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The
monthly average U.S.-dollar price of West Texas Intermediate (WTI) crude oil reversed
course in May when falling by $3.04 (-4.8%), to $60.83 per barrel. The increase
occurred within the context of a stronger U.S. dollar, the lagged impacts of a 10,000
barrel-per-day (BPD) drop in the amount of oil supplied/demanded during March (to
20.2 million BPD), and an expansion in accumulated oil stocks (May average: 483
million barrels).
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Oil
prices fell on Friday posting their biggest monthly drop in six months, after
President Donald Trump threatened tariffs on imports from Mexico. Unless the Mexican government stops people
from illegally crossing into the U.S., he would impose a 5 percent tariff on
imports starting on June 10th that would increase monthly, up to 25 percent on
Oct. 1. Following the threat Brent
crude futures fell $2.38, or 3.6 percent, to settle at $64.49 a barrel and New
York futures fell $3.09 to $53.50 a barrel, a 5.5 percent loss. Brent touched a session low of $64.37 a
barrel, lowest since March 8. WTI hit
$53.41 a barrel, weakest since Feb. 14.
During May Brent futures posted an 11 percent slide and WTI 1 percent,
their largest monthly losses since November.
U.S.
refiners import some 680,000 b/d of Mexican crude so that a 5 percent tariff
would add an additional $2 million to the cost of their daily purchases and a
25 percent tariff an extra $10 million.
Given the scale of the pushback from the Congress and the many
organizations that have interests in the U.S.-Mexico trade, it seems unlikely
that the tariffs will be imposed.
Other
important factors bearing on the price decline last week were the on-going U.S.-China
trade war and the U.S. stocks report showing that the U.S. crude inventories
decreased by less than 300,000 barrels.
The American Petroleum Institute had estimated a 5.2-million-barrel
drawdown earlier in the week sending the markets higher.
On
the last day of every month, the U.S.'s Energy Information Administration
releases its Petroleum Supply Monthly, which contains the U.S. oil production
number up to 60 days before publication. While the newest of these numbers are
two months old, they are more accurate than the forecasts the EIA releases in
its Drilling Productivity Report on the 15th of each month. Recently these forecasts have been too
optimistic about how much shale oil would be produced in the coming month
forcing revision when the actual production numbers become available ten weeks
later.
When
the May production numbers were released on Friday, Reuters headlined its
conclusions as "U.S. crude output rises 2.1% in March to a near record
high." While this sounds great,
digging into the details tells another story.
The EIA has been predicting that U.S. crude production, which now is
critical to global economic growth, will grow by some 1.2 million b/d this
year. While U.S. production was up in
March, it has been largely static for the last six months with production in
November and December 2018 slightly higher than in March 2019. Growth in output between February and March
largely came from a rebound in North Dakota production which was hampered by
frigid weather in February. The other
significant increase during March was an 11 percent increase in Gulf of Mexico
production, which usually comes when a new production platform comes online and
is unlikely to grow much in coming months.
The
most interesting revelation in the report was that oil production in Texas
declined by 0.1 percent between February and March to 4.873 million b/d. This decline suggests that the press stories
saying that small and medium-sized shale oil drillers are cutting back may be
showing up in production numbers. The decline further suggests that the U.S.
will have difficulty in achieving a 1.2 million b/d increase this year. On the positive side, the new numbers show
that oil production in New Mexico was up by 23,000 b/d last month and up by
39.5 percent since March 2018 to 870,000 b/d.
This westward extension into New Mexico's portion of the Permian Basin
seems to be the fastest growth area in the shale oil industry.
The OPEC+ Production Cut: Preliminary figures show that OPEC's production
dropped to a four-year low of 30.17 million b/d in May, as a 200,000 b/d
increase in Saudi production was not enough to offset Iran's and Venezuela's
lower output. Crude oil has fallen from
a six-month high above $75 a barrel in April to below $65 on Friday, due to
concerns about the economic impact of the U.S.-China and U.S.-Mexico trade
disputes. This decline in prices is
likely to affect the decision on whether to extend the production cut that is
to be taken at the end of this month.
Despite
the U.S. sanctions, Iran was able to ship out about 400,000 b/d last month,
less than half as much as it exported in April.
Venezuela's production fell by 50,000 b/d in May due to the impact of U.S.
sanctions and long-term deterioration of its production infrastructure. Output also dropped in Nigeria because of a
pipeline shutdown that disrupted exports.
The
decline in oil prices increases the chances that that OPEC+ production cut will
be extended for another six months at the June 25-26 meeting to consider the
cuts. The Saudis have been hinting for
weeks that they want an extension and we have indications that Russia may be
changing its position. Moscow's Finance Minister Siluanov said last week,
"there are many arguments both in favor of the extension and against it,
but we see that all these deals with OPEC result in our American partners
boosting shale oil output and grabbing new markets." Russia's energy ministry and the government
will determine their stance on the pact's extension after weighing these pros
and cons and the longevity of current market trends.
