Energy Decline Continues

Jim Brown
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Oil prices may have held at the $45 level for the past week but that is no guarantee it will continue. Analysts continue to predict $30 oil despite the enormous damage that will cause to the U.S. economy and to the energy sector as we know it. Layoff announcements are increasing and with the energy earnings cycle just ahead there are sure to be even more dismissals.

Baker Hughes was the latest to announce a major layoff with 7,000 workers getting a pink slip because of the drop in crude prices. That represents 11% of their workforce. Halliburton said it was cutting 1,000 workers and warned 2015 could be "challenging" for the sector.

So far there have been more than 30,000 layoffs and those are just from the companies I saw in the news this weekend.

Announced Layoffs

Pemex 10,000, up to 50,000 possible.
Schlumberger 9,000
Baker Hughes 7,000
Halliburton 1,000
Suncor Energy 1,000
US Steel 756
Ensign Energy 700
Hercules Offshore 324
Talisman 300
Apache 250
Civeo 200

This does not count the thousands of people who have lost their jobs because of the slowdown in activity in the drilling sector. Entire towns count on the oilfield workers for their livelihood and with drilling activity down 15% in just the last few weeks those towns and service businesses are suffering.

BHP Billiton said on Friday it would shutdown 40% of its shale drilling rigs by June to leave it with only 16 operating rigs. The company said it could concentrate its remaining force towards Eagle Ford production. BHP said it would also take a $250 million write down on its U.S. drilling business.

The company said it would make further reductions if "deferring development will create more value than near term production."

Continental Resources said it would not add any rigs this year and contrary to prior plans. Matador Resources, Concho Resources and Laredo Petroleum all announced spending cuts for 2015.

With the vast majority of energy earnings not until February they still have a couple weeks to clean up their spending plans before they announce the cuts with their earnings reports. It is going to be an ugly quarter for energy stocks and Q1 is not going to be any better if prices remain under $50.

On the positive side oil prices have declined -50% only 5 times in the last 30 years. Each time prices rebounded +50% over the next six months. This time may be different since in each of the last declines there were external factors and/or OPEC immediately cut production to stabilize prices.

In 1998 the decline was caused by Saudi Arabia in an effort to stop cheating on quotas by the rest of OPEC. They drove prices down to $10 and forced the other OPEC members back to the negotiating table and that allowed the prices to remain relatively stable for the next ten years. In fact it was so successful in halting cheating that demand caught up with supply and prices shot up to $147 in 2008.

Saudi Arabia is caused the same decline in 2014. When the November meeting failed to set a quota reduction Saudi said "Why should we cut production if nobody else in OPEC is going to cut." Now three months later they may be regretting their decision. However, the new king has reaffirmed the oil policy of King Abdullah and prices quickly fell back below $45. Saudi Arabia declared a new optimistic budget for 2015 and one that may not be possible at $45 oil. There are some analysts that believe the new king will see the red ink and decide to force a production cut by OPEC members. Time will tell.

Former Shell president, John Hofmeister, is predicting $80 oil by the end of summer. I certainly hope he is right but I have my doubts. Hofmeister compared the oil crash to a big truck slamming on its brakes to avoid an accident. Once it restarts it does so slowly and has to go through many gears before it gets back up to cruising speed. He said the truck has stopped but not yet pulled around the wreck and moved back on the highway. Once it does the price appreciation will be fairly rapid.

Boone Pickens expects oil in the $70-$80 range by year end. He correctly points out that oil at the current level is going to decimate current drilling programs and the entire sector is going to seize up. Production will drop sharply within six months because of declines on existing wells. Once production begins to decline the price will rise in anticipation of the glut being erased.

Restructuring firm Conway Mackenzie warned last week that "drillers are going to die" in Q2 because of lower oil prices. They said oil field service providers, those companies that supply equipment, line wells with cement, provide testing services, etc, would be the first to die. The oil companies are demanding 20-30% price reductions on their services while at the same time only contracting for 50% of the services they used in 2014. They are also demanding longer payment terms on their bills. Conway Mackenzie said the second quarter is going to be devastating for the service companies and companies are going to die.

Cash flow shortages are going to increase and companies with a lot of debt are going to quit paying their bills. The company warned service companies to only work for drillers that have hedged 2015 production in order to protect their cash flow. CEO John Young said service companies have to monitor how much of their revolving loans the drillers have used and immediately begin filing liens on the wells if payments begin to slow. Young said at $65 he expected a lot of restructurings where his company would sell off specific assets to raise money for the driller. At $45 Young believes companies will skip the restructuring step and go right into liquidation because of the amount of debt that was based on $100 oil.

Southern Pacific Resource Corp, a Canadian oil sands company, filed the equivalent of Chapter 11 bankruptcy in Canada last week after it missed a $4 million interest payment on its convertible debt. Legendary oil trader, Andrew Hall, warned in early January that oil sands companies were going to be the first to fail because of their high production costs. Extracting bitumen from the tar sands can cost $60 to $100 a barrel depending on the location of the source sand. That bitumen sells for less than WTI because it has to be blended with lighter crudes to make it flow through the pipelines. Typically the extra light oil produced in place like the Eagle Ford is used for blending. Southern Pacific borrowed up to $600 million to develop fields in the Athabasca oil-sands fairway thanks to the lowest borrowing costs on record.

