Prices Are Dormant

Jim Brown
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With the OPEC meeting behind us, oil prices are dormant despite several disruptions.

WTI prices have held in the $57.50 range for the last month. There has been analyst calls for $60 and calls for $50. Nothing seems to phase the price. Earlier in the week the North Sea pipeline carrying 450,000 bpd of Forties crude experienced a break and engineers said it could be shut for several weeks to make repairs. Prices barely budged despite the fact that it supplies nearly one third of Britain's offshore energy. Forties crude is the largest of the five crude oil streams that make up the Brent crude designation. Brent prices moved over $65 for the first time since mid 2015. I am sure BP is breathing a sigh of relief because they sold the pipeline to INEOS in October.

Several producers including BP, Shell and Chrysaor were forced to shut down offshore production. The Nexen Petroleum 180,000 bpd Buzzard field was also shut down.

I am sure OPEC is cheering. Losing 450,000 bpd of production for several weeks will help burn through some oil currently in storage and reduce inventories. A two-week shutdown would reduce inventories by 6.3 million barrels.

If OPEC and Russia were able to continue the production cuts for all of 2018, global inventories would decline by 274 million barrels and be well into the range OPEC would like to see. The current inventory surplus in developed nations is about 130 million barrels in November compared to 380 million when the first production cuts began.

The North Sea outage will also help US crude exports. US crude exports to Asia rose to the second highest on record at 877,000 bpd last week. The main buyers were South Korea, China and India followed by Indonesia and Japan.

For the week, the US exported 2.13 million bpd, which was a record high. As of the end of 2015 the US was only exporting 400,000 bpd. The 40-year export ban was lifted in 2015 in order to accommodate the surge in shale production. US crude is favored in Europe and Asia because it is super light and easy to refine and it is cheaper than Brent by about $7 today. Refiners are buying the oil on the spot market rather than long-term contracts. Exporters include EOG, WLL, XOM, APA and PXD.

The production in the US spiked by 73,000 bpd last week to 9.78 million bpd and a new record high. We are not going to reach 10.0 mmbpd by the end of December but it will be close. By the end of 2018, the US could be the largest oil producer on the planet. Currently Russia is producing around 10.7 mmbpd and Saudi Arabia is at 10.1 mmbpd. With the US expected to hit 10.5 mmbpd or higher in 2018, we will be very close to eclipsing the Russians. US shale producers said at a recent conference they expect to increase production by 2.0 mmbpd by 2020. That would put the US somewhere in the 12.5-13.0 mmbpd range. If OPEC cancels the 1.8 mmbpd in production cuts in Jan 2019, the increases will be spread through the cartel with Saudi increasing by 300-500,000 bpd depending on their then current capabilities.

Analysts are expecting to see a "torrent" of new US oil production over the next 4-6 weeks from producers that were able to hedge large volumes of oil at higher prices over the last month. The 73,000 bpd increase last week could have been the leading edge of that tsunami.

OPEC Production in November

In November, production at the Loma Campana Vaca Muerta shale in Neuquen Argentina, roared back to life and helped lift global oil production by 170,000 bpd to 97.8 mmbpd. By 2020, production should exceed 100.0 mmbpd.

OPEC said global oil demand is expected to grow by 1.51 mmbpd in 2018. That is up 250,000 bpd since their July 2017 forecast. In 2017 demand is thought to have risen by 1.53 mmbpd.

The US has set production records for the last six consecutive weeks. Inventories are declining because refinery utilization has risen to more than 93% as they try to flush the oil inventory out of the system before December 31st. Any oil in inventory on that date is charged a property tax. Inventories will begin to rebuild in January through April.

Note the increases in gasoline inventories. Refiners are now in full production of winter blend fuels and they are pushing that into the distribution system. Gasoline demand will begin to rise next week as people leave for their holiday travels.

The growth in the active rig count slowed last week to only 2 rigs. That is a gain of 33 rigs over the last five weeks thanks to oil prices in the $57 range. I would not expect that to continue ahead of the rise in inventories and the potential for prices to drop back closer to $50.

Natural gas prices are back at their recent lows because demand is not increasing. In 2016 we consumed 75.1 Bcf per day. That declined to 73.71 Bcfpd in 2017. It is expected to rise by the end of 2018 to 76.85 Bcfpd because of additional LNG export capacity that will be completed. Gas prices fell to $2.65 intraday on Thursday. That is the lowest level since last February.

Investor Leon Cooperman said gas was the buy of a lifetime right now because demand was going to rocket higher over the coming years. I am sure he is right but that is a long-term commodity trade and we need to see some growth in demand before we jump into that type of a position. We cannot just buy the UNG ETF and hold it for a couple years because the futures roll over would be painful. The chart today it is very tempting. For a perspective, when the ETF was over $25 in 2014, natural gas was only $6. Gas is half of that $6 price today and the ETF has fallen more than $20. This is the futures drag that erased that $20.

There is a surge in global LNG production but there is also a surge in demand. The sudden burst in production has created a shortage of LNG tankers. Several months ago you could rent a LNG tanker for $20,000 a day. That has risen to $70,000 a day and could go higher.

The entire energy cycle is always feast of famine. At $70,000 a day that will encourage the building of new tankers. 2-3 years from now when they are completed and there are enough to fill demand, the prices will fall again.

Russia just completed the $27 billion Yamal LNG project 600 km north of the Artic Circle. You do not want to work there. Temperatures can decline to -50 degrees. They had to ship 5 million tons of materials to the location to build the facility. The first cargo was just loaded and it is headed to London. This is one more way Putin keeps Europe dependent on Russia for their natural gas.

I am still not a buyer of energy stocks. Those that are not making new 52-week lows are dormant and moving sideways. When inventories begin to rise in January, prices should decline. I believe that will be our buying opportunity. Once the global inventories are balanced, prices could return to $75 and stabilize. That is the perfect price to support development and still provide profits for shareholders.

Jim Brown

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