Three Weeks

Jim Brown
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OPEC meets again on June 5th to discuss production quotas. Since they are producing about 2.0 mbpd over their existing quota they have plenty to discuss. Many of the high cost producers are pleading with Saudi Arabia to reduce production so prices will rise. Saudi refused back in November for an obvious reason.

Saudi Arabia has been the swing producer for years. That means when more production was needed they produced more. When prices were too low and they produced less to bring supply and demand back into balance.

OPEC had a quota system where everyone was supposed to produce a specific amount. If production needed to be reduce everyone was supposed to lower production. Unfortunately it did not work out that way. The majority of OPEC continued to pump as much as they could and Saudi Arabia and Kuwait were forced to cut even more to bring production back into balance.

In November Saudi Arabia called it quits and basically said "if you are not going to honor your quotas then we are not going to honor ours either." Saudi opened the valves and oil came pouring out to flood the market. Since Saudi Arabia can produce about 3 million barrels per day more than they were producing this time last year they can make up for a lower price by pumping more oil. Nobody else in OPEC has any material excess production. Some can't even produce up to their current quota and others may only have 50-100 thousand bpd of spare capacity. This price drop is killing them. Saudi Arabia produced more than 10.3 mbpd in April.

The majority of OPEC members need oil prices in the $90s to cover their budgets. Algeria needs $130 so they are really out of luck. When the cartel meets on June 5th the forecast is for nothing to change. However, the majority will be on their knees begging Saudi Arabia to relent and let prices rise. I am not saying it can't happen but the OPEC cartel has not been known for keeping its promises. If there was some way for each country to guarantee Saudi Arabia that would not produce more than their quota they might get some relief from Saudi. However, most of the countries can't be trusted. OPEC has to rely on outside tanker trackers to come up with production estimates. The numbers each country provides are notoriously incorrect. This is the reason why there is no trust between members. They have decades of history that proves they can't be trusted.

Maybe this time it will be different. Saudi Arabia pulled this same trick back in the late 1990s and drove the price down to $10 a barrel before the other members cried uncle and went back to following the Saudi guidelines.

The U.S. is rapidly turning into the new swing producer in the oil sector. Only it is not by choice. Shale production across all areas averages about $71 per barrel. Some areas cost less, some cost more. Under $70 per barrel and active rigs should decline. Oil over $70 should cause an increase in drilling. This is production management based on the supply and demand model. More demand raises prices and production increases. Less demand weakens prices and drilling activity declines. Unfortunately each of these cycle could take 6-12 months to work its way into the system. E&P companies got spoiled with oil hovering around $100 and they will have to learn how to live with $65 oil in the months and possible years ahead. Clearly high priced oil will not be drilled or produced.

Continental Resources (CLR) CEO Harold Hamm said $70 oil was profitable for Continental. EOG Resources said they would resume limited drilling if prices stabilized over $65. Whiting and Occidental said they would restart completions if oil was over $70. Diamondback Energy and Apache said they would add rigs at $60-$65 in the second half of 2015.

Today the fraclog is still growing. Since January the number of wells drilled but not completed has soared to more than 4,000.

Current Fraclog

Ohio 324
Bakken 632
Julesburg 243
Permian 1,640
Eagle Ford 1,250
Pennsylvania 401

A Bloomberg survey last week said the fraclog was now 4,731 wells with an expected 322,000 bpd in production if completed.

To put that in perspective U.S. total production has declined from 9.44 mbpd in March to 9.37 mbpd today. A decline of only -70,000 bpd but there are wells with 322,000 bpd waiting to be completed once prices rise.

Production declines are starting to take hold. Production in the Eagle Ford is expected to be 1.6 mbpd in June, down -47,000 bpd from May and -73,000 bpd since January. More than 500 drilling rigs have left Texas and more than 100 out of the Eagle Ford. The Permian Basin is projected to produce 2.0 mbpd in June, up +168,000 bpd since January. Active rigs there have fallen from 300 to 237 but they are all drilling the best of the best locations with the most initial production to maximize every dollar spent.

Halliburton has come up with a new solution to allow faster fracking of wells drilled side by side. It is called zipper fracking where the parallel wells are fracked at the same time in alternating stages to produce a frac that looks like a zipper. They claim the fracture is faster and provides a better flow at completion.

American Eagle Energy became the fourth energy company to file bankruptcy as a result of the oil crash. The Colorado company files chapter 11 bankruptcy on Monday after it missed an interest payment on its debt. Quicksilver Resources, BPZ Resources and WBH Energy were the other three bankruptcies. Sabine Oil and Gas has missed a debt payment so they could be next.

Demand for gasoline and distillates increased sharply last week and refiners pushed 20.65 mbpd of products into the market yet all inventory levels declined. Welcome to the summer driving season.

Active Rigs

Active drilling rigs declined -6 to 888 for the week ended on Friday. Oil rigs declined -8 for the week to 660. Active gas rigs rose +2 to 223. Active rigs have now declined -1,043 since the high of 1,931 in September. That is a -58.9% drop. Active offshore rigs were flat at 34 and well off their January high of 60.

Oil Inventories

Crude inventories declined -2.2 million barrels to 484.8 million and the second decline in 18 weeks. Crude inventories had risen +108.4 million barrels over the prior 16 weeks. Inventories are 23% over year ago levels.

Refinery utilization fell to 91.2% last week from 93.0%. Imports rose +340,000 bpd. U.S. production rose +5,000 barrels to 9.374 mbpd.

Cushing inventories declined slightly to 60.7 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 declined -1.1 million barrels to 226.7 million. Gasoline demand rose +416,000 bpd and imports rose +150,000 bpd.

Distillate inventories fell -2.5 million barrels to 128.3 million. Demand rose +645,000 bpd. Imports rose +182,000 bpd.

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

Jim Brown

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