$30 Oil is a Reality

Jim Brown
 
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You read every day where some analyst or talking head on TV is predicting oil at $30 because of whatever excuse they are using that day for the drop in oil prices. The next day oil rebounds a buck and analysts are forecasting $65 to $75 before the summer is over. The truth is nobody knows but the bears are closer then they realize.

On March 31st Plains Marketing was paying $31 a barrel for Bakken oil. This is the real price for light shale crude. This is what producers in the Bakken are getting for their oil today give or take a couple dollars depending on whether it is leaving by truck, railroad or pipeline. Each method has a different cost and that is factored into the sales price.

Light oil from the Eagle Ford was bid at $44 because it is closer to the Texas refiners and the cost to ship it by pipeline is a lot cheaper.

In reality oil is already at $30 for every Bakken producer. This is why the number of active rigs in the Bakken has been dropping like a rock. With the average cost of production in the $57 a barrel range in Q4 nobody can make any money drilling wells today. They would rather not drill the wells and save their capital for use in a different field. Unfortunately some of the wells still have to be drilled to anchor the leases with production. If you don't drill and produce something within a certain period you lose your lease. Once there is a producing well the lease is anchored and the producers can go elsewhere and come back later and drill additional wells.

The low cost for light shale oil, which is lighter than WTI, is going to be a continuing problem. The shale producers are really putting the pressure on the administration to cancel the oil export ban that was put in place by Richard Nixon. We don't currently have enough refining capacity in the U.S. to process all the light crude. Many refiners converted to process heavy sour crude more than a decade ago when U.S. production was declining and we were importing huge amounts of heavy oil from Venezuela and OPEC. They spent billions upgrading their refineries to process the heavy oil because U.S. light crude was drying up and heavy crude was cheaper to import. When refined it also produced more products than light crude. There were more high profit distillates like diesel.

If the president were to cancel the export ban there are numerous countries around the world that would like our light crude. This would raise the price of WTI and put it more equal to Brent. IHS Cera believes ending the export ban would add up to $26 billion a year to GDP and support at least 124,000 jobs.

Analysts believe we are right on the verge of reversal in oil inventories. Over the last 12 weeks we have added 89 million barrels into inventory to push inventory levels to a record high of 471 million barrels. That is nearly 150 million above the five year average. Refinery utilization is rising and hit 89.4% last week. As the spring maintenance season ends they are going to come roaring back with a huge appetite for crude. The crack spreads or margins per barrel were more than $12 last week. Since refiners can buy oil at WTI prices or less and sell the refined products at Brent prices they have a built in advantage. Once they all come back online we are going to see inventories begin to decline. This will raise oil prices as speculators position themselves to get ahead of the curve. Refinery used 15.73 mbpd of crude last week and that was the most in several months. That number should move over 16 mbpd in the next couple of weeks. That is already 1.0 mbpd more than the five-year average.

WoodMac said refiners are adding light crude capacity at the rate of 400,000 bpd per year through 2018, or 1.6 mbpd by 2018. For the time being i would expect to see some Canadian oil transit all the way through the U.S. and be exported from the Gulf ports. There is no ban on exporting imported oil. Refiners will continue to ramp up their exports of gasoline and diesel. We have tremendous refining capacity and by the time we get to summer I would expect it to be running at 95% utilization.

For refiners it does not get any better than this. They can buy cheap oil at $30 or more from the shale fields, transport it and refine it into exportable products and make a healthy profit. By changing the export law to allow exports the dollars would shift more to the producers as the price of WTI rises. The refiners would still be profitable but their windfall gains would be over.

Iran

The P5+1 nations and Iran announced a framework for a nuclear agreement that is supposed to keep Iran from getting a nuclear weapon for the next 15 years. In reality they probably already have one because spies in opposition to the Iranian government claim there are several other secret nuclear installations where bomb research is being carried out. The P5+1 nations don't want to know this because it would upset their carefully contrived framework and prevent them from putting this problem behind them. They want to sign anything and kick the nuclear can down the road and let the next guy handle it.

