Abundance of Wealth

Jim Brown
 
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Brent crude rose to close at $69.87 on Friday and the highest level since December 2014. Happy times are here again! Maybe not as happy as the $115 prices in mid 2014 but far better than the $28 in early 2016.


The challenge for OPEC will be to keep everyone in line and maintain the production cuts past the end of June. Russia is expected to bolt from the agreement if prices remain at this level. Russia is worried that prices this high will encourage US shale production and increased exports that would decrease Russia's market share.

Events around the world have come together to reduce the global inventory glut. However, if OPEC suddenly put their 1.8 million bpd back on the market it would kill the rally in a matter of weeks. As soon as global inventories begin to rise again, prices will fall.

Iraq has already called for the continuation of the production cuts. The energy minister said the cuts contributed to the stability in the market and should remain until all of the excess inventories have been depleted. Citigroup, SocGen and JP Morgan all predicted the reduction in cuts in July and that would be negative. The UAE warned that OPEC should ONLY review the cuts after inventory levels have reached their target.

Fortunately, the current agreement through the end of June could keep prices rising unto the high demand summer driving season. Not everyone is in agreement on that concept. Now that the US property tax deadline of December 31st is behind us, the inventory levels in the US are expected to rise. That will slow any further price gains.

The Forties pipeline is back in operation along with the Libyan pipeline that was blown up. The only real production drag at present is the collapse in Venezuela. That is not expected to improve.

On Saturday, Credit Suisse said the recent rise in prices was going to create a big rebound in oil service stocks. I think they missed the boat on that one. The rally began two weeks ago and it has been amazing. Schlumberger, Halliburton, and the rest of the service stocks exploded higher starting January 2nd. Even the lethargic sand stocks have seen a decent rally.


As you can tell by that chart above, the rebound in crude prices caught everyone off guard. Investors were expecting the normal price fade in January and instead we saw WTI rally $8 to almost $65 over the last four weeks. This has spiked all the energy stocks. At the same time, the tax reform is going to give them significant relief with additional free cash flow. Energy companies are some of the highest taxed companies in America. Reducing their liability down to 21% will give them cash to pay down debt, increase capex spending and maybe even return some money to shareholders.

US production took a significant hit last week. Analysts blamed it on the weather and the sub zero temperatures that shutdown production in some areas. There was also the hangover from the holidays with workers just returning from the Christmas/New Years break. Production was almost 300,000 bpd below the high set on December 15th. This should rebound quickly.


Active rigs exploded higher last week. Oil rigs rose by 10 and gas rigs gained 5. That is the most rigs added since May 19th. It is amazing what higher oil prices will do to the animal spirits in the oil patch. I would expect another strong pick up this coming week as well.


Stocks rebounded because of crude prices and natural gas over $3 again but investor sentiment is also building. Analysts are starting to believe that demand forecasts are too low and US production forecasts are too high. If that is the case we could see some further price strengthening by summer as those factors become common knowledge.

Credit Suisse expects capex spending to increase by 12% in 2018. If the Seaport Energy claim of more than 7,300 drilled but uncompleted wells is correct, the fastest way to increase production is to complete those wells. That means the service sector is going to be working 24/7 to frac wells and 24/7 to hire more crews. Halliburton has one of the biggest fleets of fracking crews and they will be very busy.

Some credit the current global economic growth on the artificially low oil prices of the last two years. Low prices increase demand leading to higher oil prices, which reduces demand. It is a cycle that has existed for more than 100 years. In 2016-2017 demand was stronger than the EIA-IEA had predicted. Oil prices were also at 13 year lows in late 2015 hence the rapid increase in demand. When it takes $30 to fill your gas tank instead of $60, you are going to drive more. It is a simple fact of life. It works that way in business as well. Higher prices cause cutbacks and restrictions, which slows economic growth. Profits are pressured for companies that use a lot of fuel and product and services prices rise.

I doubt we are going to see a big hit in 2018 from high fuel prices because OPEC will cheat, regardless of what they say. We could see higher oil prices heading into summer but we still have an inventory surplus so they are not going to $95 in the near future.

The next production cycle has started and even though companies claim they are going to restrict expansion and maintain a level number of rigs, history has proven otherwise. This time there is an almost unlimited amount of shale oil available if the prices continue to rise. It only takes a matter of weeks to increase shale production where it takes years to increase conventional, oil sands or offshore production. In the past, the cycle was 3-5 years to increase production significantly. Today, it may only take 3-5 months to increase production significantly. Unfortunately, demand does not grow at the same rate. It will be interesting to see if the shale producers maintain their "level" rig counts. I am betting against them.

Jim Brown

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