Rigs Up, Oil Down

Jim Brown
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Active oil rigs are up +42 rigs since the low at the end of June. Over the same period, oil prices have declined more than -30%. What is wrong with this picture?

There is always a lag in statistics in the energy sector. When oil was rebounding from $42 to $60 in April the producers were reporting Q1 earnings and outlooks and several were already planning on putting rigs back to work in July. That is the first month of Q3 and that means capital spending was still on a downward slope for the Q2 earnings cycle. At that time prices were nearing $60 and everyone was feeling bullish about the longer term outlook.

In May/June with prices at $60 the contracts were signed and well plans were laid out. By the time July arrived everything was in motion and on July 1st oil prices began to collapse. It was too late to stop the trucks and put the workers back on unemployment.

Drilling an oil well is a complicated set of gymnastics. The site has to be prepared, rig transported, well pipe shipped, frac sand ordered and on and on. Once the plans are in motion and all the material moving you cannot just pick up the phone and say stop.

The decline in oil prices is contrary to the economics in the USA. Oil production peaked at 9.61 million barrels per day for the week of June 5th. Since that peak production has declined -215,000 bpd to 9.395 mbpd and some expect it to be under 9.0 mbpd by the end of December.

In theory the decline in U.S. production will cause prices to rebound but other factors matter. Production around the world is increasing as well. If the Iran sanctions are removed they are now expected to be able to increase exports by 500,000-650,000 bpd very quickly. Tanker tracker Windward claims Iran is holding 50 million barrels of oil in tankers in the Persian Gulf. Platts is now claiming 53 million barrels. This oil would be available immediately upon removal of the sanctions.

Saudi Arabia demand is 1.0 mbpd less starting in September because they burn that much oil per day in the summer months to generate electricity for cooling. Oman just set a production record. Iraq boosted production 46,000 bpd in July and will continue to grow. Now that the summer driving season in the U.S. is about over that will remove another 1.0 mbpd from demand. Demand in China is clearly declining despite the government's claims to the contrary. China consumes 10.5 mbpd and they import 7.4 mbpd. China has been taking advantage of the cheap prices to add to their strategic reserves. However, they have run out of places to store the oil and they are leasing oil tankers to store it at sea until new tank farms are completed. The cost of leasing tankers is expensive and they have reached the limit of what they are willing to pay to store oil at sea. The Ti Europe, a 3 million barrel tanker, is costing China $40,000 per day. This means Chinese imports are slowing.

All of these factors should keep oil prices moving lower. As I write this on Sunday evening crude is under $42 and falling. The odds are very good we will see prices below $40 before the decline is over.

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Active Rigs

Active drilling rigs were flat at 884 for the week ended on Friday. Oil rigs rose another +2 for the week to 672. Active gas rigs declined -2 to 211. Active rigs have now declined -1,047 since the high of 1,931 in September. That is a -54% drop. Active offshore rigs fell -3 to 35 for a 4 rig gain in the last six weeks.

Oil Inventories

Crude inventories fell -1.7 million barrels to 453.6 million.

Refinery utilization held at the high of the year at 96.1%.

U.S. production declined -70,000 barrels to 9.395 mbpd, down from the 9.61 mbpd and 40-year high in June. Demand fell -46,000 bpd.

Cushing inventories declined slightly to 57.1 million.

Gasoline inventories declined -1.3 million barrels to 215.5 million. Gasoline demand declined -1,000 bpd.

Distillate inventories rose +3.0 million barrels to 147.8 million and a three-month high. Demand fell -235,000 bpd.

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

Jim Brown

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