Friday Was a Preview

Jim Brown
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The +7% spike in oil prices on Friday was a short squeeze triggered by a news headline. While this may not be the beginning of a return to $70 oil it was a preview of how that return will begin. Oil prices will eventually stop going down and investors will become restless while shorts will continue loading the boat on every minute dip. A headline will appear and a short squeeze will result and the low prices will begin to fade.

Friday's spike was "reportedly" due to a headline about ISIS pushing their attacks closer to the Kurdish oil fields in Iraq. Those fields are critical to maintaining and increasing Iraqi production. They are thought to contain more than 10 billion barrels of oil so it is important to keep ISIS away from this area.

The prior week hedge funds cut long positions in energy futures for the first time in three weeks and increased bearish bets to the highest level since September 2010. The market was primed for a short squeeze and the Iraqi news may have caused it. However, when the real market bottom appears the squeeze will not be a one day wonder. We could rebound from $47 to $60 in a very short period of time.

Iraq agreed to a deal with the Kurds on December 2nd to allow the Kurds to export oil over the Kurdish pipeline to the Turkish port of Ceyhan. The deal will allow shipment of 250,000 bpd of Kurdish crude in addition to 300,000 bpd of Iraqi crude from northern Iraq. The pipelines had been moving about 400,000 bpd before the agreement. That will escalate to 1.0 mbpd by the end of 2015 according to Kurdish officials. If ISIS really was in danger of occupying this area it would be a major blow to Iraq and produce a major spike in oil prices.

Iraqi production has surged to more than 4 mbpd and a 35-year high in December but slowed slightly in January due to a slight decline in southern exports. The schedule of loadings for February will be at another record high.

OPEC supply averaged 30.37 mbpd in January, up from 30.24 mbpd in December. The largest increase came from Angola, which rose +160,000 bpd to 1.8 mbpd. Output would have been even higher except for some port delays.

Nigeria also boosted exports despite outages on the Forcados and Nembe Creek pipelines. Saudi Arabia is holding its production at recent highs with the Saudi Aramco chief saying it was at 9.8 mbpd currently.

Libyan production remains constricted by fighting at 350,000 bpd and that is not expected to change in February.

OPEC's Secretary General al-Badri said in London that prices may have reached a floor. Other OPEC members have echoed this message. "Prices are stabilizing but the world economy is not very strong and inventories are still too high" according to one Gulf producer.

Badri said oil prices "should remain at this level for another month but I am sure the price will rebound." He also said OPEC is open to talks with outside producers like Russia, Brazil and Mexico about joint production cuts.

I believe we are nearing the rebound point in oil prices. The rapid decline in capex and the dramatic decline in active rigs are going to have a significant impact on future production probably a lot earlier than most expect it.

Active Rigs

The number of active oil and gas drilling rigs has fallen -388 from 1,931 in September to 1,543 today. The last seven weeks have posted the sharpest decline since records were started in 1987. Oil rigs declined -94 for the week to 1,223. Active gas rigs rose +3 to 319 and up from the 18 year low of 310 two weeks ago. The prior low set on April 4th, 2014.

Canadian rigs declined -38 to 394. This compares to 608 for the same week in 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

Crude inventories rose another 8.9 million barrels to 406.7 million and the highest level for January since 1930. Crude inventories have risen +24 million barrels over just the last three weeks. Refinery demand for crude rose by +347,000 bpd. Refinery utilization rebounded from the multi-month low at 85.5% last week to 88.0%. Imports rose +204,000 bpd. U.S. production rose to 9.213 mbpd and the highest level since 1986.

Cushing inventories rose +2.1 million barrels to 38.9 million.

Gasoline inventories fell -2.6 million barrels to 238.3 million. Gasoline demand rose +171,000 bpd while imports declined -86,000 bpd.

Distillate inventories declined -3.9 million barrels to 132.7 million. Demand rose +43,000 bpd to multi-month highs at 4.57 mbpd and imports increased +171,000 bpd.

U.S. oil demand is up +4% over the same period in 2014 and we can thank low prices for that increase. It should take another 3-6 months for global demand levels to increase another 500,000 bpd as a result of low prices. Consumer spending habits are slow to change.

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

Propane inventories declined by -1.94 million barrels to 69.31 million. Demand declined slightly from 1.66 mbpd to 1.61 mbpd. With the cold weather continuing this week we should see higher demand over the next several weeks.

Natural gas inventories declined -94 Bcf to 2,543 bcf. Inventories are now -3.0% below the five year average at 2,622 Bcf and +14.6% above year ago levels at 2,219 Bcf. The recent cold weather caused the surge in demand but the big blizzard missed New York. With only 7 weeks left in winter there will be no gas shortage like we had in early 2014. With 2543 Bcf in storage and an average of -200 Bcf in weekly demand that will only deplete 1,400 Bcf unless a new ice age suddenly descends on the Northeast.

After inventories being low for the last year they are right in line with the five year average today.

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


The market sold off on Friday again on weak economics and weak earnings. Futures opened up +5 on Sunday evening and slowly declined to -3 before rebounding back into positive territory. About the only thing we can be sure of for next week is more volatility and more whining about the strong dollar eating corporate earnings. The markets are down -3% for the year and Santa failed to call on Broad and Wall. In theory this is supposed to predict a weak market for the rest of the year but in 4 of the last 5 years where January was down the market ended the year higher.

Jim Brown

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