Archives for June 13, 2017

I don’t know about the rest of you guys, but is anyone else feeling a bit hinky about the price of oil? Every time we seem to have the table set for a rally, someone comes along and saws off a leg. So many indicators going in opposite directions at the same time. It’s… unsettling.

There are numerous factors that go into setting a price for a barrel of oil in the market, some of which actually reflect how much a particular user is ready to actually pay for that barrel, most of which involve conjecture, rumour, innuendo and blind guess work.

That said, you can typically assess all these myriad factors and get a proper Spidey sense of where things are at or should be, but in the current market, there are so many conflicting narratives and, more importantly, interpretations, that it may actually be best to just put a bunch of numbers between $40 and $70 around a dartboard, close your eyes and throw the damn dart.

In all seriousness though, I was looking at my forecast for the year the other day and while I don’t like to do this, being a firm believer in living up to your picks, I feel like I need to take a page from the OPEC/NOPEC book and leave any and all reckoning open-ended, if only to have an exit ramp.

For the record, my pick was “up to” $65 by year end. I can’t get there anymore. There’s too much headwind. And tailwind! I still believe that price is coming and that there is a high likelihood that is just the beginning of a higher price deck, but in the current market, who knows.

In arriving at my “conclusion”, I’ve looked at a number of factors, both positive and negative, qualitative and quantitative, some of which are described below. All of which could be bullish or bearish for prices, it depends.

OPEC/NOPEC intervention – this should be very bullish for oil prices, yet strangely it isn’t. Cutting 1.8 million barrels of production a day is in theory is a great way to reduce oversupply and draw down inventories. Everyone was waiting for the big pop in prices that didn’t materialize. Maybe there is something else afoot. We covered the risks here a couple of weeks ago, but they bear repeating – cheating (inevitable, but for now solidarity is strong), Nigeria/Libya (not part of the deal, recovering production, suspect they will be forced to join in the cuts before long), Iraq (hard to fund a war against an insurgency when you don’t have cash flow – they will be the first to break ranks). So, all those risks, but still, a big cut in production that will hit inventories. Market reaction? Meh. Where this breaks is anyone’s guess but I suspect that OPEC/NOPEC, Saudi Arabia in particular, is just fine with the current, uncertain, arrangement.

Inventory levels – stubbornly refuse to cooperate. Winning the inventory battle gets the price where it needs to be. But inventories need to drop from the current level to the 5-year average (a decline of about 300 mm barrels) which will take some work. Personally, I feel that there is a rising risk of an inventory shock, particularly in non-US OECD given the lagging nature of the data which is typically a month old and lagging, so it’s of little utility except to remind everyone of old news, usually at the wrong time. On the other hand, U.S. data is great, we see it every week and it’s precise – however it is also ubiquitous and represents only 10 percent of the global market. That said, any aberration in that data generates outsized market reactions because it is really the only accurate and timely data the market can access.

Consider for example that last week (June) we found out that U.S. week over week inventory went down by 6 mm barrels and at the same time found out that OECD inventory at the end of March was pretty much unchanged. Thanks. This week we had a surprise build in U.S. inventories and other data? Nada. May as well have been a Windows Blue Screen of Death. Maybe come August, when we get the June or July data, we will see a decline in those stocks which will be bullish for prices, unless the market is freaking out over yet another questionably relevant 1 percent seasonal increase in PADD 3 gasoline stocks sending the market into freefall.

Shale Boom – 2.0. U.S. activity continues to accelerate and we are soon going to see significant additional production from tight oil activity as completions ramp up. It is worth noting that a majority of the growth off the lows of last year was from offshore production, not onshore, but the small 15,000 and 20,000 bpd increases in production we have been seeing for the past few months are the result of many land-based wells coming online. As alluded to above, this weekly climb affects prices by keeping US inventories full and helps create short term swings in inventory numbers such as we saw this past week. We are also continually being told that the US is going to average over 10 million bpd of production in 2018 which of course the market interprets as an OPEC/NOPEC failure, pushing down prices in the short term. Shale drilling is the push-me/pull-you of the oil market – when prices are high, they all get to work and when they all get to work prices come down. My point? As long as tight oil is drilling, absent any other influences, prices will be held in check

Nice soft backwardation – this should be a net positive for prices. It encourages the draining of inventories since the price available now is better than what is available farther out. Of course it is also a negative, since short cycle shale drillers will be motivated to drill to generate cash flow today. On the other hand, highly indebted shale drillers require the ability to hedge production to lock in prices and cash flows to pay their banks and in a backwardation environment they can’t, which should depress activity. The recent price drop may be enough to bring back a contango situation, which of course has just the opposite effect.

