Light in the Tunnel

Jim Brown
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Crude inventories declined for the first time in 17 weeks and the decline in active rigs is slowing. The light at the end of the tunnel is not a train.

Active rigs declined by only -11 last week and the smallest decline since the drop began in December. However, they are still declining and based on the recent earnings reports they should continue to decline at a slower pace until at least July and then flatten out for the rest of the year.

Shale drillers are not stupid despite what David Einhorn said last week. When oil was over $100 a barrel it made sense to drill as many wells as possible to capitalize on those prices. Now with oil under $60 it no longer makes sense. They do understand that production is slowing and prices are rising. As production begins to decline faster this summer the prices will rise faster. It is a cause and effect scenario.

Shale producers need oil prices over $65 or even $75 to breakeven. In the recent earnings reports the various drillers reported their average selling price for oil and it was well under WTI prices. I have reported in these pages multiple times that oil prices in the shale fields were significantly less than WTI for multiple reasons including transportation costs and the quality of shale crude.

Continental Resources (CLR) the second largest producer in the Bakken received an average of $38.56 per barrel in Q1. Whiting Petroleum (WLL) received an average of $39.25 per barrel. Marathon (MRO) received $36.92 and that was down from $84.79 in the comparison quarter. That is a huge decline in operating income for these companies and it is very damaging to their capital expenditure plans for 2015.

Almost every company said they were going to continue cutting rigs and crews through July and then remain flat at a minimum operating level through the end of 2015. They are planning on waiting on oil production to decline to the point where prices rise enough for them to be profitable again.

The wild cards here are numerous. There is the potential for Iranian production to come back online after June. If Iran adds another 1.0 million barrels to the market the prices will decline again. While nobody expects it at the June 30th deadline it could happen by the end of August when prices normally decline anyway.

Libyan production has declined to about 400,000 bpd, down from 800,000 bpd several months ago as a result of the civil war. That could be resolved at any time, although not likely, and production could eventually return to the 1.6 mbpd from before the war started.

Saudi Arabia is still raising production and disrupting prices. They apparently want to capture sales in any way possible. They still have a reported excess capacity of more than 2.0 million barrels per day if they wanted to flood the market in one last effort to push the high cost producers out of the market.

OPEC has a production meeting in June. While nobody expects a production cut that is always a possibility. The other OPEC members may agree to cut equally with Saudi Arabia in order to raise prices. In the past Saudi ended up being the country that cut production and everybody else produced as much as they could.

U.S. producers understand all these threats. They don't want to ramp up activity again only to have some new headline push prices lower. They want to sit back and watch the market past the normal pricing weakness that occurs in Aug/Sept and plan to reenter the market for the spring rebound next year. Ramping up production in Q1-2016 gets their new oil to market in April/May and just in time for the summer price rise.

These drillers have been hurt significantly but they are not going under. They are only going quiet for the rest of the year until the future of oil prices is not so cloudy.

Active Rigs

Active drilling rigs declined -11 to 894 for the week ended on Friday. Oil rigs declined -11 for the week to 668. Active gas rigs declined -1 to 221. Active rigs have now declined -1,037 since the high of 1,931 in September. That is a -58.4% drop. Active offshore rigs were flat at 34 and well off their January high of 60.

Oil Inventories

Crude inventories declined -3.9 million barrels to 497.0 million and the first decline in 17 weeks. Crude inventories had risen +108.4 million barrels over the prior 16 weeks. Inventories are 23% over year ago levels.

Refinery utilization rose to 93.0% last week from 91.3%. Imports declined -905,000 bpd. U.S. production fell -4,000 barrels to 9.369 mbpd.

Cushing inventories were flat at 61.7 million. Cushing was over 87.6% of capacity the prior week and well over the level where inflows are normally curtailed in order to maintain operational capability. Cushing has about 71 million barrels of capacity according to the EIA. The highest utilization on record was 91% set in March 2011.

EIA Crude Inventory Chart

Gasoline inventories rose +400,000 barrels to 227.9 million. Gasoline demand fell -135,000 bpd and imports fell -137,000 bpd.

Distillate inventories rose +1.5 million barrels to 130.8 million. Demand rose +114,000 bpd. Imports declined -23,000 bpd.

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

Jim Brown

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