Decision Time

Jim Brown
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The President is going to announce his decision on the Iranian nuclear deal at 2:PM on Tuesday.

If it were not for the geopolitical short squeezes oil prices would be a lot lower today. Everything seems to be working in favor of futures traders with Iran and the U.S. making daily threats against the other. The U.S. appears set to reinstitute sanctions against Iran in an effort to bring them back to the table to negotiate a new deal. Iran is promising "deep regret" if the U.S. backs out of the nuclear agreement. One avenue for the U.S. is to not pull out of the agreement but to reinstitute sanctions not covered by the nuclear deal. That would not give Iran an excuse to pull out of the agreement but still put them back in the penalty box until they agree to talks.

One of the most important sanctions would be on their oil exports. The U.S. does not import oil from Iran but could lean on other countries that do purchase their oil.

The deadline for the U.S. action is next Saturday but the president is going to announce his decision on Tuesday at 2:PM. If the U.S. does impose new sanctions, it could reduce oil on the market by 1.0 mmbpd. That would accelerate the decline in global inventory levels and assist in balancing supply and demand. Brent crude futures rose to nearly $76 on Sunday.

Another OPEC country is also adding to the supply declines. Venezuela is falling further into a hole every day. This weekend the government essentially nationalized Banseco. That is a bank with 8 million customers. The government said if seized the bank in a "90 day intervention" because the bank was trading in currencies on the black market. The government said it arrested over 130 criminal bankers and it now controls the institution. This is all a staged event ahead of Maduro's re-election. He claims he is looking out for the common person in order to protect them against the evils of capitalism. Unfortunately, the country needs some capitalism to provide food so that they do not starve. People have already eaten their pets, all the animals in the jungles, all the farm animals within a hundred miles of the major cities and all the pigeons from those cities. Anything that can be consumed has been consumed and the entire population is starving.

Some people believe Maduro seized the bank to get cash to support the energy sector. With production dropping like a rock because of unpaid bills, the government had to take action ahead of the election. Bank customers were lining up Sunday night at all the branches in hopes of extracting some cash before it all disappears into Maduro's coffers. I wish them luck.

U.S. dollars now cost 69,000 bolivars at the official exchange rate but the black market is paying 800,000 per dollar. Hyperinflation has made everything in Venezuela unobtainable.

Reuters said Venezuelan production was falling apart. Workers are walking off the job on a daily basis and production bottlenecks are forming everywhere because of a lack of workers. The lack of food, wages and hyperinflation is making the search for food more important than retaining your job. Reuters said more than 25,000 workers, out of 146,000 have recently walked off their jobs. Many of those were the top-level engineers responsible for managing and directing the company. The lack of funds has meant a decline in rig safety as problems are ignored because there is no money to fix them. Maduro turned over control of the state owned oil company, PDVSA, to the military in order to keep the armed forces on his side. The military has sucked all the money out of PDVSA and workers are no longer getting paid. Many rigs in the Orinco belt are only operating intermittently because of a lack of crews.

Fires are breaking out in the refineries because of a lack of maintenance and a lack of staff to run them. Ports are breaking down because all the workers have left.

With Venezuelan production falling rapidly and Iranian production likely to be constrained, oil prices are at four-year highs. This is good for futures traders but given the big ramp in prices anyone buying energy stocks at this level is at higher risk because geopolitical headlines can reverse just as quickly. If President Trump elected to postpone decertification of the nuclear deal for another 90-180 days, we could have $55 oil very quickly.

Prices are rising despite surging inventories in the U.S. Over just the last two weeks inventories have risen 8.4 million barrels. Production hit another new high at 10.619 million bpd and could hit 11.0 million bpd by midsummer. Active rig counts are surging with 39 rigs added since the beginning of April. The U.S. added 11 rigs last week.

Production is surging so fast in the Permian that prices for WTI for delivery in Midland fell to a three-year low at $14 below the benchmark price. With WTI at Cushing at $70 the DUC wells, drilled but not completed, are being completed as quickly as possible. Keane Group (FRAC) said all 26 of their fracking fleets are at 100% utilization and they have two new build fleets under construction for delivery over the next two months and they already have full year commitments. U.S. Silica said sand volumes are expected to rise 10-15% in Q2 because of increased drilling activity. Sand pricing is expected to rise by mid single digit percentages.

A prime reason for the increase in sand demand other than the DUC well completions is the rapid increase in demand per well. In 2014 Pioneer initiated what they called their Version 1.0 well technology with 1,000 pounds of sand per foot of the lateral along with 30 barrels of fluid. In mid 2015 they implemented Version 2.0 with 1,400 pounds of sand and 36 barrels of fluid per lateral foot. In early 2016 they implemented Version 3.0 with 2,000 pounds of sand and 50 barrels of fluid per lateral foot. They cut the cluster spacing down to 15 ft and stage spacing down to 100 feet. During the first quarter of 2018 they put 47 Version 3.0 wells into production. They also placed 16 wells into production that had even higher intensity completions than the Version 3.0 wells. Based on the "significant outperformance" of the higher intensity wells they are likely to announce a version 4.0 specification very soon.

Now multiply this over the current 834 active rigs each averaging 3 wells per month and the sand demand is rapidly increasing. It is amazing to me that SLCA shares are not exploding higher.

Ironically, OPEC production in April fell to a one-year low at 32.0 mmbpd and well below the 32.73 mmbpd if everyone was producing at quota. Venezuela was the biggest drag with production falling to 1.41 mmbpd and the lowest level in the 30 years that records have been kept by Platt. That is down 540,000 bpd over the last 12 months. The man that ran PDVSA from 2004-2014 said he expects production to fall by 600,000 bpd per year until the socialist regime is ousted.

Iraq production declined 40,000 bpd due to severe weather and a pipeline leak. Nigerian production fell 40,000 bpd due to a pipeline outage. It is expected to decline again in May as an offshore facility is closed for maintenance. Angola saw production fall to 1.53 mmbpd and the lowest since October 2016. Angola has dozens of mature fields that are in severe depletion and production is not likely to increase in the future. They are starting a new field at Kaombo with eventual production of 230,000 bpd. Libyan production held steady at 970,000 bpd despite pipeline outages.

OPEC remain highly compliant with the 17 month old production cuts despite the recent confrontation with Russia about ending participation at the end of June. The next OPEC meeting is June 22nd.

Saudi Araiba appears content to let prices rise ahead of the eventual IPO of Saudi Aramco. The higher the price of oil the more the company is worth.

The next several weeks should be interesting in the energy sector. With energy equities up over the last three weeks, there is a high risk of a decline if the Iranian deadline is extended. Likewise, imposition of sanctions could lift prices even higher.

Jim Brown

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