The price of oil declined on the news of the agreement because Iran was claiming the sanctions would be lifted as soon as the formal agreement was signed in June. Iran is sitting on 30 million barrels of oil stored on tankers in the Persian Gulf. Plus they can produce 2.8 mbpd and they are prohibited from selling more than 1.0 mbpd by the sanctions. If they were suddenly lifted there would be a huge flood of additional oil into the market. However, the U.S. said the sanctions would only be lifted after Iran complied with all the terms of the deal and it could take several years for all the sanctions to be lifted.

There is obviously a difference of opinion here and a lot of political spin focused to the folks at home in the various countries. I seriously doubt the sanctions will be lifted any time soon and the deals will not have any lasting impact on oil prices.

The only thing that will impact prices is increasing demand and that needs to come from China and Europe. I don't see that happening in the near future. This is a long term solution and it will eventually happen.

The CEO of Exxon was asked last week why they were planning on drilling in the Arctic given all the hurdles they would have to overcome in the drilling process and again in the pipeline and transportation of any oil they will discover. He replied that we are in a race with depletion. Every year we lose about 4.5 mbpd of oil production that has to be replaced with new production that is becoming harder to find. Exxon would not be spending billions to drill in the Arctic if there was any major supply of oil left to find in warmer climates. He said it could take 20-30 years to produce the first barrel of Arctic oil and by then the price of oil could be a lot higher. Without a continued supply of new oil the global gas tanks would run dry.

Those comments may seem out of place given the oil glut we have today but they could never be more true. The glut we have today is just temporary. The price of oil has declined by more than 50% 8 times in the last 35 years yet the historic high was just a few years ago before the Great Recession. We will see new highs in this decade. Anybody with a pencil and 4th grade math can prove that fact very quickly. Enjoy the cheap gasoline while it lasts.

Active Rigs

Active drilling rigs declined -20 to 1,028 for the week ended on Friday. Oil rigs declined -11 for the week to 802. Active gas rigs fell -11 to 222 and a new 18 year low. Active rigs have now declined -903 since the high of 1,931 in September. That is a -46.7% drop. Active offshore rigs declined -3 to 31 and well off their January high of 60.


Oil Inventories

Crude inventories rose another 4.8 million barrels to 471.4 million and the highest level for April since 1931. Crude inventories have risen +89 million barrels over just the last 12 weeks. Inventories are 24% over year ago levels and 27% above the five-year average.

Refinery utilization rose to 89.4% last week from 89.0%. Imports declined from 7.39 mbpd to 7.35 mbpd. U.S. production declined -36,000 barrels to 9.386 mbpd and the first weekly decline since January.

Cushing inventories rose +2.6 million barrels to 58.9 million and a historic high. Cushing is now over 80% of capacity and the level where inflows are curtailed in order to maintain operational capability.

EIA Crude Inventory Chart

Gasoline inventories declined -4.3 million barrels to 229.1 million. Gasoline demand soared by +816,000 bpd and imports rose +45,000 bpd.

Distillate inventories rose +1.3 million barrels to 127.2 million. Demand declined -78,000 bpd. Imports rose +45,000 bpd.

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


Propane inventories rose by 2.33 million barrels to 57.36 million. Demand was 890,000 bpd.

Natural gas inventories declined slightly by -18 Bcf to 1,461 bcf. Inventories are now -11.5% below the five year average of 1,651 Bcf and +75.4% above year ago levels at 833 Bcf.

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


Market

The market finished slightly positive for the week but remained close to critical support. After the negative surprise on the Nonfarm Payrolls on Friday the S&P futures declined -22 points. Late Sunday evening they have rebounded to be down -12 but still down. Monday's open should be negative. WTI prices are up 50 cents at $49.96.

Jim Brown

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