Tag Archives: OPEC

Crude Oil Market Structure Looks Weak, But It Is Only One Part Of A Complicated Puzzle

Summary

  • Term structure – contango says too much oil around.
  • Brent-WTI says Iran will flood the market.
  • Crack spreads could crack the recent lows for crude.
  • OPEC meeting is the next big event – signals are that these guys cannot agree on anything.
  • Crude oil and a turbulent world.
 

The price of crude oil has not looked this bad since March, when it made lows of $42.03, or on August 24, when it fell to $37.75. On Friday, November 20, active month January NYMEX crude oil settled at $41.90 per barrel. The expiring December contract traded down to lows of $38.99 on the session. There are very few positive things to say about the future prospects for the price of crude oil at this time. The fundamental structural state of the oil market is bearish for price.

Term Structure – contango says too much oil around

Two weeks ago, the IEA told us that the world is awash in crude oil. The international agency told us that worldwide inventories have swelled to 3 billion barrels.

When crude oil was trading over $100 per barrel on the active month NYMEX futures contract during the summer of 2014, the market was in backwardation. Deferred futures prices were lower than nearby prices. This condition tells us that a market is tight, or there is a supply deficit. As the price of oil began to fall, term structure moved from backwardation to contango. This told us that the market moved from deficit to a condition of oversupply. This past week, the contango on the nearby versus one-year oil spread once again validated the glut condition in crude oil.

(click to enlarge)The December 2015 versus December 2016 NYMEX crude oil spread closed last week at over $8.00 per barrel. The contango has increased to 20.46%, the highest level yet for this spread. The January 2016 versus January 2017 NYMEX spread also made a new high and traded above the $7 level.

Brent crude oil futures have rolled from December to January. The January 2016 versus January 2017 Brent crude oil spread was trading around the $7.62 or 17% level last Friday. Market structure is telling us that huge inventories of crude oil will weigh on the price in the weeks ahead. At their current levels, a new low below the current support at $37.75 seems likely. Meanwhile, a location/quality spread in crude oil is also telling us that prospects for the oil price are currently bleak.

Brent-WTI says Iran will flood the market

The benchmark for pricing North American crude is the NYMEX West Texas Intermediate (WTI) price. When it comes to European, African and Middle Eastern crudes, Brent is the benchmark pricing mechanism. For many years, Brent crude traded at a small discount to WTI. That is because WTI is sweeter crude; it has lower sulfur content. This makes WTI more efficient when it comes to processing the oil into the most ubiquitously consumed oil product, gasoline.

That changed in 2010. The Arab Spring caused uncertainty in the Middle East to rise. As the majority of the world’s oil reserves are located in this region, the price of Brent crude rose relative to the price of WTI. Brent crude included a political premium. Additionally, increasing production from the United States, due to the extraction of oil from shale, exacerbated the price differential between the two crudes. In 2011, the price of Brent traded at over a $25 premium to the price of WTI. Recently, the spread between these two crudes has been converging. While the spread on January futures was trading at a premium of $2.40 for the Brent futures as of last Friday, it had moved much lower during the week.

The premium of Brent over WTI has evaporated over the course of 2015. The reason is two-fold. First, the number of operating oil rigs in the United States has fallen dramatically over the past year, indicating that production of the energy commodity will fall. Last Friday, Baker Hughes reported that the total number of oil rigs in operation as of November 20 stands at 564 down from 1,574 at this time last year. While lower U.S. production is one reason for a decline in the spread, increased production of Iranian crude oil has had a more powerful effect on the spread.

The nuclear nonproliferation agreement with Iran means that sanctions will ease and Iran will pump and export more crude oil in the weeks and months ahead. Iran has stated that their production will initially rise by 500,000 barrels per day and it will eventually rise to over one million. These two factors have caused the Brent-WTI spread to converge. The price trend in this spread is a negative for the price of crude at this time.

Crack spreads could crack the recent lows for crude

Recently, we have seen divergence emerging in crude oil processing spreads. Gasoline cracks have been outperforming crude oil, while heating oil crack spreads continue to trade at the weakest level in years.

Last Friday, the NYMEX gasoline crack spread closed at just over $14 per barrel.

The monthly chart of the gasoline crack highlights the recent strong action in this spread. Gasoline is a seasonal product; it tends to trade at the lows during this time of year. In 2014, the high in the gasoline crack at this time of year was $12.36. Therefore, compared to last year, gasoline prices are strong relative to the price of raw crude oil. This could be due to the current low level of gasoline futures – the December NYMEX gasoline futures contract closed last Friday at $1.2866 and the January futures closed at $1.2670 per gallon. The current low level of gasoline prices has increased demand from drivers as refineries work to process heating oil as the winter is only a few weeks ahead. In September U.S. drivers set a record for miles traveled by automobile.

The heating oil processing spread is a very different story. While the gasoline crack is relatively strong, the heating oil crack is very weak.

(click to enlarge)Last Friday, the January heating oil processing spread closed at around the $17.50 per barrel level. Last year at this time, the low in this spread was $22.73. In 2013, the low was $24.53 and in 2012, the low was $37.75 per barrel. The current level of the heating oil crack spread is seasonally the lowest since November 2010 when it traded down to $12.35 per barrel. In November 2010, crude oil was trading above $84 per barrel.

One of the many reasons that the crude oil price is weak these days is that demand for seasonal products, heating oil and diesel fuel, is low and inventories of distillates are high. As you can see, there are very few bullish signs in the fundamental structure for the crude oil market these days. In two weeks, the oil cartel will sit down to decide what to do now that the commodity they seek to “control” is awash in a sea of bearishness.

OPEC meeting is the next big event – Signals are that these guys cannot agree on anything

When OPEC met in November 2014, the price of crude was around the $75 per barrel level. When they met late last spring, the price had recovered to around $60. In both cases, the cartel left production levels unchanged. The stated production ceiling for the members of OPEC is 30 million barrels per day. The member nations are currently producing over 31.5 million barrels per day and increasing Iranian production means that OPEC output will likely rise. As the price of oil falls, the members need to sell more to try to recoup revenue. For the weaker members, the oil revenue is an imperative. Even the stronger members are under pressure. Saudi Arabia recently began selling bonds; they are borrowing money from the markets to replace lost income due to the lower crude oil price.

Meanwhile, OPEC’s current strategy is to continue to produce to flush high cost producers out of the market and build market share for the cartel members. However, OPEC did not count on a global economic slowdown, particularly in China. At the December 4 meeting of oil ministers in Vienna, it is likely that demand for crude oil will be an important consideration.

Dominant members of the cartel remain at odds. Saudi Arabia and Iran are on opposite sides and are involved in a proxy war in Yemen. The weaker members of OPEC want the stronger members to shoulder the burden of production cuts, and that is not likely to happen any time soon. In a hint of the discord between the member nations, on November 17, OPEC’s board of governors was unable to agree on the cartel’s long-term strategy plan and they tabled the issue until 2016. The issues revolve around ceiling output, setting production quotas and methods of maximizing member profits.

This tells us that unless the cartel is planning a giant spoof on the market, there is probably going to be no change in production policy. The current level of cheating or daily sales above the production ceiling may even increase. At this point, I doubt whether OPEC members could agree on whether it is sunny or cloudy outside given vast political, economic and cultural divergences among member nations. This means that selling will continue and even increase over the months ahead.

Crude oil and a turbulent world

All of the news, fundamentals and technicals for crude oil point to new lows and a challenge of the December 2008 lows of $32.48 per barrel. Last week, Goldman Sachs came out with a prediction that oil could fall to $20 per barrel. This is not such a bold call given the current state of the oil market, the strength of the dollar and the overall bear market for raw material prices. Last week, copper put in another multi-year low, iron ore fell to new lows and the Baltic Shipping Index fell to the lowest level since 1985.

However, all of the bad news for crude oil is currently in the price. We have seen this before. In March when crude oil traded to lows, there were calls for crude oil to fall – Dennis Gartman, the respected commodity analyst, went on CNBC and said that crude oil could fall to $10 per barrel as the energy commodity could go the way of “whale oil.” In late August, when oil fell to recent lows at $37.75, there were multiple calls for oil to fall to the low $30s and $20s. In both cases, powerful recovery rallies followed these bearish market calls. Following the March 2015 lows, oil rallied for over two months and gained 48.9%. In August of this year, a seven-week rally took oil 35% higher. The bearish prediction by Goldman Sachs last week could just turn out to be a contrarian’s dream.