Not too hot, not too cold. Meh, get a life Goldilocks. I’m the “market” and I want it now, now, now! Seriously though, the market wants higher prices and all this nonsense is standing in the way of higher prices. Plus all those hedge funds went long on the market and they were wrong (at least in the short term) so the sell-off happened.

In the chart below you can see the crude price plowing through and below its 200, 50 and 9 day moving average. From a market timer’s perspective, this chart is a giant red flag. The technical play on oil is to sell, sell, sell and run for the hills! Based on this chart, in the very short term, oil could touch $42. Given that, the path back past $50 is long.

Nonsense in the Middle East – So Saudi Arabia and the Gulf Cooperation Council collectively decided they were going to punish Qatar and isolate them because of their supposed support of Iran and terrorism. The market initially pushed oil prices up but then they came back as the assessment was that this wasn’t a supply risk given Qatar’s natural gas orientation. But wait a second, a week after Trump visits, rips Iran while in Saudi Arabia and gets the cold shoulder from Qatar, all of a sudden Saudi Arabia and friends isolate this lightly populated country? I don’t think there was any one thing said by Trump that gave rise to this, but I think the Saudis were left with the distinct impression that the U.S. wouldn’t care, or tacit approval (tweet supported!). And thus we have another tentative step towards even broader proxy if not outright conflict in the Middle East between Iran and Saudi Arabia. If that isn’t bullish for crude prices, I’m hard-pressed to think what might be. (As an aside on the supply situation, Qatar is the world’s largest exporter of LNG – wouldn’t it be just ducky if Canada had an LNG facility to fill that potential shortfall, you know, kinda like the U.S. and Australia do?)

All Trump, all the time – at some point the constant turmoil in the Trump White House has to start wearing on the markets, doesn’t it? An unceremonious crash from over-valued heights, a weakening of the U.S. dollar, pushing oil prices up a bit? You would think, but that has not yet happened. That said, with the ongoing controversy regarding Russian election interference, questions about collusion and obstruction of justice, a puzzling approach to world affairs and global alliances and a legislative agenda that has only a passing chance of actually being implemented, one can only surmise that at some point the sell light is going to start flashing over the U.S.

Demand – much to the chagrin of anti-fossil fuel activists everywhere, demand for fossil fuels continues to grow and is expected to surpass 100 million bpd by 2019 if not sooner. That is a staggering number. Bullish, right? So add 2mm bpd of demand growth to the average decline rates of 4 percent to 6 percent (if not higher), and the oil industry needs to add up to 8 million bpd of production a year to meet this demand, an annual add that is greater than Canada’s production (4 mm bpd), US tight oil (5 mm bpd) and OPEC spare capacity. Plus, as detailed here previously, the lack of investment in large scale projects since the crash of 2014 and the absence of major discoveries in a longer time frame than that is more than problematic. Where is that supply going to come from? Currently this can be met with the excess inventory that exists (which we are supposedly drawing down), but once that five year average line gets crossed, and it will, the price direction can be nowhere but up until major, game-breaking supplies get brought on line. And, sorry everyone, tight oil isn’t going to solve that problem, fortunately for Canada though, oil sands play a part, but there needs to be much more. The upper bound on prices at that point will depend on how fast new resource can be brought on stream or Elon Musk. My money is on the patch.

Is there a conclusion here? You’d think, right? But no, not really. The signals are all so conflicting that it is hard to get a handle on where the market is actually going to go. It’s all over the map, much like most of the narrative above. And I guess that’s the point because really, who knows!

This seems to be the textbook definition of “range bound”, too many opposing signals, but none of them yet strong enough to propel the price definitively in one direction. Currently that range appears to be $45 to $55. Which isn’t that bad, all things considered. It’s hard to see a sustained break below that or a significant move above that. At least in the short term.

So, am I ready to throw in the towel on my price forecast? Not yet, but I am fully prepared to throw my year end timing under the bus and push out significant price increases to mid to late 2018. I’m not overly concerned about the 10 million bpd of U.S. production in 2018 because, quite frankly, we will probably need all those barrels if not more.

For all the positive reasons described above, prices have to come up. For all the negative reasons described above, prices have to come down. For the foreseeable future, expect the market to continue overreacting to incremental production increases of 20,000 bpd here and there and getting spooked by the short term click bait of Libyan output and Nigerian refinery bombings. It is also fair to say that the market will continue to under-appreciate the implications of four years of stagnant exploration and discovery, until it’s too late.

Year end? I’ll go back to my blind-folded dart board $56. Even that may be too high. But expect $75 sometime in 2018.

// USA News Group