Oil Prices Under $50

Jim Brown
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That is the headline we are likely to see early next week as the last round of portfolio restructuring hits the energy sector. I have warned for a couple weeks we could see a test of that level but I don't think it will last more than a few days. Oil at $50 is simply too low.

With companies slashing their spending for 2015 and one company halting operations completely (AMZG) the future is clear. Crude production is going to slow in 2015 and potentially faster than anyone could have expected.

OPEC production declined only -1% in December to 30.239 mbpd and that was probably due to an output drop from Libya because everyone else is pumping every barrel they can to make up for the drop in price. Saudi Arabia did cut production -150,000 bpd to 9.5 mbpd but that was likely a production delivery issue rather than an outright cut. Saudi warned last week they were considering increasing production to 12.5 mbpd if they could find buyers. That may have been just an idle threat designed to strike fear into the market.

The Libyan civil war continues to cause trouble with production. A tank farm at the port of Es Sider caught on fire due to fighting in the area. More than 1.8 million barrels of oil burned. Total damage from the attack is estimated at $213 million but the slowdown in exports and the time to repair the damage is the real problem. However, it did force Libyan exports below 300,000 bpd and well below the 580,000 bpd in early December. That December level was below the 800,000 bpd three months ago and the 1.585 mbpd before Qaddafi was removed from power. If there was peace in Libya our oil glut would be a lot worse.

The UAE cut production by -100,000 bpd because November production filled up Japanese storage facilities where their oil is sold. The weakness in the Japanese economy is reducing demand in that country.

Iraq exports rose +150,000 bpd to 3.52 million and the most since 2000. It was the largest increase in the OPEC nations. The Iraqi government reached a deal with the Kurdish region to export more oil and that began flowing in late December. Iraq exported about 180,000 bpd of Kirkuk oil before the agreement and now they can export 300,000 bpd through the Kurdish pipeline.

Nigeria produced an additional 110,000 bpd raising their total to 2.08 mbpd. After a month without any major militant attacks Shell lifted the Force Majeure and resumed production at the EA field when repairs were completed.

Oil supplies from Russia rose to the highest level in decades as that country tries to compensate for lower prices by producing more oil. Russia produced a post Soviet record of 10.667 mbpd in December. That is very close to Russia's capacity limits. If they try to force more oil out of the ground they will damage their wells and reduce future capacity. The prior record was 10.64 mbpd in October. In the Soviet era their peak was 11.4 mbpd in 1987 but some of those fields are no longer in Russia.

In China the Purchasing Managers Index (PMI) fell from 50.3 to 50.1 and the lowest reading in 18 months. This suggests that China's oil demand will decline further in the coming months. China has been buying huge amounts of oil to fill their strategic stockpile but those tanks are nearing capacity. There were more than 88 million barrels of oil delivered to China in December.

It looks like production will increase in the short term as everyone tries to make up losses by pumping more. However, this will be short lived because of the almost immediate shutdown of drilling in various parts of the world. The Saudi Oil minister reminded everyone on Friday that Brazil's deepwater subsalt oil was very expensive as are West African wells and the proposed drilling in the Arctic. All of those efforts are going to come to a screeching halt very quickly. Nobody is going to invest more money to produce new oil at $75 a barrel and sell it for $55.

The Saudi Minister said they were comfortable with $20 oil if it forced high priced fields to shutdown and halt exploration. I think the $20 number was voiced simply as shock value but everyone got the general idea. Saudi is going to continue pumping as much as possible to keep prices low and force the high priced producers out of the market.

If they can force Russia, Venezuela and Iran into financial ruin then those countries will not have the money to continue developing new fields or maintain the old ones. All three countries depend on oil revenue for more than 50% of their budgets and that revenue has been cut in half.

Cheap oil is here to stay for the coming months although it may firm somewhat once that $50 level is tested. It will take six months for any material decline in global production and it will accelerate from there. However, prices should return to the $75-$80 level over the next 12-18 months.

Demand is rising quickly thanks to the $2.20 gasoline in the U.S. with similar declines around the world.

Remember, U.S. shale wells average a 70% decline in production in the first year and falling to an 85% decline by the end of the second year. All Saudi Arabia has to do is prevent new wells from being drilled for a year and U.S. production could decline by more than 1.0 mbpd. After two years it could drop another 1.0 mbpd.

Also, bear in mind that companies drill the easy oil first. That means that drilling in the sweet spots in all the major shale fields is about over. There are only so many drilling locations and then companies have to move towards the edges of the fields where production is lower and it declines faster. With low oil prices the drillers are not going to drill those edges. They will wait for prices to rise before risking the money on what could be a low production well.

Once they start drilling those lower production areas it will take twice as many new wells to offset the rapid decline rate in the earlier high production wells.

I have documented in these pages multiple times the decline rates for various shale fields and the fact that the EIA expected U.S. production to peak in 2016 and begin declining in 2017 and that was at $100 oil. At $50 oil those dates will accelerate closer very quickly. We may never be able to catch the crest of the wave again. This is similar to surfing. As long as you paddle in front of the wave you have a good chance of catching a smooth ride. Once the crest passes you all the paddling in the world will only make you tired and not get you back up on the wave.

Once U.S. oil production begins to decline rapidly as a result of a slowdown in drilling we may never be able to get in front of that rapid decline rate again. Enjoy your $2 gasoline while it lasts.

Oil Inventories

Crude inventories declined -1.8 million barrels last week but they should increase again now that the year end property tax deadline has passed. Inventories at Cushing rose +2 million barrels to 30.8 million. However, the new pipeline to the coast has been completed for an additional 200,000 bpd and the first deliveries were made on December 21st. This will help drain Cushing but it also may entire more producers to send their oil in Cushing's direction rather than by rail car to the west coast.

Refineries ramped production utilization back up to 94.4% in a frantic effort to flush as much oil through the system as possible before tax day. These numbers are for the week ended Dec 26th so production should still be high in the next report. Once we get past Dec 31st they should slow dramatically since we currently have a glut of gasoline. They have been pumping out about 20.0 mbpd on average of refined products since mid November.

Gasoline inventories rose +3.0 million barrels and the 8th consecutive week of gains totaling 28 million barrels. This is why gasoline prices are so low. Gasoline demand rose to a new multi-month high at 9.61 mbpd thanks to the low prices and the fast and furious shopping prior to Christmas.

Distillate inventories rose +1.9 million barrels with demand flat for the last three weeks but also at multi-month highs.

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

Propane inventories declined by -.60 million barrels to 77.24 million. Demand rose slightly from 1.25 mbpd to 1.26 mbpd. With the cold weather this week we should begin to see higher demand over the next several weeks.

Natural gas inventories declined -26 Bcf to 3,220 bcf. Inventories are now -2.5% below the five year average at 3,301 Bcf and +7.8% above year ago levels at 2,988 Bcf. There were big declines in the last four weeks in 2013 and that offset the mild weather we have seen over the last several weeks. The cold weather this week should put the numbers back into relative sync.

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


The market sold off last week and it is looking kind of shaky for Monday. The S&P futures are down -6.5 points late Sunday night. After three years of double digit gains on the S&P we may be seeing investors take a wait and see attitude for January. There are plenty of gains that still need to be captured with sales and until new buyers step up we could continue to see some choppy markets.

Jim Brown

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