There are a number of issues, big issues, going on in the world that can turn crude oil on a dime. First, Brent has fallen relative to WTI and the political premium for oil has evaporated. In 1990, when Saddam Hussein invaded Kuwait, the price of crude oil doubled in a matter of minutes. While the Middle East has always been a turbulent and dangerous part of the world, I would argue that today, it is far more turbulent and far more violent. The odds of attacks against oil fields and refineries in the Middle East have increased exponentially particularly given the recent ISIS attacks in France and around the world. At the same time, all of the bearish fundamental news about crude oil has decreased the political premium, and it is politics and war that could turn out to outweigh all of the current fundamentals.

Moreover, a surprise from outside of the Middle East could foster an increase in the price of oil. The world is now almost counting on Chinese economic weakness. Last week, Jamie Dimon, the Chairman of JPMorgan Chase, said that he is bullish on Chinese growth. If China does begin to show signs of growth, this could turn out to be supportive of crude oil and commodities in general, which remain mired in a bear market. Right now, the price of crude oil looks awful and fundamentals support a new low. However, all of that bearish data is in the price, and any surprise, in a world that always seems be full of surprises, could ignite the price once again. We saw this in March and again in August. As oil makes new lows, keep in mind that crude oil is a complicated puzzle. It is the unknown that will likely dictate the next big price move in oil. I am watching crude oil now and wondering whether Goldman Sachs called the turn in the market with their bearish forecast.

As a bonus, I have prepared a video on my website Commodix that provides a more in-depth and detailed analysis of the current state of the oil market to illustrate the real value implications and opportunities.

By Andrew Hecht in Seeking Alpha

Is Big Oil In Bed With The Saudis To Destroy The Fracking Industry?

Summary

  • Saudis want Big Oil to win – have predictable working relationship with them.
  • Big Oil is waiting on the sidelines until the price of properties drop.
  • Those with DUC wells and enough reserves will be able to survive the onslaught.
  • U.S. shale oil remains viable, but the players are going to change.

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As the strategy of Saudi Arabia becomes clearer, along with the response of shale producers to low oil prices, the question now has to be asked as to whether or not the big oil companies support the decision by Saudi Arabia to crush frackers until they have to offer their various plays at fire sale prices.

With the emergence of frackers came a significant number of new competitors in the market that didn’t have an interest in playing nice with OPEC and Saudi Arabia, as major oil companies have in the past. This was a real threat as other OPEC members and shale companies started to take share away from Saudi Arabia.

The general consensus is Saudi Arabia isn’t interested in crushing any particular competitor, rather it’ll keep production at high levels until the weakest producers capitulate. I have thought that as well until recently.

What changed my thinking was analyzing who was the biggest threat to OPEC and Saudi Arabia, and in fact it is the shale industry in the U.S. The reason I draw that conclusion is the energy industry had its traditional competitors in place for many years, and other than occasional moves to impact the price of oil using production levels as the weapon, it has been a relatively stable industry. Shale changed all that.

I think what bothered Saudi Arabia in particular was it didn’t have a working relationship with many of these new competitors, who have been very aggressive with expanding production capacity over the last few years. They were in fact real competitors who were working to take market share away from existing players. And with Saudi Arabia being the low-cost producer with the highest reserves in the world, it was without a doubt a direct assault on its authority and leverage it historically has had on the oil market. Its response to frackers is obvious: it isn’t willing to give up share for any reason.

Where the challenge for Saudi Arabia now is it has started to have to draw on its own reserves and issue bonds to make up for budget shortfalls. It has plenty of reserves, but it appears we now have a clear picture on when it would really come under pressure, which is within a four to five year period. That’s the time it has to devastate its shale competitors.

The other problem for the country is it could take down some members of OPEC in the process, where there are already significant problems they’re facing, which could lead to unrest.

From a pure oil perspective, it seems to be an easy read. Saudi Arabia can outlast the small shale producers with no problem. I think that’s its goal. But it is putting enormous pressure on other countries as well, and there will be increasing pressure for them to slow production in order to support oil prices.

This even extends to Russia, which produces more oil than any other country.

My belief is Saudi Arabia is attempting to force consolidation in the shale industry, so it can resume its dealings with big oil players it has worked with for many years. I believe it’s also what big oil players want. All they have to do is sit back and experience some temporary pain and wait for some of the attractive plays to come onto the market at low prices.

So far the price is still high in the U.S., but as time goes on, the smaller companies will be forced to sell, one way or another. That’s the big opportunity for investors. Identifying those companies with the resources and desire to acquire these properties is the key. That and evaluating the plays with the most potential for those buying them up.

At what price can Saudi crush shale oil?

There are analysts predicting oil price levels that are all over the board. I’ve seen those that believe it’s going to shoot up to over $100 per barrel again, and those that have estimated it could fall to as low as $15 per barrel.

The best way to analyze this is to consider what Saudi Arabia can handle over the longest period of time without destroying its own economy and industry, meaning at what price it can remain fairly healthy and outlast its competitors.

Looking at the price movement of oil and the range it’s now settled into, I think it’s close to what the Saudi have been looking for.

Most smaller shale producers will struggle to make it, if the price of oil remains under $60 per barrel, which it will probably do until Saudi Arabia cuts back on production. There will be occasional moves above that, and probably below $50 per barrel again as well, but I think we can now look to somewhere in the $50 per barrel area as the target being sought. We’ll probably see this be the price range oil will move in for the next couple of years, with $50 being the desired low and $60 being the desired high.

I don’t mean by this Saudi Arabia can absolutely control the price of oil, but it can influence the range it operates in, and I think that’s where we are now.

For that reason oil investors should be safe in investing under these assumptions, understanding there will be occasional price moves outside of that range because of usual trading momentum.

Response from shale oil companies

Some may question why the price of oil got slammed not too long ago, falling below $40 per barrel, if the probable price range for oil is about $10 to $20 per barrel higher.

As mentioned above, some of that was simply from trading momentum. It didn’t take long for it to rebound soon afterward.

The other element was the response by shale companies to the new price of oil, which threatened their ability to pay interest on loans that were due.

Frackers weren’t boosting production because they believed they could outlast Saudi Arabia; they kept production levels high because they had to continue to sell even into that low-price environment or default on their payments. This was a major factor in why prices dropped so far over the short term.

With the bulk of the over $5 trillion spent on shale exploration and development coming from companies operating in the U.S., that is also where the bulk of the risk is.

Much of the efficiencies have been wrung out of operations, and moving to higher producing wells that are less costly to operate can only last so long. I believe efficiencies will position some in the industry to survive the current competitive environment, but they will also have to have enough reserves to tap into in order to do so.

Top producing shale wells are at their highest level of productivity in the first 6 months it goes into operation. It gradually fades after that.

Larger players like EOG Resources (NYSE:EOG) have continued to drill, but they are stopping short of production, with approximately 320 DUC wells ready to bring online when the price of oil reaches desired levels. Its smaller competitors don’t have the resources to wait out existing production levels, which is what will again offer the opportunity for patient investors.

In other words, most of what can be done has been or is currently being done, and from now on it’s simply a waiting game to see how long the Saudis are willing to keep the oil flowing.

Most shale producers believed the lowest oil prices would sustainably fall and would be about $70 per barrel. Decisions were made based upon that assumption.

Big oil and Saudi Arabia

Saudi Arabia and big international energy companies have had close relationships a long time via Saudi Aramco, the state-owned firm.

Those relationships, while competitive, still operated within parameters most agreed upon. Shale producers weren’t playing that game, as they invested trillions and aggressively went after market share. If Saudi Arabia wanted to maintain market share, it had to respond.

If the smaller shale producers thought their strategy though, they must have underestimated the will of Saudi Arabia to fight back against them. Either that or they became overly optimistic and started to believe their own press about the shale revolution.

It’s a revolution for sure, but the majority of those that helped launch it won’t be finishing it.

My point is big oil, in my opinion, doesn’t mind quietly standing on the sidelines as their somewhat friendly competitors destroys their competition and prepares the way for them to acquire shale properties at extremely attractive prices.

I’ve said for some time the shale revolution will go on. The oil isn’t going anywhere. What is changing is who the players will end up being, and what properties they’ll end up acquiring.

With EOG, the strongest shale player, it said the prices of those plays now for sale are still too high; that means the smaller players still think they have some leverage.

My only thought is they are hoping for the large players to enter a bidding war and they can at least recoup some of their capital. I think they’re going to wait until they’re desperate and have no more options.

Sure, some big players may lose out on a desirable property or two, but everyone will get a piece of the action. It appears once the prices move down to levels they’re looking for, at that time they’ll swoop in and make their bids. At that time it’s going to be a buyer’s market.

