Who is Winning the Oil War

Jim Brown
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OPEC is pumping at 100% of capacity and prices are still going down. They have run out of additional production capacity to bring online to offset the lower prices they are receiving. While Saudi Arabia can still make a profit at $50 oil that is not true for other producing nations.

Back in November 2014 OPEC, actually Saudi Arabia, decided not to cut production to support oil prices and to go to war with high cost producers in an effort to drive them out of business. For some producers in the U.S. that may actually happen but for the others they are becoming leaner and meaner and finding ways to cut costs and continue to drill.

Half of global crude reserves are in OPEC countries but that does not mean they can just run out into the desert and stick a pipe in the ground and have crude oil bubble out. It still cost them to drill wells, build pipelines and create the infrastructure necessary to develop a new field.

We hear all the time about the cost of production. If your cost of production is $75 a barrel you are probably not going to be drilling too many wells to sell oil for $50 a barrel. The table below shows the nominal cost of production for major producers. Data Source

Data Source

Shale oil in the U.S. costs between $28 to more than $85 to produce depending on which field and which location within that field. For instance in the Bakken, McKenzie County costs about $28 but Divide County is $85. The difference is the depth, cost of the wells and the production rate. An $8 million well that produces 1,500 bpd has a different cost per barrel than an $8 million well that produces 300 bpd. That is the difference between being in the sweet spot in the field or in an outlying location on the fringe of the reserves.

There is also the problem of the sales value of the oil in specific fields because of viscosity and content and the cost to transport it to market. With WTI at $48 the oil from some parts of the Bakken sells for $40 with some bids under $40. Transportation from some locations can cost $15 per barrel while pipeline costs from other areas are $8 a barrel.

If oil prices are going to remain under $50 for the foreseeable future then oil production is eventually going to decline in those regions with costs over $40. It makes no sense to pay $50 to produce oil just so you can sell it for $50.

While Saudi Arabia has the lowest cost of production they also have one of the biggest problems. When oil was over $100 for years the Saudi royal family made huge promises to the citizens to keep them from revolting during the Arab Spring movement. They need a minimum of $80 just to make their budget and more than $100 a barrel to continue to follow through with those promises of homes, jobs and higher salaries.

Saudi does have a very active drilling program. Active rigs have risen 30% in 2015 to 125, up from 96 at the same time in 2014. This is a historic high. Fortunately the other OPEC countries are not as cash rich as Saudi Arabia and they have not increased their drilling as much. Venezuela is broke and they cannot afford to even produce the oil they have much less drill for new oil. Production there is declining every month. Libya is in the midst of a civil war. Nigeria is still fighting production halts caused by the MEND rebels. Etc, etc.

Saudi Arabia may be winning the war at present simply because they had more excess capacity than anyone else, which could be activated to offset the falling prices. However, they are now seeing billions of dollars in exploration expenses that are raising their overall cost of future production. In other words they are paying more now but they will benefit less.

The end result is that demand will rise because of the cheaper fuel prices. When the 1.5 mbpd of excess global production is consumed in 2016 the price of oil will rise. The boom-bust cycle in the oil patch always repeats. Lower prices produce higher demand. High demand produces higher prices. Higher prices produces more production but also decreases demand leading to excess production and the cycle repeats. It can take 3-5 years for the bust cycle to complete and we are just now completing year one of this cycle.

Active Rigs

Active drilling rigs rose +19 to 876 for the week ended on Friday. Oil rigs surged +21 for the week to 659. Active gas rigs fell -2 to 216 and a new 18-year low. Active rigs have now declined -1,055 since the high of 1,931 in September. That is a -58% drop. Active offshore rigs were unchanged at 31 and -29 off their peak.

Oil Inventories

Crude inventories rose +2.5 million barrels to 463.9 million.

Refinery utilization rose slightly from 95.3% last week to 95.5% and the high for the year.

U.S. production declined -4,000 barrels to 9.558 mbpd and a three-month low but that is only -53,000 bpd off the 40-year high in June. Demand rose +45,000 bpd.

Cushing inventories rose slightly to 57.9 million.

Gasoline inventories declined -1.7 million barrels to 216.3 million. Gasoline demand rose +345,000 bpd.

Distillate inventories rose +0.2 million barrels to 141.5 million and a three-month high. Demand spiked +530,000 bpd.

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

Jim Brown

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