Lookout Below

Jim Brown
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With all the major oil companies warning of tough times ahead for oil prices the energy sector plunged to new lows last week. If enough credible people warn you of a coming disaster maybe we should believe them.

Exxon, Chevron, Conoco, Shell, etc, all warned that oil prices could go lower for longer and volatility would be high. While some of that warning may have been cover for their weak earnings, I do believe they are afraid of what is to come. Whether they are right or wrong remains to be seen.

OPEC production is at record highs and Saudi Arabia produced 10.6 mbpd last month. Iraq is boosting production almost daily and Iran could be back in the market by the end of December with an additional 1.5 mbpd. Libya is up to 432,000 bpd from their low of 200,000 bpd several months ago. With a capacity of more than 1.3 mbpd they could flood the market if they could solve their civil war. The country is looking to boost output by another 200,000 bpd over the several weeks as electricity is restored to some fields and facilities.

Another problem for oil prices is the battle for market share. Since OPEC resigned as the market regulator in November it is a fight to gain/regain market share. The only way to do that is by lowering prices. Saudi Arabia has raised and lowered prices more than once over the last nine months as they try to charge what the market will bear without losing market share to other countries. With a dozen oil producing countries accepting lower bids for production the price will remain under pressure until demand and production level out.

Currently there are between 800,000 bpd and 1.5 million bpd of excess production. That will rise sharply once Iran is back in the picture. Iran is going to be a serious price competitor because they will have a huge supply and they will be trying to regain share they lost due to sanctions.

Until Iran is back in the market that 800,000 bpd of excess production is the key. I am using the lower number because that is the easiest to confirm. There are disputes over the claim of 1.5 mbpd. Global inventories are rising by 800,000 bpd so that is the number to watch.

Last week in the U.S. production declined by -145,000 bpd. That was a dramatic drop from 9.558 mbpd to 9.413 mbpd. That is -197,000 bpd off the June 5th peak of 9.61 mbpd. These numbers are volatile but the trend has finally begun to decline by significant amounts.

Different experts in the sector are predicting a continued decline of 50-100 thousand barrels per day per month through the end of December. If that were to happen and production dropped under 9.0 mbpd the impact on price would be dramatic.

If we take the current 800,000 bpd of excess global production and subtract the 600,000 bpd of U.S. production declines that would bring the global supply and demand numbers back into balance with only a minimal overage.

Personally I have a hard time rationalizing that possibility. While I believe U.S. production is going to decline since the depletion rates on shale wells are roughly 70% in the first year, I do believe OPEC production will rise to compensate. Simply adding Iraq, Iran and a rejuvenated Libya back into the mix will easily compensate for that 600,000 bpd drop in U.S. production.

I believe this is what the oil majors are looking at when they are projecting lower prices for a longer term. The battle between the forecasters will never be over. Opinions are like noses, everybody has one. Until Chinese demand recovers we are likely to have excess production.

Multiple analysts believe it will take $40 oil a minimum of six-months to force a drastic restructuring of not only U.S. production profiles but also the profiles of other producing countries. Venezuela is on the verge of collapse and continued low prices could accelerate that collapse and oil exports could fail once the country fails. Russia is in a deep recession, suffering under sanctions because of military incursions and $40 oil could eventually force a regime change.

The outlook for the energy sector is bleak if you believe the oil majors. However, oil crashes come about once a decade and they cause carnage throughout the sector. Once those rigs are laid down, production falls and workers find a new career the boom/bust cycle will repeat. We will see $100 oil again. It is only a matter of time.

Active Rigs

Active drilling rigs declined -2 to 874 for the week ended on Friday. Oil rigs rose another +5 for the week to 664. Active gas rigs fell -7 to 209 and a new 18-year low. Active rigs have now declined -1,015 since the high of 1,931 in September. That is a -58% drop. Active offshore rigs rose +3 to 34 and -26 off their peak.

Oil Inventories

Crude inventories fell -4.2 million barrels to 459.7 million.

Refinery utilization declined slightly from 95.5% last week to 95.1%.

U.S. production declined -147,000 barrels to 9.413 mbpd and a three-month low, down from the 9.61 mbpd and 40-year high in June. Demand fell -108,000 bpd.

Cushing inventories declined slightly to 57.7 million.

Gasoline inventories declined -0.4 million barrels to 215.9 million. Gasoline demand fell -410,000 bpd.

Distillate inventories rose +2.6 million barrels to 144.1 million and a three-month high. Demand fell -376,000 bpd.

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