Big oil companies are the preferable players Saudi Arabia wants to do business with and compete against. They will play the game with them, and there won’t be a lot of surprises.

Some of the companies to watch

Some of the larger companies that have already filed for bankruptcy this year include Hercules Offshore (NASDAQ:HERO), Sabine Oil & Gas (SOGC) and Quicksilver Resources (OTCPK:KWKAQ).

Companies known to have hired advisers for that purpose are Swift Energy (NYSE:SFY) and Energy XXI Ltd. (NASDAQ:EXXI).

Some under heavy pressure include Halcón Resources Corporation (NYSE:HK), SandRidge Energy, Inc. (NYSE:SD) and Rex Energy Corporation (NASDAQ:REXX).

There are more in each category, but I included only those that had at least a decent market cap, with the exception of those that already declared bankruptcy.

Here are a couple of other companies to look at going forward, which can be used for the purpose of analyzing ongoing low prices.

Stone Energy’s credit facility of $500 million is reaffirmed, but may not be liquid enough to endure the next couple of years, even though in the short term it does have decent liquidity. If Saudi Arabia keeps up the pressure, it’s doubtful it will be able to survive on its own. There are quite a few companies falling under these parameters, including Laredo (NYSE:LPI). The basic practice of all of them was to limit the amount of leverage they have in place in order not to have paying off interest as the priority use of their capital, while maintaining a strong credit facility.

I’m not saying these companies will survive, but they will survive if the price of oil stays low, but it will take a lot more to root them up than their highly leveraged peers.

Clayton Williams (NYSE:CWEI) recently put itself up for sale because it can’t afford to continue operating at these prices. It has approximately 340,000 acres under its control, and two of the most productive shale basins in the U.S.

Once it announced it was open to selling, the share price skyrocketed, but since it’s struggling to afford extracting the oil, it’s puzzling as to why some believe it’s going to attract a premium price. It’s possible because of the quality of assets, but it would make more sense for larger companies to wait.

This will be a good test on how big oil companies are going to respond. It’s possible they may be willing to pay for the higher quality shale plays, but under these conditions shareholders would resist paying a significant premium.

If Clayton Williams does go for a premium, it doesn’t in any way mean that’s how it’ll work out for most of the shale companies.

There would have to be a significant reason they would pay such a high price. In the case of CWEI, the catalyst would be high production.

Conclusion

All of this sounds neatly packaged, and if all things proceed as planned, this is how it will play out.

Where there could be some risk is if the Middle East explodes and oil production is interrupted. That would change this entire scenario, and if it were to happen soon, shale companies still in operation would not only survive, but thrive.

Barring that level of disruption, which would have to be something huge, this is how it will play out. After all, with everything going on there now, it hasn’t done anything to disrupt Middle East oil. It would take a big event or a series of events to bring it about. That’s definitely a possibility, but it’s one that is unlikely.

Once all of this plays out, there is no doubt in my mind the bigger oil companies will be much stronger and able to produce a lot more oil.

What we’ll probably see happen is for them to cut back on production to levels where everyone is happy, including the Saudi.

That’s what this war is all about, because shale oil deposits remain in the ground. While some companies can quickly resume production because of the nature of shale oil, which can ramp up production fast, it depends on the will and determination of Saudi Arabia and whether or not the geopolitical situation remains under control.

I don’t care too much about the number of rig counts in shale plays because production can be resumed or initiated quick. The risk is how leveraged the shale companies are, and whether or not they have to continue production at a loss in order to pay off their interest on loans in hopes the price of oil will rise.

What I’m looking for with existing plays is for companies like EOG Resources, which continues to develop wells, but does so without the idea of completing them and bringing them into production until the price of oil rebounds.

Shale oil in the U.S. is alive and well, but those companies overextended and few resources are going to be forced to sell at bargain prices. That will produce a lot of added value to the big oil companies waiting on the sidelines watching it all unfold.

Read more by Gary Bourgeault on Seeking Alpha

Is $50 “Hard Floor” Oil Price Already In?

Volte-Face Investments believes that it is …

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The Last Two Oil Crashes Show Peak Oil Is Real

Summary

  • Recent oil crashes show you the hard floor for gauging value oil company equities.
  • Properly understood, the crashes lend an insight into the concept of Peak Oil.
  • All oil equity investors should understand the overarching upward trend on display here.
 

Note: ALL prices used in this article are using current 2015 dollars, inflation adjusted using the
US BLS inflation calculator.

Generally, when I invest, I try to keep my thesis very simple. Find good companies, with good balance sheets and some kind of specific catalytic event on the horizon. But when one starts to concentrate their holdings in a sector, as I have recently in energy (see my recent articles on RMP Energy (OTCPK:OEXFF) and DeeThree Energy (OTCQX:DTHRF), you need to also get a good handle on the particular tail or headwinds that are affecting it. Sometimes a sector like oil (NYSEARCA:USO) can be subjected to such forces, like the recent oil price crash, where almost no company specific data mattered.

One of the biggest arguments, normally used by proponents of owning oil stocks as core holdings, in the energy sector is “Peak Oil.” For the unfamiliar, it is a theory forwarded first by M. King Hubbert in the 1950s regarding U.S. oil production. Essentially, the theory stated that the U.S. would reach a point where the oil reserves would become so depleted that it would be impossible to increase oil production further, or even maintain it at a given level, regardless of effort. This would inevitably lead to oil price rises of extreme magnitudes.

Since those early beginnings, the details have been argued over in an ever-evolving fashion. The argument has shifted with global events, technological developments, and grown to encompass nearly every basin in the world (even best-selling books have been written about peak oil like Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matt Simmons about a decade ago) consuming endless bytes of the Internet in every kind of investment forum and medium of exchange.

In general, I believe that the term “peak oil” is a highly flawed one. Some picture peak oil in a Mad Max fashion, with oil supplies running out like a science fiction disaster movie. Others simply dismiss peak oil as having failed to predict these so-called peaks repeatedly (the world is producing a record amount of oil right now, so all previous absolute “Peak Oil” calls below these amounts are obviously wrong). But what people should be stating when they use these terms is a Peak Oil Price.

Using my own thinking and phrasing, I believe civilization has probably passed $25 Peak Oil. This means that if you set the oil price to $25 a barrel, there is no method available to humanity to provide enough oil to meet demand over any period of time that’s really relevant. I also believe we are in the middle of proving that we have also passed $50 Peak Oil. My final conjecture here is that we will prove in the near-term future to have reached $75 Peak Oil. I don’t believe we are quite at $100 Peak Oil.

Notice that in my formulation the term Peak Oil is always stated as a peak price. Oil is not consumed in a vacuum. The price affects the demand the world has for the product and simultaneously changes the ability of all sorts of entities (businesses and governments) to retrieve deposits of it. This is what I hope to prove in this article.

So what data could I bring to this crowded table?

Well we have one thing we now have that previous entrants into the Peak Oil melee didn’t, which is the recent price crash in oil. Peak oil is often falsely portrayed as a failed idea since it hasn’t resulted in a super squeeze to ultra high prices. These spike prices are viewed as the really critical element by energy investors since they are trying to find the best case. After all, who doesn’t want to own an oil producer if they can identify a spot in which oil prices will rise to some enormous number.

But that is the wrong way to go about it for your oil investments over the long haul. Because what $50 Peak Oil really provides is a floor. In a world where we have passed $25 Peak Oil, it should be impossible, without exogenous events of enormous magnitude (world war, etc.), to press the price of the product below that price. If you could do so, you would immediately disprove the thesis. You would then know the floor provided by whichever peak oil price level you selected was wrong. The same idea seems to hold true for $50 Peak Oil now.

To prove this “floor” we need to choose times of extreme stress in the oil markets, and look at those oil prices and see what the bottoms were. For these examples, let’s select WTI oil, whose weekly average prices are reported all the way back to 1986 by the EIA.

Let’s take the three big crashes in the oil markets. I will use a full year’s average to try to smooth out the various difficulties presented by weather, seasonal effects, or various one-off events (outages, etc.). The first crash I will use as a benchmark is The 1986 Oil Crash. The 1986 breakdown was a supply crash, caused by supply swamping demand. How big a disaster was it for the oil industry?

In 1986, the Saudis opened the spigot and sparked a four-month, 67 percent plunge that left oil just above $10 a barrel. The U.S. industry collapsed, triggering almost a quarter-century of production declines, and the Saudis regained their leading role in the world’s oil market.

