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The
monthly average U.S.-dollar price of West Texas Intermediate (WTI) crude oil rose
again in May, increasing by $3.72 (+5.6%), to $69.98 per barrel. The advance occurred
within an environment of a much stronger U.S. dollar, the lagged impacts of a 954,000
barrel-per-day (BPD) jump in the amount of oil supplied/demanded during March (to
20.6 million BPD), and a very modest increase in accumulated oil stocks (monthly
average: 435 million barrels).
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In
a short trading week, oil prices closed mixed with London futures holding
steady but New York declining on higher US oil output. US oil prices continue to fall well behind
world prices, as booming shale oil production deals with pipeline constraints,
leading to the biggest discount to North Sea Brent in three years. On Thursday,
the discount climbed to over $11 a barrel. The weekly US stocks report showed
that while oil production grew by 44,000 b/d, a drop in US imports and a surge
in exports to 2.1 million b/d resulted in a decline in US commercial crude
inventories of 3.6 million barrels from the week before last.
The
regional discount problem is not confined to Permian Basin oil production. Western Canada Select consistently trades at
a substantial discount to US futures prices. Last week the Canadian heavy crude
was trading at only $41 per barrel or $25 below New York futures. These
discounts are good for refiners and exporters but are causing problems for the
drillers who are struggling to break even.
Although
the recent decline in prices is based on the possibility the OPEC production
freeze will be modified or lifted and steadily increasing US oil production,
many authoritative voices are saying that these developments will not be enough
to prevent much higher oil prices later this year. It currently appears that
Saudi Arabia and Russia are talking about adding somewhere between 300,000 and
1 million b/d to the world’s oil supply which should hold down prices. However,
Goldman Sachs is arguing that inventories are already back down to the
five-year average and that demand is being underestimated. Venezuela is losing
production and infrastructure bottlenecks in the Permian Basin could foretell
that US shale production for the rest of the year will not be as high as
expected. Without OPEC and Russia increasing supply from current levels,
inventories would fall “to historically low levels by the first quarter of next
year”. In addition to the Venezuelan meltdown, growing tension surrounding the
new US sanctions on Iran have led to Iranian threats to resume enriching
uranium in the next few months. The impact of the growing US trade war with
China is unknown, but some are suggesting this alone could force all prices
towards $100 a barrel this summer.
The
fundamental principle underlying the future of oil prices is that worldwide we
are not finding as much oil as is being demanded at current prices and reserves
are depleting faster than ever before. A supply crunch is coming. The only
issue is when not if. In the US, we’ve
been drawing down inventories steadily February of 2017, because our net
imports are not sufficient to meet demand.
The
OPEC Production Cut: The cartel’s oil production dropped in May by 70,000 b/d
to 32.00 million b/d largely due to militant attacks in Nigeria and the ongoing
decline in Venezuela that dragged total production to the lowest level since
April 2017. The decision that will emerge from the OPEC plus meeting to set new
oil productions levels will depend on policy decisions in Moscow, Riyadh, and
Washington. These three countries, each of which can produce over 10 million
b/d or one-third of the world’s oil supply, have differing price objectives
that will determine where the oil markets go in the immediate future. Russia
and the Saudis would like much higher prices to help their lagging economies
while President Trump is already demanding that OPEC increase production to
keep prices lower before the US mid-term elections.
Washington
is saying that there is so much oil in the world that its new Iranian
sanctions, which kick in this fall, would not be significant. Tehran is saying
that OPEC members at their meeting later this month should protect members
targeted by US sanctions. The Iranian government is busy courting European,
Russian and Chinese leaders for continued support of the nuclear agreement and
is threatening to resume nuclear enrichment if Washington’s new initiative
hurts its exports.
US
Shale Oil Production: Drillers added two oil rigs in the week to June 1,
bringing the total count to 861, the highest level since March 2015. The US rig
count, an early indicator of future output, is much higher than a year ago when
733 rigs were active. However, decisions to activate or mothball rigs have to
be taken at least several weeks in advance; we could be seeing a carryover from
steadily rising prices last spring.
