a little bit that depletion rate would overtake them and production would decline. The IEA said 4% of U.S. production costs more than $80. Sanford Bernstein analysts put it closer to 33%. Shale oil accounts for 55% of U.S. production so there is a definite risk we could see production decline in 2015 if prices remained low.

Sand Update

I have talked about the demand for sand in these pages many times. Apparently I am not the only one paying attention. Baker Hughes and Halliburton both said in their earnings reports they were stockpiling sand so they would have enough to frac customer wells and reduce the impact of future price increases.

Halliburton said it was doubling their railcar fleet and the capacity of sand terminals. The terminals are where the sand is transferred from railcars to trucks for delivery to the wells. As of June 30th Halliburton had about 3,500 railcars under management.

Baker Hughes, the number 3 oilfield services provider, said it had "significantly" increased its railcar fleet and is buying more sand under contract to buffer against price increases.

Baker Hughes said there is a shortage of sand at drilling sites because of the rail congestion problem. With thousands of railcars hauling sand every day plus thousands of oil tanker cars taking oil from the shale plays to the refiners in addition to the thousands of cars carrying agricultural products, building materials, autos, well pipe and of course coal cars by the thousands, the railroads are a permanent traffic jam.

Halliburton said they experienced downtime in Q3 because of the lack of sand deliveries by rail. The company said they had committed about $100 million in 2014 to upgrade its infrastructure to move frac sand to customers. Halliburton signed up 30 additional trucking companies just to transport sand. They also bought large volumes of sand under contract to avoid the 15-20% spikes in spot sand prices. Prices for sand have increased from 5% to 20% in 2014 alone. Sand delivered from Illinois to the Eagle Ford costs $127 per ton on average with transportation and warehousing accounting for about two-thirds of that cost.

U.S. Silica has about 30 transloading terminals for transferring sand from rail to trucks and they plan on investing $300 million to expand the logistics network by 2020 according to CEO Bryan Shinn. They are expecting to add 15-20 locations in the coming years.

Shale drillers are complicating the problem. In an effort to produce more oil at a faster rate they are down spacing wells whenever possible. The closer they can drill wells to each other the more wells they can drill on existing acreage. The trick is not to drill them so close that they steal production from each other. The science of determining the correct spacing for each field is an ongoing challenge. Different layers of rock frac differently and the fracs reach farther from the well bore.

If a company starts out with 50,000 acres with a well spacing of one every 640 acres that limits the number of wells they can drill. If they can down space them to every 320 acres, 160 acres or even smaller than that then the amount of wells they can drill is multiplied many times over. Add in the different layers of production from different zones and drillers can drill 6-8 wells from the same pad in different directions and at different depths. This speeds up the drilling rate since the rig does not have to be moved. Here is a good article on the well spacing problem. Race to Space Wells

The higher number of wells drilled at a faster rate puts even more demands on pipe and sand deliveries. The faster wells are drilled the faster products are consumed and the more congestion on the railroads.

If these weekly commentaries are helping you please let me know. If there is something else you would rather I write about I am open to suggestions. I want to write about what you want to read so shoot me an email and I will do my best to handle your topics.

Jim Brown

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Oil Inventories

Crude inventories are exploding higher with another +7.1 million barrel increase last week. This is the period where low demand and high maintenance outages for refiners normally allow inventories to rise but this is ridiculous.

Crude imports declined -260,000 bpd to 7.48 mbpd but that did not seem to impact inventories. Refinery inputs of crude declined -110,000 bpd so that number does not make sense either. There has to be something in the accounting system that is lagging significantly to account for the inventory gains.

Note in the chart below that the blue line is following the five year highs.

Gasoline inventories declined -1.3 million barrels to 204.4 million and a multi-month low. This is normal because refiners are trying to flush the system of summer blends and then refill it with winter blend fuels.

Distillate inventories rose +1.0 million barrels but supplies have been relatively flat over the last two months. There is nothing to see here, move along.

Refinery utilization declined to 86.7% as a result of the seasonal maintenance. This is normal.

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

Propane inventories rose 0.24 million barrels to 81.61 million. Inventories are at the highest level since October 1998. Demand increased slightly from 1.1 mbpd to 1.18 mbpd. Propane supplies are not likely to run short this winter. This is typically the peak inventory level for the season.

Natural gas inventories rose +94 Bcf to 3,393 bcf. Inventories are still -7.1% below the five year average at 3,731 Bcf. There is only 1 week 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.


The market was very bullish last week and is due for a pause to consolidate. With the FOMC meeting on Wednesday investors could use that unknown outcome to take profits. However, almost every likely outcome would be market positive. Whether that is already priced into the market is unclear. The coming week before midterm elections has been up 75% of the time since 1982.

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Jim Brown

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