This was quite a crash obviously. Triggering a 25 year decline? Not going to find a lot worse than this. So in inflation adjusted dollars what was WTI oil at for the year of 1986? It sold for around $32 a barrel. Now let’s note that at this time WTI crude was actually at a higher price vs. Brent and other world prices. On a Brent basis, crude would have been just around $25 for the year. This will prove to be an important point in a short while.

The next crash we will use to benchmark was the 2008 Financial Crisis. On this website, I should hope that this world crisis will need no introduction and little explanation. This crash in oil prices (and just about every other thing priced by human beings) was a demand crash. The financial disintegration across the world led to massive drops in demand, as jobs were lost across the world by the millions. So with this demand crash what was the average price of WTI crude in the year 2009? It sold in that year for a little over $60.

The last crash I will add is the current drop, starting sometime around October by my reckoning. I would find it hard to imagine any reader of this article is unfamiliar with the current situation in North America or the world regarding oil, at least in a headline sense. This seems to be a supply crash again, where North American-led tight oil drillers have caused an increase in production that the world’s demand couldn’t handle at the $100 price level. Since then, prices have dropped down to a level that suppresses the production of oil and enhances demand.

In the first four months of 2015, the North American oil rig count has already dropped by more than 50% as compared to last year and the demand for oil has begun to increase according to EIA statistics. The current price of WTI oil has been just over $49 as an average for the year 2015. However, let us note that WTI oil now sells for a large discount to world prices, and during the previous two crashes, WTI sold for a premium.

Now we have three data points. Each one is a fairly long period of time, not just a single week. We know that the world in 1986 nearly ended for the oil industry, yet in current dollars, WTI oil was unable to trade for a year below $30 a barrel. Then we had in 2008 and 2009 an economic crisis which was widely described as being the most dire financial disaster since WWII. In 2009, WTI oil still ended up trading well over the 1986 low. In fact it was nearly double that price. This shows just how hard it can be using almost any technique to push oil prices below a true peak number.

Now we have another supply led crunch. One that is widely described as the worst oil crash since 1986, a nearly 30 year time gap. We are attacking the oil price from the supply side instead of 2008’s demand side. Yet thus far, in 2015, oil is still trading more than 50% higher than the 1986 year average, inflation adjusted. In fact, WTI, when adjusted for its current discount to world prices, is trading close to its 2009 average price. Again, nearly double the price of the 1986 crash.

What does this all mean for investing? It means to me that $25 Peak Oil is behind us. You couldn’t really hit and maintain that number in the 1986 crash when many more virgin conventional reservoirs of oil were available. Despite the last three oil crises, not one of them could get WTI oil to $25 and keep it there. Now, using much more expensive oil resources (shale fracing, deep water drilling, arctic development, etc.), it doesn’t seem like the last two disasters have been able to press WTI oil much below $50 for a material length of time. In this recent crash, the $50 floor was able to be reached only with several years of hyper-investment made possible by the twin forces of sustained high prices and access to ultra-cheap capital. Both of these forces are no longer present in the oil markets.

Therefore, I think using a $50 Peak Oil number is a very reasonable hard floor to use when stress testing your oil stocks. It means that when I am choosing a stock that produces oil, it can survive both from supply and the demand led crashes using the worst the world can throw at it.

Some will say this reasoning is simplistic. One could claim any number of variables in the future (technology, peace in the Middle East, etc.) could change all the points I am relying on here. But we have thrown everything at the oil complex between 2008 and now; both from the supply side and the demand sides; breakdowns of the whole world economy, wars, sanctions, natural disasters, hugely stupid governmental policies, OPEC’s seeming fade to irrelevance, biofuels, periods of ultra-high prices, technological progress, electric cars, etc. Yet, here we stand with these numbers staring us in the face.

In conclusion, I feel these price points prove the reality of $50 Peak Oil (WTI). If WTI oil averages more than $50 in 2015 (which I strongly feel the data shows will happen), then it will confirm my thesis that no matter what happens in the world, human beings cannot seem to produce the amount of oil they require for less than that number. Therefore, one will know what the hard floor for petroleum is provided by the hugely complex interplay of geology, politics, economics, and technology by simply measuring those effects on one easy-to-measure point of data, namely price. This version of peak oil also means I have a minimum to test my selections on. I can buy companies that can at least deal with that floor, then make large profits as the prices rise from that hard floor. All oil fields deplete, and for the past twenty years, the solution has universally been to add more expensive technological solutions, exploit smaller or more physically difficult deposits, or use more expensive alternatives. The oil market does not have the same options available to it like it did 1986. Large, cheap conventional oil deposits are no longer available in sufficient supply, which is likely what the oil price is telling us by having higher Peak Floors during crashes. Without the magic of sustained ultra high prices, the investment levels that made this run at the $50 Peak Oil level will not exist going into the future. This means that the Peak Oil floor price should be creeping higher as a sector tailwind, giving a patient and selective investor a tremendous advantage for themselves.

Read more: Volte-Face Investments: The Last Two Oil Crashes Show Peak Oil Is Real

US Oil Rig Count Decline Quickened This Week

Idle rigs in Helmerich & Payne International Drilling Co.'s yard in Ector County, Texas. North Dakota has also been hit hard, forcing gains in technology.

Source: Rigzone

The fall in U.S. rigs drilling for oil quickened a bit this week, data showed on Friday, suggesting a recent slowdown in the decline in drilling was temporary, after slumping oil prices caused energy companies to idle half the country’s rigs since October.

Drillers idled 31 oil rigs this week, leaving 703 rigs active, after taking 26 and 42 rigs out of service in the previous two weeks, oil services firm Baker Hughes Inc said in its closely watched report.

With the oil rig decline this week, the number of active rigs has fallen for a record 20 weeks in a row to the lowest since 2010, according to Baker Hughes data going back to 1987.
Since the number of oil rigs peaked at 1,609 in October, energy producers have responded quickly to the steep 60 percent drop in oil prices since last summer by cutting spending, eliminating jobs and idling rigs.

After its precipitous drop since October, the U.S. oil rig count is nearing a pivotal level that experts say could dent production, bolster prices and even coax oil companies back to the well pad in the coming months.

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Pioneer Natural Resources Co, a top oil producer in the Permian Basin of West Texas, said this week it will start adding rigs in June as long as market conditions are favorable. U.S. crude futures this week climbed to over $58 a barrel, the highest level this year, as a Saudi-led coalition continued bombings in Yemen.

That was up 38 percent from a six-year low near $42 set in mid March on oversupply concerns and lackluster demand, in part on expectations the lower rig count will start reducing U.S. oil output.

After rising mostly steadily since 2009, U.S. oil production has stalled near 9.4 million barrels a day since early March, the highest level since the early 1970s, according to government data.

The Permian Basin in West Texas and eastern New Mexico, the nation’s biggest and fastest-growing shale oil basin, lost the most oil rigs, down 13 to 242, the lowest on record, according to data going back to 2011.

Texas was the state with the biggest rig decline, down 19 to 392, the least since 2009.
In Canada, active oil rigs fell by four to 16, the lowest since 2009. U.S. natural gas rigs, meanwhile, climbed by eight to 225, the same as two weeks ago.

Cheaper Foreign Oil Caps US Drilling Outlook

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By Chris Tomlinson | Houston Chronicle | MRT.com

The shale oil revolutionaries are retreating in disarray, and cheap foreign oil may banish them to the margins of the market.

As oil and natural gas move into a period of low prices, new data shows that North American drillers may not have the wherewithal to keep producing shale wells, which make up 90 percent of new drilling. In fact, if prices remain low for years to come, which is a real possibility, then investors may never see a return on the money spent to drill shale wells in the first place.

The full cost of producing oil and natural gas at a representative sample of U.S. companies, including capital spent to build the company and buy assets, is about $80 per barrel of oil equivalent, according to a study from the Bureau of Economic Geology’s Center for Energy Economics at the University of Texas.

The analysis of 2014 corporate financial data from 15 of the top publicly traded producers, which I got an exclusive look at before it’s published this week, determined that companies will have a hard time recovering the capital spent that year and maintaining production unless prices rise above $80 a barrel.

The price for West Texas Intermediate has spent most of the year below $50 a barrel.

Low prices, though, won’t mean that producers will shut in existing wells. Many of these same companies can keep pumping to keep cash coming into the company, and they can still collect a 10 percent return above the well’s operating costs at $50 a barrel of oil. They just won’t make enough money to invest in new wells or recover the capital already spent.

This harsh reality of what it will take to keep the shale revolution going shows how vulnerable it is to competition from cheap overseas oil.

