World Massively Oversupplied with Oil

Jim Brown
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The IEA claims oil prices may fall further before prices firm in 2016. The IEA claims there will not be any non-OPEC production growth in 2016 for the first time since 2008.

While the IEA is far from fallible there is a general consensus that shale oil production in the USA will begin to peak in mid 2016 and decline in 2017. The reason is because producers are drilling wells in the most productive regions now and they will run out of these locations before the end of 2015. They will be forced to drill in areas that have only 50-75% of the volumes they are currently seeing from new wells. Secondly, shale wells decline at roughly 65% in year one and 35% each year thereafter. A 1,000 bpd well to start will only be producing 350 bpd in 12 months and 225 bpd in 24 months and 145 bpd in 36 months. This is called depletion.

The only way producers can keep production rising is to drill new wells at a faster pace than the old wells are depleting. By late 2016, early 2017 they are going to lose this battle.

The IEA believes Russian output will also decline in 2016. Russia is producing at 100% of capacity today to try and replace the money they are losing on lower oil prices. They can't add production at the rate they are depleting existing production. It is a long-term process, not something you can just turn on and off.

The IEA chart below shows the U.S. contribution to non-OPEC supply growth in red and everyone else in blue. Note the sharp decline in late 2015 and early 2016. The recovery in late 2016 and 2017 depends on oil prices. If prices return to $75 or higher then production will increase again. There are several deepwater projects that are on hold pending a rise in oil prices.

The IEA said prices might need to decline further in 2015 in order to stabilize the market. There has been a lot of speculation that the low was in March and production would decline because of the large drop in rig counts. In theory this would push prices higher. Unfortunately production did not drop. Last week it was only 5,000 bpd below the 40-year highs set in June. The forecast for a production decline did not come true.

Now that rig counts are rising again this suggests that production is not going down materially in the weeks ahead. There are also reports that the fraclog has begun to decline. Producers are now spending the money to complete wells that were drilled over the last nine months and left un-fracked. This could be one reason production is not declining even though the pace of drilling has slowed significantly.

The drop in crude prices has impacted deepwater drilling more than shale drilling even though the onshore rig count is down more than -1,000 rigs. Deepwater oil is expensive with $75 to $90 a barrel not uncommon. Offshore rigs are down -50% over the last 7 months.

Those wells have a very long lead-time in years while a shale well can be drilled and completed in about 45 days.

The IEA believes U.S. production growth in 2015 will be +900,000 bpd but that will decline to +300,000 bpd in 2016. There are some deepwater wells that have been in development for several years that will come online later this year. Chevron did have a major setback with the Bigfoot platform when the anchor tendons sank unexpectedly and set the project back at least a year. Bigfoot was supposed to begin producing 75,000 bpd later this year. They also launched the $8 billion Jack/St Malo platform, which will produce 90,000 bpd starting later this year. Chevron made 30 deepwater discoveries in the last year but the decisions have not been made on when they will be developed. Projects are on hold until prices firm.

Analysts believe oil demand will rise 1.5 mbpd in 2015 because of the reduced prices. Demand is expected to increase another 1.2 mbpd in 2016 to 95.2 mbpd but continued low prices could expand that growth. Currently analysts believe there will be 1.4 mbpd of excess production in 2016. That is not low enough to really firm the prices.

Boone Pickens was on CNBC last week and he continues to predict $70 oil by the end of 2015. He correctly reminded everyone that we are currently producing roughly 93 mbpd and every barrel that comes out of the ground is one less barrel available to produce in the future. Global depletion as acknowledged by the IEA, EIA and OPEC is about 6% per year. Quick math shows that 6% of 93,000,000 bpd equals 5.58 mbpd of depletion. That means existing production declined by about 5.5 mbpd every year. New production must exceed 5.5 mbpd in order to see production growth. Just maintaining production at last year's levels means we have to find and produce an extra 5.5 mbpd every year. The depletion clock never stops running.

Depletion will eventually raise prices. It is a proven fact that we cannot continue to accelerate production by enough every year to stay ahead of the depletion monster. The shale revolution produced an amazing 5 million barrel per day boost in U.S. production since 2008 but it has run its course. By mid 2017 it will be impossible to keep pace with the decline in existing shale wells at the 65%, 35% rate described above.

While lower crude prices today may slow production enough to allow for higher prices in 2016, the lower prices will also cause a sharp rise in demand. Over the next several years we will see $100 oil again and possibly even higher.

Crude prices have fallen more than 50% eight times since 1950. The supply/demand equation requires constant balancing and each time one side reaches an excess the prices adjust to compensate and the cycle repeats. If the IEA is right about lower prices in the months ahead I would be a buyer of quality energy stocks because the pendulum is going to swing back in the other direction in the years ahead.

Active Rigs

Active drilling rigs rose +1 to 863 for the week ended on Friday and the third consecutive week of gains. Oil rigs rose +5 for the week to 645. Active gas rigs fell -2 to 217. Active rigs have now declined -1,068 since the high of 1,931 in September. That is a -60% drop. Active offshore rigs rose +2 to 31 and -29 off their peak.

Oil Inventories

Crude inventories rose +0.4 million barrels to 465.8 million.

Refinery utilization declined slightly from 95.0% last week to 94.7%. Imports fell -197,000 bpd. U.S. production rose +9,000 barrels to 9.604 mbpd. Demand was flat rose +65,000 bpd.

Cushing inventories rose slightly to 56.7 million.

Gasoline inventories rose +1.2 million barrels to 218.0 million. Gasoline demand fell by -199,000 bpd and imports rose +92,000 bpd.

Distillate inventories rose +1.6 million barrels to 137.5 million. Demand fell -110,000 bpd. Imports were flat.

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

Jim Brown

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