Low Gasoline Prices Will Not Last

Jim Brown
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The price of gasoline is directly related to the price of oil and crude is cheap today and will be getting cheaper. However, this is a short-term event and the price cycle will eventually repeat.

Crude prices are currently stuck between $44 and $46.50. That is cheap but it will be getting cheaper. I wrote last week that the drop in the price of crude was putting shale producers out of business. They can lose money on every barrel they produce for a while just to keep the cash flow moving but they are rapidly burning up their cash reserves. They will have to shut down until oil prices recover. It is a fact of life that you cannot lose money on every barrel and stay in business.

They got some more bad news last week. Iran said it was planning on increasing exports by 500,000 bpd as soon as late November. That is about five months sooner than analysts had expected. They will be shipping to China, South Korea and India, countries that did not really obey the existing sanctions. Iran said exports would increase by up to 1.0 mbpd by the end of Q2. That is roughly in line with analyst estimates.

Increasing production in November will further depress crude prices. Iran expects another $3 to $4 drop. That will make it even tougher for the high cost producers to make a profit. Those include oil sands, deepwater and shale producers. Oil prices are expected to dip under $40 again over the next two months as low demand and refinery maintenance allows inventories to rebuild.

Once the price cycle bottoms and the remaining drillers begin to pick over the scraps they do have a bright future because global production is declining at an accelerated rate. The vast majority of global oil comes from giant fields with more than 5 billion barrels of initial reserves. There are 56 of those fields and the vast majority have been producing for decades.

The Joint Data Oil Initiative (JODI) was formed back in the 1990s to try and get a better handle on where the oil was coming from, at what rate and how much longer we could expect that production to continue. Horn and Associates compiled the data and Ron Patterson of OilPrice.com produced the following graphic of the 56 largest fields in the world. The key numbers in this graphic is the percentage of reserves remaining. Note that the majority of the fields only have a very small percentage left.

The average of all these fields is 23.49% remaining reserves. That is still a lot of oil but it is becoming harder to produce.

Everyone should understand that the lower the amount of oil in a field the slower that oil can be removed. It is kind of like a Slurpee. When you first get the frozen beverage the first 20-35% comes through the straw relatively easy. The next 20-35% requires a little patience. The last 20-35% requires a lot of effort and repositioning of the straw to coax the last drops to the surface. The same is true with an oil field. The first 35% comes out easy. The next 35% requires some enhancement like water flooding, CO2 injections, etc. The last 30% comes out very slowly over decades as the last few drops gravitate to the well pipe.

The IEA claims a global depletion rate of 4.5% per year. We are currently producing about 92 million barrels per day. The annual depletion rate is about 4.0 mbpd. That means we have to find and produce an extra 4.0 mbpd every year just to keep production level.

With the advent of shale drilling the U.S. production rate has risen from about 4.0 mbpd in 2008 to 9.61 mbpd in April 2015. We more than doubled our production but we did it on higher oil prices that averaged about $90 over the last six years. Even at that $90 level the shale producers barely made any money. They borrowed every cent they could to drill faster and faster but now the debt service is going to be an anchor dragging them under.

After the current Saudi Arabian price war is over and the high cost producers have either failed, filed bankruptcy or been acquired, the global production levels are going to be a lot lower. One report suggested we could lose as much as 2.0 mbpd by 2017. Since our global surplus today is about 2.0 mbpd that means prices are going higher again.

Global demand growth has been in the 1.2-1.4 mbpd range for the last several years. Not the highest but not the lowest growth rate either. With gasoline and diesel now under $2.50 a gallon and some expect gasoline to drop to $2, we should see demand growth accelerate as consumers upgrade cars and move farther into the suburbs because the commute is cheaper than in the past.

The fly in the demand ointment is the economic slowdown in China. This is impacting all of Asia and Europe. If China does not stabilize soon we could see a global recession. That will reduce oil demand and postpone higher prices.

They say the only things in life that are guaranteed are death and higher taxes. However, I can guarantee you the current disaster in the energy sector is going to lead to higher prices and a return to oil over $100. It is only a matter of time. Oil always rebounds to a higher level. There have been nearly a dozen oil crashes like this in the last several decades and it is always a disaster at the time but it leads to a restructuring of the sector, creates higher demand and eventually higher prices. People forget oil was under $10 a barrel in 1998 the last time Saudi Arabia opened all the pumps and flooded the market to force the other OPEC nations back to the negotiating table. From $10 oil in 1998 we rose to $148 oil in 2008. I seriously doubt it will take ten years this time.

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Active Rigs

Active drilling rigs declined -4 to 838 for the week ended on Friday and that is a 10 year low . Oil rigs fell -4 for the week to 640. Active gas rigs fell -1 to 197. Active rigs have now declined -1,093 since the high of 1,931 in September 2014. That is a -60% drop. Active offshore rigs were rose +2 to 33, down -33 from year ago levels.

Oil Inventories

Crude inventories fell -1.9 million barrels to 454.0 million.

Refinery utilization fell from 93.1% to 90.9%. That is down from the high of 96.1% on August 7th.

U.S. production rose +19,000 barrels to 9.136 mbpd, down from the 9.61 mbpd and 40-year high in June. Demand fell -310,000 bpd.

Cushing inventories fell to 54.0 million from 54.5 million.

Gasoline inventories rose +1.4 million barrels to 218.8 million. Gasoline demand rose +232,000 bpd.

Distillate inventories fell -2.1 million barrels to 151.9 million. Demand rose +840,000 bpd.

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

Jim Brown

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