“Everyone walks around thinking that they know how much this stuff costs because they see published information on what people spend to just drill wells,” explained Michelle Foss, who leads the Houston-based research center. “That is not what it takes for a company to build these businesses, to recover your capital and to make money.” The bureau was founded in 1909 and functions as the state geological agency.

Low oil prices will also exacerbate the economic impact of low natural gas prices. For years natural gas has kept flowing despite prices below $4 for a million British thermal units because about 50 percent of wells produced both gas and liquids, such as crude oil and condensate.

True natural gas costs

High oil prices have helped companies subsidize natural gas wells, but lower oil prices mean natural gas wells that don’t produce liquids will need to stand on their own economics.

The center’s analysis found that among the sample companies focused primarily on gas, prices will need to top $6 a million BTUs just to cover full costs and rise above $12 a million BTUs to recover the capital expended to develop the wells.

“We have important resources, but people have to be realistic about the challenges of developing them,” Foss told me. “There will have to be higher prices.”

Everyone predicts prices will rise again. The only questions are how quickly and to what price. Some experts predict WTI prices will reach $70 a barrel by the end of 2015, while others see $60. The soonest most expect to see $80 a barrel oil is in 2017. Saudi Arabian officials have said they believe the price has stabilized and don’t see oil returning to $100 a barrel for the next five years.

High prices and shale

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The Saudi opinion is particularly important because that nation can produce oil cheaper than any other country and can produce more oil than any other country. As the informal leader of the Organization of the Petroleum Exporting Countries, Saudi Arabia kept the price of oil inside a band between $80 and $100 a barrel for years. Now, the Saudis appear ready to keep the price low.

That’s because high prices inspired the shale revolution, where American companies figured out how to economically drill horizontally into tight rocks and then hydraulically fracture them to release oil and natural gas. Since OPEC countries rely on high oil prices to finance their governments, everyone assumed OPEC would cut production and keep revenues high.

Arab leaders, though, were more concerned about holding on to market share and allowed prices to fall below levels that make most shale wells economic. Foss, who recently returned from meetings in the United Arab Emirates, said OPEC is unlikely to change course because developing countries are seeking alternatives to oil and reducing demand.

“The Saudis and their partners see pressures on oil use everywhere they look, and what they want is their production, in particular their share of the global supply pie, to be as competitive as it can be to ensure they’ve got revenue coming into the kingdom for future generations,” she said.

OPEC is afraid rich countries like the U.S. are losing their addiction to oil, and by lowering prices hope to keep us hooked. And OPEC has plenty of product.

“There’s 9 million barrels a day in current and potential production capacity in Iraq and Iran that is tied up by political conflicts, and if you sort that out enough, that’s a flood of cheap oil onto the market,” Foss said.

On the losing end

If prices remain low, the big losers will be the bond holders and shareholders of indebted, small and medium-size companies that drill primarily in North America. Since these companies are not getting high enough prices to pay off capital expenditures through higher share prices or interest payments , they are in serious trouble.

The inability of Denver-based Whiting Petroleum to sell itself is an example. The board of the North Dakota-focused company was forced to issue new shares, reducing the company’s value by 20 percent, and take on more expensive debt. Quicksilver Resources, based in Fort Worth, filed for Chapter 11 bankruptcy on March 17 because it couldn’t make the interest payments on its debt and no one was willing to invest more capital.

Until one of these companies is bought, we won’t know the true value of the shale producers at the current oil and natural gas prices.

But as more data reaches the market, there is a real danger that these companies are worth even less than investors fear, even though they may have high-quality assets.

Junk-Rated Oil & Gas Companies in a “Liquidity Death Spiral”

by Wolf Richter

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On the face of it, the oil price appears to be stabilizing. What a precarious balance it is, however.

Behind the facade of stability, the re-balancing triggered by the price collapse has yet to run its course, and it might be overly optimistic to expect it to proceed smoothly. Steep drops in the US rig count have been a key driver of the price rebound. Yet US supply so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations.

So said the International Energy Agency in its Oil Market Report on Friday. West Texas Intermediate plunged over 4% to $45 a barrel.

The boom in US oil production will continue “to defy expectations” and wreak havoc on the price of oil until the power behind the boom dries up: money borrowed from yield-chasing investors driven to near insanity by the Fed’s interest rate repression. But that money isn’t drying up yet – except at the margins.

Companies have raked in 14% more money from high-grade bond sales so far this year than over the same period in 2014, according to LCD. And in 2014 at this time, they were 27% ahead of the same period in 2013. You get the idea.

Even energy companies got to top off their money reservoirs. Among high-grade issuers over just the last few days were BP Capital, Valero Energy, Sempra Energy, Noble, and Helmerich & Payne. They’re all furiously bringing in liquidity before it gets more expensive.

In the junk-bond market, bond-fund managers are chasing yield with gusto. Last week alone, pro-forma junk bond issuance “ballooned to $16.48 billion, the largest weekly tally in two years,” the LCD HY Weekly reported. Year-to-date, $79.2 billion in junk bonds have been sold, 36% more than in the same period last year.

But despite this drunken investor enthusiasm, the bottom of the energy sector – junk-rated smaller companies – is falling out.

Standard & Poor’s rates 170 bond issuers that are engaged in oil and gas exploration & production, oil field services, and contract drilling. Of them, 81% are junk rated – many of them deep junk. The oil bust is now picking off the smaller junk-rated companies, one after the other, three of them so far in March.

On March 3, offshore oil-and-gas contractor CalDive that in 2013 still had 1,550 employees filed for bankruptcy. It’s focused on maintaining offshore production platforms. But some projects were suspended last year, and lenders shut off the spigot.

On March 8, Dune Energy filed for bankruptcy in Austin, TX, after its merger with Eos Petro collapsed. It listed $144 million in debt. Dune said that it received $10 million Debtor in Possession financing, on the condition that the company puts itself up for auction.

On March 9, BPZ Resources traipsed to the courthouse in Houston to file for bankruptcy, four days after I’d written about its travails; it had skipped a $60 million payment to its bondholders [read… “Default Monday”: Oil & Gas Companies Face Their Creditors].

And more companies are “in the pipeline to be restructured,” LCD reported. They all face the same issues: low oil and gas prices, newly skittish bond investors, and banks that have their eyes riveted on the revolving lines of credit with which these companies fund their capital expenditures. Being forever cash-flow negative, these companies periodically issue bonds and use the proceeds to pay down their revolver when it approaches the limit. In many cases, the bank uses the value of the company’s oil and gas reserves to determine that limit.

If the prices of oil and gas are high, those reserves have a high value. It those prices plunge, the borrowing base for their revolving lines of credit plunges. S&P Capital IQ explained it this way in its report, “Waiting for the Spring… Will it Recoil”:

Typically, banks do their credit facility redeterminations in April and November with one random redetermination if needed. With oil prices plummeting, we expect banks to lower their price decks, which will then lead to lower reserves and thus, reduced borrowing-base availability.

April is coming up soon. These companies would then have to issue bonds to pay down their credit lines. But with bond fund managers losing their appetite for junk-rated oil & gas bonds, and with shares nearly worthless, these companies are blocked from the capital markets and can neither pay back the banks nor fund their cash-flow negative operations. For many companies, according to S&P Capital IQ, these redeterminations of their credit facilities could lead to a “liquidity death spiral.”

Alan Holtz, Managing Director in AlixPartners’ Turnaround and Restructuring group told LCD in an interview:

We are already starting to see companies that on the one hand are trying to work out their operational problems and are looking for financing or a way out through the capital markets, while on the other hand are preparing for the events of contingency planning or bankruptcy.

Look at BPZ Resources. It wasn’t able to raise more money and ended up filing for bankruptcy. “I think that is going to be a pattern for many other companies out there as well,” Holtz said.

When it trickled out on Tuesday that Hercules Offshore, which I last wrote about on March 3, had retained Lazard to explore options for its capital structure, its bonds plunged as low as 28 cents on the dollar. By Friday, its stock closed at $0.41 a share.

When Midstates Petroleum announced that it had hired an interim CEO and put a restructuring specialist on its board of directors, its bonds got knocked down, and its shares plummeted 33% during the week, closing at $0.77 a share on Friday.

When news emerged that Walter Energy hired legal counsel Paul Weiss to explore restructuring options, its first-lien notes – whose investors thought they’d see a reasonable recovery in case of bankruptcy – dropped to 64.5 cents on the dollar by Thursday. Its stock plunged 63% during the week to close at $0.33 a share on Friday.

