Drilling Already Slowing

Jim Brown
 
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The drop in crude prices has already prompted a decline in drilling activity. You could not tell from the weekly rig counts because they are still flat but that just means the rigs drilling last week were still drilling this week. You have to look out farther than that to see what is coming.

Reuters reported a drop in new well permits of almost 40% in November. In an industry filing by data firm Drilling Info new well permits approved in November declined from 7,227 to 4,520. This is a monster drop and suggests a corresponding drop in production growth 6 months from now. That is how long it takes to permit, drill, complete and connect a new well to production.

Drilling permits are a snapshot of what rigs will be doing 60-90 days in the future. This was the first steep decline in shale drilling since the boom began in 2007.

The Permian Basin posted a -38% decline in permits. The Eagle ford declined -28% and the Bakken -29%.

Some of that decline could be related to the onset of winter and a slowdown in the pace of drilling but I would bet it is mostly related to the price of oil. Nobody wants to drill unprofitable wells.

The active rig count rose +3 rigs last week but we can expect this to be very close to a peak given the permit data above.

Some analysts are predicting significantly lower prices for crude in the weeks ahead. A news headline out on Friday alerted us to new supply coming from Iraq. The Iraqi government signed a deal with the Kurds that will add 250,000 to 300,000 bpd of oil to Iraq's exports. The deal allows up to 550,000 bpd of Iraqi crude to be exported from Kurdistan across Turkey by pipeline to the Turkish port of Ceyhan. Kurdistan was already shipping about 220,000 bpd through the pipeline.

Not only does this bring more oil to market but it now makes Kurdistan oil legal. The Kurds had been struggling to sell their oil because Iraq had been threatening to sue anyone that bought it. The disagreement is over who actually owns the oil. The agreement last week provided legitimacy to the Kurdish oil sales and now that oil will flow freely to market along with another 300,000 bpd of Iraqi oil.

Iraq exported 2.51 mbpd in November. That will rise to nearly 3.0 mbpd in December. Oil from the Kirkuk field is being exported again after being halted by attacks on the pipeline earlier in the year.

OPEC members pumped 30.56 mbpd in November, down -424,000 bpd from October. OPEC is already slowing production but they never announced this to the world.

Analysts claim there is a 1.8 mbpd surplus of production over demand. However, the low oil prices are already boosting demand. U.S. gasoline demand rose from 8.84 mbpd on October 17th to 9.43 mbpd last week. That was an increase of 590,000 bpd or roughly +5% thanks to the lower gasoline prices. Goldman Sachs predicted for every 25 cent decline in gasoline prices we could see a global demand increase of 500,000 bpd. With gasoline down from an average of $3.31 in June to $2.75 today that could easily equate to an increase in demand of 1.0 mbpd or more than half of the current production surplus.

Historically when gasoline prices fall is takes a few weeks for driving habits to change. This suggests the biggest increase in demand is still weeks in the future. AAA now believes we could see prices decline into the $2.50 range by the end of December. Some states will see prices under $2. Oklahoma had posted prices at $1.99 going into this weekend.

The energy sector is no stranger to bear markets and cleansing itself of the operators that over leveraged themselves with debt. High oil prices can cover over a multitude of sins but when prices decline sharply about once a decade those over leveraged companies are exposed and end up on the auction block.

Analysts believe as many 10-15 of the minor drillers could go bankrupt if prices were to stay low for 6 months or more. The high yield debt market where drillers borrow money to buy leases, equipment and to fund drilling, contains roughly 18% of its loans from drillers. The $90 billion in debt owed by these drillers is now really high risk and its market value is dropping rapidly.

Producers like EOG that hedged their production will survive with little interruption. EOG has much of their production hedged at an average of $90 per barrel for 2015.

Continental Resources (CLR) said last week that 2015 production will rise between 23% to 29% despite a sharp decline in capex expenses. They are planning on spending $4.6 billion to drill 350 new wells. That is a -12% decline in capex from previously announced levels.

Shale drillers are going to be shifting rigs from high cost areas to low cost areas until the bear market fades away. Continental said it could be profitable in some areas with oil as low as $25. These prolific areas will heat up and the high cost areas will turn into ghost towns.

These bear markets in oil come about routinely and long time producers have learned how to cope with the wild ride. It is the new and aggressive drillers that will see their hopes and dreams dashed.

Oil Inventories

Crude inventories declined -3.7 million barrels last week as opposing events clashed. The first event is the normal decline in inventories into the end of December so that refiners can pay less property taxes on oil in inventory at year end.

The second event was the surge in gasoline demand and the spike in refinery utilization to 93.4% a number unheard of for this time of year. Refiners are running flat out because oil prices have fallen faster than gasoline prices and profits are expanding. This surge in demand is helping deplete crude inventories and stuffing their coffers with cash at the same time.

Crude demand rose +399,000 bpd and crude imports declined by -177,000 bpd. Refiner inputs of crude rose to 16.54 mbpd and the highest level in months.

Gasoline inventories rose +2.1 million barrels thanks to a rise in imports of +284,000 bpd. Inventories are still -1.8% below year ago levels.

Distillate inventories rose +3.0 million barrels after a 5-week decline. Distillate demand imploded with a drop of -546,000 bpd. This was probably due to a lot of truckers staying home for the holidays or simply a decline in demand after everyone stocked up the prior week ahead of the holidays. Demand the prior week of 4.12 mbpd was a multi month high.

Distillate inventories in the Midwest in the prior week were the lowest on record since the EIA began publishing data in 1990. Analysts chalk this up to unplanned refinery outages and a large harvest that consumed more diesel than usual. Inventories in the Northeast are also low. More than 27% of the homes in the Northeast rely on heating oil for heating. The early arrival of severe winter weather has been a drag on inventory levels.

Crude imports declined from 7.5 to 7.3 mbpd. U.S. production rose to a new 28 year high at 9.083 mbpd. Cushing inventories declined slightly to 23.9 million barrels.

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


Propane inventories rose slightly by +.22 million barrels to 79.42 million. Demand declined slightly from 1.55 mbpd to 1.24 mbpd.

Natural gas inventories declined -22 Bcf to 3,410 bcf. Inventories are now -9.8% below the five year average at 3,782 Bcf and -6.2% below year ago levels at 3,637 Bcf.

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


Market

The market ended the week at new highs on the Dow and S&P. Crude prices continue to fall and this should weigh on energy stocks next week. With crude trading at $65 Sunday night it is possible we could see $60 in the near future. This is a test for OPEC or specifically Saudi Arabia. Their cash pile is shrinking as each day passes. There is a rumor that OPEC will call an emergency meeting in January. If that is correct the announcement of that meeting will be the bottom for oil prices. There is no reason to call an emergency meeting if they are not planning on cutting production.

Jim Brown

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