Walking a Tightrope

Jim Brown
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The $40 level on WTI is holding but the margins are razor thin. This is the equivalent of walking a tightrope between two skyscrapers. One misstep or one headline could lead to a fall to much lower levels.

WTI is holding at $40.02 on Sunday night. I can visualize one of those balancing acts on America's Got Talent where they are just a heartbeat from disaster at any time. As long as the $40 level holds, the energy equities are probably going to pause in their descent. Should crude break into the mid $30s it would cause another capitulation event in equities. A significant drop under $40 would give credence to those analyst forecasts for declines into the mid $20s.

With equity prices so low you would have expected to see a lot of M&A activity. Instead, we are seeing a flurry of bankruptcies from mostly smaller companies. However, we may not be far away from some higher profile disasters. With companies beginning the reserve restatement process, a lot of them will lose a significant portion of their credit lines and that could lead to shutdowns and defaults.

Some companies can still make money or at least breakeven at $40 oil. Once under that level the remaining profits will turn into red ink really quickly.

Other than the proposed $70 billion deal for Shell to acquire BG Group and the $3.9 billion deal for Noble Energy to acquire Rosetta Resources the merger activity has been minimal. The Anadarko CEO said they were frustrated with the high asset prices even though oil is down more than 60%. He said we have been trying to find reserves but the acreage they are bidding on is either priced higher than they want to pay or they have been significantly outbid. Sometimes by as much as twice the Anadarko bid. This suggests oil producers are firm in their belief that prices will recover and they are willing to hold on through the pain until they do.

In other cases existing leaseholders paid significantly more than the leases are currently worth and while they need to raise cash they don't want to take the book loss on the sale.

While the investor community is dumping energy stocks on a daily basis the actual energy firms are clinging to what they own like a thirsty man clings to his canteen in the desert .

The Linn Energy CEO said private equity funds have a massive $100 billion cash hoard and they are looking to invest in assets with positive upside. Because so many companies are looking to pickup distressed assets those assets are still commanding a price that is above market.

We have hundreds of companies, funds and investors looking for energy assets and this makes those companies holding the assets believe they are worth a lot of money.

The second problem is finding the right fit. A producer may find some assets for sale but they may not fit in with their current production footprint. In this economy, companies do not want to keep expanding their operations to other areas just for the sake of expanding. Companies are being really picky about what they are willing to bid on and when they find that piece that fits correctly into their lease holdings they are willing to pay for it.

The key here is that acquisitions are still being made but it is at the acreage level rather than at the corporate levels. We are not seeing deals for entire companies and we may not see that wave of corporate acquisitions until early 2016 and after the bank credit lines are chopped in this reserve restatement cycle.

This is all somewhat amazing since oil prices have now declined for eight consecutive weeks. That is the longest losing streak since 1986 when there was a ten-week losing streak.

Some analysts thought Hurricane Danny could provide support for prices with it headed for the Gulf in a couple of days. It is scheduled to pass directly over Cuba and into the Gulf of Mexico. Currently Danny has been downgraded to a tropical storm but should intensify once it reaches the Gulf. There are two more storms following Danny, marked in Xs that could also hit the Gulf.

One analyst said even if Danny knocked out all the Gulf production for weeks the global market would still have surplus production of 500,000 barrels per day. It would be highly unlikely for any single storm to knock out more than a portion of Gulf production and then only for a few weeks. Should that happen the uncertainty would definitely put a floor under prices but I doubt it would raise them materially.

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Active Rigs

Active drilling rigs were up +1 to 885 for the week ended on Friday. Oil rigs rose another +2 for the week to 674. Active gas rigs were unchanged at 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 another -3 to 32 and down -32 from year ago levels.

Oil Inventories

Crude inventories rose +2.6 million barrels to 456.2 million.

Refinery utilization declined from the high of the year at 96.1% to 95.1%.

U.S. production declined -47,000 barrels to 9.348 mbpd, down from the 9.61 mbpd and 40-year high in June. Demand fell -254,000 bpd.

Cushing inventories rose slightly to 57.4 million.

Gasoline inventories declined -2.7 million barrels to 212.8 million. Gasoline demand rose +19,000 bpd.

Distillate inventories rose +.6 million barrels to 148.4 million and a three-month high. Demand rose +350,000 bpd.

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

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