Numerous other oil and gas companies are heading down that path as the oil bust is working its way from smaller more vulnerable companies to larger ones. In the process, stockholders get wiped out. Bondholders get to fight with other creditors over the scraps. But restructuring firms are licking their chops, after a Fed-induced dry spell that had lasted for years.

Investors Crushed as US Natural Gas Drillers Blow Up

by Wolf Richter

The Fed speaks, the dollar crashes. The dollar was ripe. The entire world had been bullish on it. Down nearly 3% against the euro, before recovering some. The biggest drop since March 2009. Everything else jumped. Stocks, Treasuries, gold, even oil.

West Texas Intermediate had been experiencing its biggest weekly plunge since January, trading at just above $42 a barrel, a new low in the current oil bust. When the Fed released its magic words, WTI soared to $45.34 a barrel before re-sagging some. Even natural gas rose 1.8%. Energy related bonds had been drowning in red ink; they too rose when oil roared higher. It was one heck of a party.

But it was too late for some players mired in the oil and gas bust where the series of Chapter 11 bankruptcy filings continues. Next in line was Quicksilver Resources.

It had focused on producing natural gas. Natural gas was where the fracking boom got started. Fracking has a special characteristic. After a well is fracked, it produces a terrific surge of hydrocarbons during first few months, and particularly on the first day. Many drillers used the first-day production numbers, which some of them enhanced in various ways, in their investor materials. Investors drooled and threw more money at these companies that then drilled this money into the ground.

But the impressive initial production soon declines sharply. Two years later, only a fraction is coming out of the ground. So these companies had to drill more just to cover up the decline rates, and in order to drill more, they needed to borrow more money, and it triggered a junk-rated energy boom on Wall Street.

At the time, the price of natural gas was soaring. It hit $13 per million Btu at the Henry Hub in June 2008. About 1,600 rigs were drilling for gas. It was the game in town. And Wall Street firms were greasing it with other people’s money. Production soared. And the US became the largest gas producer in the world.

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But then the price began to plunge. It recovered a little after the Financial Crisis but re-plunged during the gas “glut.” By April 2012, natural gas had crashed 85% from June 2008, to $1.92/mmBtu. With the exception of a few short periods, it has remained below $4/mmBtu – trading at $2.91/mmBtu today.

Throughout, gas drillers had to go back to Wall Street to borrow more money to feed the fracking orgy. They were cash-flow negative. They lost money on wells that produced mostly dry gas. Yet they kept up the charade. They aced investor presentations with fancy charts. They raved about new technologies that were performing miracles and bringing down costs. The theme was that they would make their investors rich at these gas prices.

The saving grace was that oil and natural-gas liquids, which were selling for much higher prices, also occur in many shale plays along with dry gas. So drillers began to emphasize that they were drilling for liquids, not dry gas, and they tried to switch production to liquids-rich plays. In that vein, Quicksilver ventured into the oil-rich Permian Basin in Texas. But it was too little, too late for the amount of borrowed money it had already burned through over the years by fracking for gas below cost.

During the terrible years of 2011 and 2012, drillers began reclassifying gas rigs as rigs drilling for oil. It was a judgement call, since most wells produce both. The gas rig count plummeted further, and the oil rig count skyrocketed by about the same amount. But gas production has continued to rise since, even as the gas rig count has continued to drop. On Friday, the rig count was down to 257 gas rigs, the lowest since March 1993, down 84% from its peak in 2008.

US-rig-count_1988_2015-03-13=gas

Quicksilver’s bankruptcy is a consequence of this fracking environment. It listed $2.35 billion in debts. That’s what is left from its borrowing binge that covered its negative cash flows. It listed only $1.21 billion in assets. The rest has gone up in smoke.

Its shares are worthless. Stockholders got wiped out. Creditors get to fight over the scraps.

Its leveraged loan was holding up better: the $625 million covenant-lite second-lien term loan traded at 56 cents on the dollar this morning, according to S&P Capital IQ LCD. But its junk bonds have gotten eviscerated over time. Its 9.125% senior notes due 2019 traded at 17.6 cents on the dollar; its 7.125% subordinated notes due 2016 traded at around 2 cents on the dollar.

Among its creditors, according to the Star Telegram: the Wilmington Trust National Association ($361.6 million), Delaware Trust Co. ($332.6 million), US Bank National Association ($312.7 million), and several pipeline companies, including Oasis Pipeline and Energy Transfer Fuel.

Last year, it hired restructuring advisers. On February 17, it announced that it would not make a $13.6 million interest payment on its senior notes and invoked the possibility of filing for Chapter 11. It said it would use its 30-day grace period to haggle with its creditors over the “company’s options.”

Now, those 30 days are up. But there were no other “viable options,” the company said in the statement. Its Canadian subsidiary was not included in the bankruptcy filing; it reached a forbearance agreement with its first lien secured lenders and has some breathing room until June 16.

Quicksilver isn’t alone in its travails. Samson Resources and other natural gas drillers are stuck neck-deep in the same frack mud.

A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. It too hired restructuring advisers to deal with its $3.75 billion in debt. On March 2, Moody’s downgraded Samson to Caa3, pointing at “chronically low natural gas prices,” “suddenly weaker crude oil prices,” the “stressed liquidity position,” and delays in asset sales. It invoked the possibility of “a debt restructuring” and “a high risk of default.”

But maybe not just yet. The New York Post reported today that, according to sources, a JPMorgan-led group, which holds a $1 billion revolving line of credit, is granting Samson a waiver for an expected covenant breach. This would avert default for the moment. Under the deal, the group will reduce the size of the revolver. Last year, the same JPMorgan-led group already reduced the credit line from $1.8 billion to $1 billion and waived a covenant breach.

By curtailing access to funding, they’re driving Samson deeper into what S&P Capital IQ called the “liquidity death spiral.” According to the New York Post’s sources, in August the company has to make an interest payment to its more junior creditors, “and may run out of money later this year.”

Industry soothsayers claimed vociferously over the years that natural gas drillers can make money at these prices due to new technologies and efficiencies. They said this to attract more money. But Quicksilver along with Samson Resources and others are proof that these drillers had been drilling below the cost of production for years. And they’d been bleeding every step along the way. A business model that lasts only as long as new investors are willing to bail out old investors.

But it was the crash in the price of “liquids” that made investors finally squeamish, and they began to look beyond the hype. In doing so, they’re triggering the very bloodletting amongst each other that ever more new money had delayed for years. Only now, it’s a lot more expensive for them than it would have been three years ago. While the companies will get through it in restructured form, investors get crushed.


This Chart Shows the True Collapse of Fracking in the US

by Wolf Richter
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Rex Tillerson, Exxon Mobile CEO

“People need to kinda settle in for a while.” That’s what Exxon Mobil CEO Rex Tillerson said about the low price of oil at the company’s investor conference. “I see a lot of supply out there.”

So Exxon is going to do its darnedest to add to this supply: 16 new production projects will start pumping oil and gas through 2017. Production will rise from 4 million barrels per day to 4.3 million. But it will spend less money to get there, largely because suppliers have had to cut their prices.

That’s the global oil story. In the US, a similar scenario is playing out. Drillers are laying some people off, not massive numbers yet. Like Exxon, they’re shoving big price cuts down the throats of their suppliers. They’re cutting back on drilling by idling the least efficient rigs in the least productive plays – and they’re not kidding about that.

In the latest week, they idled a 64 rigs drilling for oil, according to Baker Hughes, which publishes the data every Friday. Only 922 rigs were still active, down 42.7% from October, when they’d peaked. Within 21 weeks, they’ve taken out 687 rigs, the most terrific, vertigo-inducing oil-rig nose dive in the data series, and possibly in history:

US-rig-count_1988_2015-03-06=oilAs Exxon and other drillers are overeager to explain: just because we’re cutting capex, and just because the rig count plunges, doesn’t mean our production is going down. And it may not for a long time. Drillers, loaded up with debt, must have the cash flow from production to survive.

But with demand languishing, US crude oil inventories are building up further. Excluding the Strategic Petroleum Reserve, crude oil stocks rose by another 10.3 million barrels to 444.4 million barrels as of March 4, the highest level in the data series going back to 1982, according to the Energy Information Administration. Crude oil stocks were 22% (80.6 million barrels) higher than at the same time last year.

“When you have that much storage out there, it takes a long time to work that off,” said BP CEO Bob Dudley, possibly with one eye on this chart:

US-crude-oil-stocks-2015-03-04So now there is a lot of discussion when exactly storage facilities will be full, or nearly full, or full in some regions. In theory, once overproduction hits used-up storage capacity, the price of oil will plummet to whatever level short sellers envision in their wildest dreams. Because: what are you going to do with all this oil coming out of the ground with no place to go?

