May 2018 Monthly Average Crude Oil Price

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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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From the 4 June 2018 issue of Peak Oil Review:

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.

Selected highlights from the 1 June 2018 issue of Oil & Energy Insider include:

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.