U.S. Shale Oil Production: Despite the hype of lower breakeven prices, and the
hype around longer laterals, energy digitalization, and other technological
breakthroughs, most shale companies are still not profitable. Nine in ten U.S. shale oil companies are
burning cash, according to Rystad Energy.
The consulting firm has studied the financial performance of 40
dedicated U.S. shale oil companies, focusing on cash flow from operating
activities. Free cash is the money
available to expand the business, reduce debt, or return to shareholders. Only four companies in the group reported a
positive cash flow balance in the first quarter of 2019, bringing down the
share of companies with a positive cash flow balance from the recent average of
around 20% to just 10%.
Evidence
continues to mount that U.S. shale oil production is slowing. Last week, Schlumberger, the largest oilfield
service company in the world, saw its debt rating downgraded by S&P due to
the slowdown in drilling by U.S. shale companies. Meanwhile, rival Halliburton saw its outlook
downgraded from "stable" to "negative." An analyst at S&P wrote in a report,
"The oilfield services industry has fundamentally changed due to permanent
efficiency and productivity gains realized by E&P companies as well as
investor sentiment calling for E&P companies to live within cash flow and
limit production growth."
Independent
shale drillers in the U.S. are facing pressure to either expand or be acquired,
Robert Kaplan, president of the Federal Reserve Bank of Dallas, said
recently. "Smaller, independent
drillers are losing access to capital and hearing complaints from
shareholders." In the Dallas Fed's
most recent Energy Survey - a quarterly poll of about 200 oil and gas companies
- one anonymous oil industry executive wrote that "the shrinkage in market
capitalization of some companies is breathtaking."
North
Dakota drillers are falling short of the state's goals to limit the burning of
excess natural gas. This situation comes
five years after the state adopted rules to reduce the environmentally harmful
practice. The industry has spent billions of dollars on building new
infrastructure but is at least two years from catching up. Regulators are saying that the state's
increasing gas production will continue to outstrip new pipeline capacity to
pipe it away.
Occidental
Petroleum acquired some of the richest shale oilfields in Texas when it beat
out Chevron Corp in a bidding war to acquire Anadarko Petroleum. It also quadrupled its debt - to $40 billion
- at a time when investors are calling for spending cuts and higher
dividends. The acquisition's success
will depend on how quickly Occidental can sell off some of Anadarko's assets
and focus on optimizing and integrating the assets it keeps - especially the U.S.
shale fields. Corporation activist
investor Carl Icahn has filed a lawsuit against the company over what it called
its "misguided" acquisition of Anadarko and may seek a special
meeting to remove and replace board members.
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Oil
prices are on track for their largest monthly decline in six months. The Trump
administration exacerbated the selloff with another threat of trade escalation.
Trump
threatens Mexico with 5 percent tariffs. President Trump
threatened
to slap a 5 percent tariff on all goods imported from Mexico beginning on June
10. In a tweet, he said that the tariff would gradually increase over time
unless illegal immigration stopped. The announcement is also a serious blow to
attempts to pass the NAFTA 2.0 agreement, which needs be ratified in the
national legislatures of Mexico, the U.S. and Canada. "The decision,
understandably, is sending shivers down investors' spines," PVM
said
in a note. "U.S. refiners import roughly 680,000 barrels per day of
Mexican crude. The 5% tariff adds an extra $2 million to the cost of their
daily purchases."
Fed
under pressure to cut rates. The
escalating trade war, which may now include Mexico, has led bond investors to
bet that the U.S. Federal Reserve will cut interest rates. If the trade war is
not resolved soon, "the patience needed to keep from easing will be
severely tested sometime in the months ahead," Steven Blitz, chief U.S.
economist at TS Lombard, told the
Wall
Street Journal. For now, the central bank is not making any moves.
Trump
to lift summer E15 ban. The Trump
administration has
approved
the sale of higher concentrations of ethanol in summer months, a move that will
be welcomed by ethanol producers and American farmers, already battered by the
trade war. Until now, the 15 percent ethanol mix was only allowed to be sold
eight months out of the year over concerns about smog in summer months. The oil
and refining industries oppose the move and will likely launch legal
challenges.
OPEC
output falls by 60,000 bpd in May.
A Reuters
survey
puts OPEC's production at 30.17 million barrels per day in May, down 60,000 bpd
from April and the lowest figure in nearly four years. Saudi Arabia increased
output by 200,000 bpd, but Iran lost 400,000 bpd.
U.S.
delays petrochemical sanctions on Iran. In what is being interpreted as an attempt to dial back tensions, the
Trump administration has
delayed
sanctions on Iran's petrochemical sector.
Oil
majors won't bail out struggling Permian drillers. The oil majors have said that they will not overpay
for indebted and struggling drillers in the Permian. There is "not always
alignment among buyers and sellers," ExxonMobil (NYSE: XOM) CEO Darren
Woods
said
Wednesday, a diplomatic way of saying that smaller companies are demanding too
much. He suggested that these companies will be squeezed over time and will
lower their expectations.
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.