A couple of days ago, the EIA estimated that crude oil stock levels nationwide on February 20 (when they were a lot lower than today) used up 60% of the “working storage capacity,” up from 48% last year at that time. It varied by region:

Capacity is about 67% full in Cushing, Oklahoma (the delivery point for West Texas Intermediate futures contracts), compared with 50% at this point last year. Working capacity in Cushing alone is about 71 million barrels, or … about 14% of the national total.

As of September 2014, storage capacity in the US was 521 million barrels. So if weekly increases amount to an average of 6 million barrels, it would take about 13 weeks to fill the 77 million barrels of remaining capacity. Then all kinds of operational issues would arise. Along with a dizzying plunge in price.

In early 2012, when natural gas hit a decade low of $1.92 per million Btu, they predicted the same: storage would be full, and excess production would have to be flared, that is burned, because there would be no takers, and what else are you going to do with it? So its price would drop to zero.

They actually proffered that, and the media picked it up, and regular folks began shorting natural gas like crazy and got burned themselves, because it didn’t take long for the price to jump 50% and then 100%.

Oil is a different animal. The driving season will start soon. American SUVs and pickups are designed to burn fuel in prodigious quantities. People will be eager to drive them a little more, now that gas is cheaper, and they’ll get busy shortly and fix that inventory problem, at least for this year. But if production continues to rise at this rate, all bets are off for next year.

Natural gas, though it refused to go to zero, nevertheless got re-crushed, and the price remains below the cost of production at most wells. Drilling activity has dwindled. Drillers idled 12 gas rigs in the latest week. Now only 268 rigs are drilling for gas, the lowest since April 1993, and down 83.4% from its peak in 2008! This is what the natural gas fracking boom-and-bust cycle looks like:

US-rig-count_1988_2015-03-06=gasYet production has continued to rise. Over the last 12 months, it soared about 9%, which is why the price got re-crushed.

Producing gas at a loss year after year has consequences. For the longest time, drillers were able to paper over their losses on natural gas wells with a variety of means and go back to the big trough and feed on more money that investors were throwing at them, because money is what fracking drills into the ground.

But that trough is no longer being refilled for some companies. And they’re running out. “Restructuring” and “bankruptcy” are suddenly the operative terms.


“Default Monday”: Oil & Gas Face Their Creditors

by Wolf Richter

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Debt funded the fracking boom. Now oil and gas prices have collapsed, and so has the ability to service that debt. The oil bust of the 1980s took down 700 banks, including 9 of the 10 largest in Texas. But this time, it’s different. This time, bondholders are on the hook.

And these bonds – they’re called “junk bonds” for a reason – are already cracking. Busts start with small companies and proceed to larger ones. “Bankruptcy” and “restructuring” are the terms that wipe out stockholders and leave bondholders and other creditors to tussle over the scraps.

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Early January, WBH Energy, a fracking outfit in Texas, kicked off the series by filing for bankruptcy protection. It listed assets and liabilities of $10 million to $50 million. Small fry.

A week later, GASFRAC filed for bankruptcy in Alberta, where it’s based, and in Texas – under Chapter 15 for cross-border bankruptcies. Not long ago, it was a highly touted IPO, whose “waterless fracking” technology would change a parched world. Instead of water, the system pumps liquid propane gel (similar to Napalm) into the ground; much of it can be recaptured, in theory.

Ironically, it went bankrupt for other reasons: operating losses, “reduced industry activity,” the inability to find a buyer that would have paid enough to bail out its creditors, and “limited access to capital markets.” The endless source of money without which fracking doesn’t work had dried up.

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On February 17, Quicksilver Resources announced that it would not make a $13.6 million interest payment on its senior notes due in 2019. It invoked the possibility of filing for Chapter 11 bankruptcy to “restructure its capital structure.” Stockholders don’t have much to lose; the stock is already worthless. The question is what the creditors will get.

It has hired Houlihan Lokey Capital, Deloitte Transactions and Business Analytics, “and other advisors.” During its 30-day grace period before this turns into an outright default, it will haggle with its creditors over the “company’s options.”

On February 27, Hercules Offshore had its share-price target slashed to zero, from $4 a share, at Deutsche Bank, which finally downgraded the stock to “sell.” If you wait till Deutsche Bank tells you to sell, you’re ruined!

When I wrote about Hercules on October 15, HERO was trading at $1.47 a share, down 81% since July. Those who followed the hype to “buy the most hated stocks” that day lost another 44% by the time I wrote about it on January 16, when HERO was at $0.82 a share. Wednesday, shares closed at $0.60.

Deutsche Bank was right, if late. HERO is headed for zero (what a trip to have a stock symbol that rhymes with zero). It’s going to restructure its junk debt. Stockholders will end up holding the bag.

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On Monday, due to “chronically low natural gas prices exacerbated by suddenly weaker crude oil prices,” Moody’s downgraded gas-driller Samson Resources, to Caa3, invoking “a high risk of default.”

It was the second time in three months that Moody’s downgraded the company. The tempo is picking up. Moody’s:

The company’s stressed liquidity position, delays in reaching agreements on potential asset sales and its retention of restructuring advisors increases the possibility that the company may pursue a debt restructuring that Moody’s would view as a default.

Moody’s was late to the party. On February 26, it was leaked that Samson had hired restructuring advisers Kirkland & Ellis and Blackstone’s restructuring group to figure out how to deal with its $3.75 billion in debt. A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. KKR has written down its equity investment to 5 cents on the dollar.

This is no longer small fry.

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Also on Monday, oil-and-gas exploration and production company BPZ Resources announced that it would not pay $62 million in principal and interest on convertible notes that were due on March 1. It will use its grace period of 10 days on the principal and of 30 days on the interest to figure out how to approach the rest of its existence. It invoked Chapter 11 bankruptcy as one of the options.

If it fails to make the payments within the grace period, it would also automatically be in default of its 2017 convertible bonds, which would push the default to $229 million.

BPZ tried to refinance the 2015 convertible notes in October and get some extra cash. Fracking devours prodigious amounts of cash. But there’d been no takers for the $150 million offering. Even bond fund managers, driven to sheer madness by the Fed’s policies, had lost their appetite. And its stock is worthless.

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Also on Monday – it was “default Monday” or something – American Eagle Energy announced that it would not make a $9.8 million interest payment on $175 million in bonds due that day. It will use its 30-day grace period to hash out its future with its creditors. And it hired two additional advisory firms.

One thing we know already: after years in the desert, restructuring advisers are licking their chops.

The company has $13.6 million in negative working capital, only $25.9 million in cash, and its $60 million revolving credit line has been maxed out.

But here is the thing: the company sold these bonds last August! And this was supposed to be its first interest payment.

That’s what a real credit bubble looks like. In the Fed’s environment of near-zero yield on reasonable investments, bond fund managers are roving the land chasing whatever yield they can discern. And they’re holding their nose while they pick up this stuff to jam it into bond funds that other folks have in their retirement portfolio.

Not even a single interest payment!

Borrowed money fueled the fracking boom. The old money has been drilled into the ground. The new money is starting to dry up. Fracked wells, due to their horrendous decline rates, produce most of their oil and gas over the first two years. And if prices are low during that time, producers will never recuperate their investment in those wells, even if prices shoot up afterwards. And they’ll never be able to pay off the debt from the cash flow of those wells. A chilling scenario that creditors were blind to before, but are now increasingly forced to contemplate.

Study: Government’s Control of Land Is Hurting Oil Production, Job Growth

by Ben Smith

Current government regulations imposed by the Bureau of Land Management are harming energy production and holding back the U.S. economy, a new study reveals.

“While federally owned lands are also full of energy potential, a bureaucratic regulatory regime has mismanaged land use for decades,” write The Heritage Foundation’s Katie Tubb and Nicolas Loris.

The report focuses on the Federal Lands Freedom Act, introduced by Rep. Diane Black, R-Tenn., and Sen. James Inhofe, R-Okla. It is designed to empower states to regain control of their lands from the federal government in order to pursue their own energy goals. That is a challenge in an oil-rich state like Colorado.

“We need to streamline the process as there are very real consequences to poor [or nonexistent] management,” Tubb, a Heritage research associate, told The Daily Signal.

“Empowering the states is the best solution. The people who benefit have a say and can share in the benefits. If there are consequences, they can address them locally with state and local governments that are much more responsive to elections and budgets than the federal government.”

Emphasizing the need to streamline the process, Tubb pointed to the findings in the new report.