Connacher Oil & Gas, which also operates in the Albertan oil sands said last week it was seeking a buyer because of liquidity problems. We can expect to see this play out all over North America over the next several months. Cheap gasoline comes with a price and that price is going to be multiple fatalities in the energy sector.

Enterprise Product Partners is trying to find a buyer for a year's supply of ultra-light oil to the global market and not having any luck. The company is trying to market 600,000 barrels per month of condensate starting in March. Enterprise received permission from the government to ship the lightly processed oil from U.S. shale formations. The recently received government permissions to export condensate could put an extra 1.0 mbpd of crude on the export market by the end of 2015 according to Citigroup. Japan and South Korea have previously bought single cargoes. The ultra-light oil is used to blend with the heavy sour crudes from the Middle East and South America.

Raymond James said U.S. gasoline demand is poised to grow the most since the 1970s as low prices boost consumption. Demand is expected to rise +300,000 bpd in 2015 according to Raymond James. Goldman Sachs previously said they expect an increase of 500,000 bpd. Gasoline prices have declined for 119 consecutive days and averaged $2.03 on Friday. The lowest prices were $1.49 in Oklahoma. It normally takes about six months for demand patterns to change. Consumers don't believe the price decline will stick and when it does their consumption habits change and that is about the time prices rise again.

President Obama took aim at Alaska and future energy production this weekend when he called for Congress to designate more than 12 million acres of the Arctic National Wildlife Refuge as "wilderness" area and effectively banning drilling for decades to come. One 1.5 million acre section on the coastal plain has more than 10 billion barrels of oil according to USGS studies. Alaskan senator Lisa Murkowski, chairwoman of the Senate's energy and natural resources committee immediately responded. The announcement amounted to a "stunning attack on Alaska's sovereignty." With the republican controlled congress the proposal by the president has little to no chance of passage just like all the tax hikes he proposed in the SOTU speech. The president said the biggest problem facing the U.S. is climate change. In referring to the terrorist and economic problems he said the "window of crisis has passed." Unfortunately we don't live in a world where just saying something makes it true. Ignoring the rising terrorist threat, the potential economic impact of dramatically low oil prices and the meltdown in Europe does not make those problems disappear.

Europe will be a challenge for the market this week because the election in Greece went to the far left Syriza party. They want to abandon all the austerity programs, refuse payment on the 200 billion euro bailout by the Troika and potentially withdraw from the eurozone. It is going to be a challenging week for Europe.

Active Rigs

The number of active oil and gas drilling rigs has fallen -298 from 1,931 in September to 1,633 today. The last six weeks have posted the sharpest decline since records were started in 1987. Oil rigs declined -43 for the week to 1,317. Active gas rigs rose +6 to 316 and up from the 18 year low of 310 the prior week. The prior low set on April 4th, 2014.

Other than during the financial crisis the number of active rigs has been above 1,700 since the beginning of 2006. We are poised for a significant decline, possibly to the 1,100 level. The pace of decline will scare additional companies into panic mode.

Baker Hughes warned that in those previous oil declines of 50% or more the active rig counts declined by 40% to 60%. So far we are only down -15% so we have a long way to go. A 50% decline in oil rigs would be -805 from the 1,609 peak on October 10th. So far we have declined -292 oil rigs so we could lose another 500 before it is over.

Oil Inventories

Oil inventories posted the biggest weekly gain since March 2001 adding a whopping +10.1 million barrels. Now that the yearend property tax deadline is well behind us refiners are allowing stocks to build using the cheapest oil since 2009.

Refinery utilization fell to 85.5%, down from 95.4% just six weeks ago. That is the lowest level since April 2013. The -5.5% decline from last week was the biggest drop since September 2008. After running flat out for the 8 weeks leading up to year end the refiners are taking a break for maintenance. Also, with gasoline prices so low the profits from refining gasoline are very tight. There is no incentive to run at peak speed just to make a few cents per barrel.

Crude inventory levels rose to 397.9 million barrels and the highest level since May. Cushing inventories rose +2.9 million barrels to 36.8 million and a multi-month high.

Gasoline inventories rose only slightly by 600,000 barrels as a result of the decline in refinery utilization. Inventory levels of 240.9 million barrels was the highest since February 2011.

Distillate inventories declined -3.3 million barrels after 4 weeks of large builds. The drop was due to a sharp +581,000 bpd increase in distillate demand.

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

Propane inventories declined by -3.61 million barrels to 71.25 million. Demand rose sharply from 1.30 mbpd to 1.66 mbpd. With the cold weather continuing this week we should see higher demand over the next several weeks.

Natural gas inventories declined -216 Bcf to 2,637 bcf. Inventories are now -5.5% below the five year average at 2,790 Bcf and +8.2% above year ago levels at 2,438 Bcf. The recent cold weather caused the surge in demand and it could last until the end of January according to Accu-Weather. The Northeast is under blizzard warnings for this week.

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


The market sold off on Friday ahead of the Greek elections and futures are down -12 points late Sunday night. The Syriza party won the election and this will throw the European markets into turmoil. This could be a rocky week for U.S. markets with the European backlash, FOMC decision and the GDP for Q4.

Jim Brown

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