The
surge in shale oil production continues to run into bottlenecks. From West
Texas pipelines to Oklahoma storage centers and Gulf Coast export terminals,
the delivery system for American crude is straining to keep up with production,
limiting the industry’s ability to take full advantage of growing demand. Last week Barclays analysts predicted, “a new
shock" for energy markets as a lack of pipeline capacity near the Cushing,
Okla. storage hub threatened the flow of oil. Pipeline shortages in the Permian
basin, meanwhile, may not be overcome by new construction for another 18
months. These problems are undercutting the conventional wisdom that US shale
oil production will stabilize global prices as crude exports from Venezuela and
probably from Iran seem likely to decline.
The
recent increase in oil prices to above $60 a barrel is helping oil companies
refinance some $138 billion in debt due this year and a total of $400 billion
is coming due before the end of 2019. Between 2012 and 2014 there was an “an
irrational exuberance” going on when oil prices were high, and interest rates
were low resulting in a surge of borrowing that must be paid back. Conventional wisdom on Wall Street says that
shale oil is profitable above $60 a barrel, but this may not be the case. As
bottlenecks grow, many drillers are being forced to accept large discounts for
their oil and the industry as a whole is far from profitable.
The
Wall Street Journal recently reported that only five of the Top 20 US oil
companies that focused on hydraulic fracking generated more cash than they
spent in the first quarter of this year. This continues a trend that has been
ongoing throughout the fracking boom where companies are spending $1.13 for
every $1 they take in. While lenders are hoping that much higher prices will
soon wipe out the massive debts drillers are accumulating, it could be a
question of whether drillers are forced to default before the days of $100+ oil
prices return.
Oil
prices were a mixed bag this week, with Brent holding steady but WTI declining
on higher U.S. output. The spread between the two benchmarks is rare, and
reflects uncertainty and confusion in the oil market, as well as regional
differences in supply and demand.
U.S.
tariffs threaten financial markets. President Trump resumed this trade war this
week, slapping steel and aluminum
tariffs
on Canada, Mexico and the EU and industrial tariffs on China. The decision
comes after offering exemptions to U.S. trading partners in recent months, and
comments from the Treasury Secretary just last week that the trade war would be
“put on hold.” The about-face has spooked financial markets. As for oil, a
trade war threatens to undermine demand, although the magnitude of the slowdown
is hard to predict.
WTI
blowout. WTI dropped to a more than $10-per-barrel discount to Brent this week,
the widest spread in three years. The pipeline bottlenecks in the Permian are
starting to bite. “This was inevitable. There was way too much production
growth for infrastructure to handle,” Vikas Dwivedi, global oil and gas strategist
at Macquarie, told Reuters. Meanwhile, the uncertainty surrounding the OPEC
deal, plus geopolitical risk, has Brent looking for direction. “The market
doesn’t know where the price of oil is going to be and probably doesn’t know
where it should be, and so it’s open to some major price fluctuations,” Richard
Hastings, an independent analyst, told
Reuters.
U.S. exports of crude are rising, while Brent-linked cargoes in the Atlantic
Basin are struggling to find buyers.
Permian
bottleneck crushes Midland oil prices. While WTI is trading at a steep discount
to Brent, things are worse in the Permian. Oil in Midland is trading more than
$20 per barrel below Brent. “This is probably just the start with more downside
to come for the local Permian crude price in order to halt the ongoing booming
production growth as there is nowhere to store the local surplus production and
limited means to get it to market,” Bjarne Schieldrop, chief commodities
analyst at SEB, said in a statement. Schieldrop predicts that U.S. shale will
only grow by 1 million barrels per day over the coming year, or 0.5 mb/d less
than previously expected.
GE
backs out of Iran. GE (NYSE: GE) will
end
sales of oil and natural gas equipment in Iran later this year, the latest
sign that pending U.S. sanctions are having a serious impact. GE had received
contracts from Iran for tens of millions of dollars for oil and gas equipment
since 2017. For Iran, the withdrawal is a problem because the gear and
equipment are crucial to maintaining and growing oil and gas production.
Shell
starts Gulf of Mexico project year ahead of schedule. Royal Dutch Shell (NYSE:
RDS.A)
started
up the Kaikias oil field in the Gulf of Mexico this week, one year ahead of
schedule. "Shell has reduced costs by around 30% at this deep-water
project since taking the investment decision in early 2017, lowering the
forward-looking, break-even price to less than $30 per barrel of oil," the
company says in a statement. The project will have peak daily output of 40,000
bpd.
The foregoing comments represent the
general economic views and analysis of Delphi Advisors, and are provided solely
for the purpose of information, instruction and discourse. They do not
constitute a solicitation or recommendation regarding any investment.