“The Bureau of Land Management estimates that it took an average of 227 days simply to complete a drill application,” Tubb said.

That’s more than the average of 154 days in 2005 and more than seven times the state average of 30 days, according to the report.

The report blames this increase in the application process on the drop in drilling on federal lands.

“Since 2009,” Tubb and Loris write, “oil production on federal lands has fallen by nine percent, even as production on state and private lands has increased by 61 percent over the same period.”

Despite almost “43 percent of crude oil coming from federal lands,” government-owned lands have seen a 13-point drop in oil production, from 36 percent to 23 percent.

The report also examines the recent oil-related job boom.

“Job creation in the oil and gas industry bucked the slow economic recovery and grew by 40 percent from 2007 to 2012, in comparison to one percent in the private sector over the same period,” according to the report.

That boom has had a big impact on jobs.

Map: John Fleming

“Energy-abundant states like Colorado and Alaska would stand to benefit tremendously. We’ve seen oil and natural gas production increase substantially in Colorado over the past eight years, bringing jobs and economic activity to the state,” said Loris, an economist who is Heritage’s Herbert and Joyce Morgan fellow.

Tubb cautioned that any change will happen slowly. “The federal government likely will not release the land that easily.”

Loris agreed, noting the long-running debate about the Arctic National Wildlife Refuge.

“It was no surprise that the Alaskan delegation was up in arms when the administration proposed to permanently put ANWR off limits to energy exploration,” Loris told The Daily Signal. “Many in the Alaskan delegation and Alaskan natives, including village of Kaktovik—the only town in the coastal plain of ANWR, support energy development.”

“We are putting power to the people,” Tubb concluded.

Oil Doomsayers Were Wrong In 2009: 4 Reasons Why They’re Wrong Now

https://i0.wp.com/img0.etsystatic.com/000/0/6787557/il_340x270.350576144.jpgSource: Hawkinvest

Summary

  • Oil is extremely oversold and due for a rebound.
  • Oil consumption remains strong and is likely to increase thanks to cheaper prices.
  • Historically oil rebounds quite quickly, especially when the U.S. and global economy are growing.
  • Investors are overly negative on oil ever since the OPEC meeting, but production cuts could still be on the way.

Ever since the November 27th OPEC meeting the price of oil has plunged by about 20% and many stocks are off by much, much more. The doomsayers and shorts are out in force now, emboldened by the weakness in this sector. There is a tremendous amount of negative sentiment towards oil now. But this extreme level of negativity appears to be very overdone. It also seems to be based on psychology, forced margin call selling, panic selling and tax-loss selling. With all these factors, it’s been a perfect storm that has brought some small-cap oil stocks back to levels not seen since the depths of the financial crisis. Back in 2009, oil plunged to the $40 range, but the U.S. and the global economy were in free fall and oil consumption was also falling. The factors that drove oil to collapse in 2009 like bank failures, financial system imploding, home prices collapsing, massive layoffs, and other negatives that just do not exist today. That is why it does not make sense to be expecting oil to plunge back towards the lows seen in 2009. Furthermore, it is really important to realize that even when oil plunged in 2009, it rebounded very, very quickly (in spite of all the doomsayers back then). That is another big factor to consider because since the global economy is significantly stronger now, it could rebound sooner than most investors realize. Here are a few more reasons why this is a buying opportunity as oil is not likely to go down much more and why it is not likely to stay down for very long:

Reason #1: Energy company insiders are calling the recent plunge in stocks a “fire sale” and they are buying at a pace that has not been seen in years. Oil industry insiders have seen the ups and downs in oil prices and have experienced market pullbacks before. If oil company insiders are buying en masse now, there is a good chance that they see bargains and a strong future for oil. This supports the idea that there is a disconnect between the current market price of many oil stocks and the longer-term fundamentals of this industry. Citigroup (NYSE:C) recently made a strong case that indicates there is a disconnect between asset prices in the oil industry and the fundamentals. A Bloomberg article details some of the recent insider activity, it states:

“This is an absolute fire sale,” he said. “It’s an overreaction and the result is it’s oversold.” With valuations at a decade low, oil executives such as Rochford and Chesapeake Energy Corp.’s (NYSE:CHK) Archie Dunham are driving the biggest wave of insider buying since 2012, data compiled by the Washington Service and Bloomberg show. They’re snapping up stocks after more than $300 billion was erased from share values as crude slipped below $70 for the first time since 2010.”

Reason #2: Just because OPEC did not act at the November 27th meeting, it does not mean they won’t act. OPEC is scheduled to meet again in 2015, but there is always the possibility for an emergency meeting at any time. Even a statement from OPEC discussing the willingness to cut production or to address “cheating” by some members who are producing more than their quota allows could cause a significant short-covering rebound in the oil sector. A CNBC article points out that some industry watchers believe OPEC could act soon with an extraordinary or “emergency” meeting, it states:

“We see the possibility they call an extraordinary meeting sometime next year,” said Dominic Haywood, crude and products analyst with Energy Aspects. “We think they’re going to address countries not living within their quota.” OPEC has a quota of 30 million barrels a day, but it has been producing more.

On December 2, a Saudi Prince stated that his country would cut production if other countries would also participate. This seems the first “olive branch” since the OPEC meeting and it appears to be in response to the slide in oil since that meeting took place.

Reason #3: The perceived “glut” of oil is much smaller than most people realize. Furthermore, that excess supply could be taken out rather rapidly because cheaper oil is likely to lead to more demand and consumption. Toyota (NYSE:TM) just reported that sales of its 4Runner sport utility vehicle just jumped by 53% in November and sales of the Prius fell by 14% in the same period. This is just one example of how quickly demand for oil can rise and if you multiply even slight increases in global oil consumption because of much lower prices the numbers get quite large. Urban Carmel (a former McKinsey consultant and President of UBS Securities in Asia) believes that oil is going back to $80 per barrel and a recent article he wrote explains why the perceived glut is not going to last long, he states:

“Excess oil supply (over demand) is presently about 1 mbd. That would be a problem for oil prices except for one thing: existing fields lose about 6% of their production capacity each year, equal to about 5.5 mbd. That means that even if demand is flat, at least 4.5 mbd in new production is needed. Opec has spare capacity of only about 3 mbd. The remainder must come from new investment. New deep water and oil sand projects have a breakeven cost of about $80-90. There will be little incentive to make these investments unless the price of oil is at least $80. If the price stays lower than $80, supply will be insufficient for demand. It’s exactly under those circumstances that spikes higher in oil prices have occurred in the past.”

Reason #4: Oil can be very volatile, but it historically rebounds very quickly because it is used in very large quantities every day. The chart below shows that oil has reached a level that is giving investors a buy signal. Also, it is worth noting that prior oil price slides typically lasted about 20 weeks and the current slide is on week 25 which is another sign a rebound is way overdue. Oil and most oil stocks are extremely oversold now and that means a powerful relief and short covering rally could be coming soon. Some “smart money” investors are recognizing the buying opportunity at hand. Hedge funds are starting to position for a rebound in oil as there is a growing belief that the oil slide has run its course and is now due for a rally.

Oil is already down by about 40%, and the global economy is not in a current state that would support drastically lower prices as some are predicting. It is worth noting that most analysts and economists have a terrible track record when it comes to forecasting oil prices. If you had told anyone that oil was going to surge to over $100 within a couple years of the financial crisis you would have been ridiculed. I believe that the inaction at the OPEC meeting triggered margin call selling, and as we know, selling begets selling especially at this time of year when tax-loss selling fuels even more downside pressure. Some investors are making too much of the oil price decline by trying to connect the dots which should not be connected. I don’t believe that oil’s decline is a major sign of global economic weakness, I believe it is partially because supplies are temporarily a bit higher than needed, the dollar has been strong, and because too many speculators held futures contracts that were suddenly liquidated after the OPEC meeting sparked a sell-off. This has created bargains, especially in small-cap oil stocks. I have been primarily focusing my buying on companies that have no direct exposure to the price of oil and significant contract backlogs. This has led me to buy stocks like McDermott International (NYSE:MDR) which is now incredibly cheap at less than $3 per share. This company is an engineering and construction firm that specializes in the energy industry. It has a $4 billion contract backlog and it has about $900 million in cash and (incredibly) a market cap of just $584 million. That means that this company could buy all the outstanding shares and still have over $300 million left in cash on the balance sheet. McDermott shares are also trading for less than half of the stated book value which is $6.30 per share. On November 14, David Trice (a director) bought 20,000 shares at $4.16, which was about $83,000 worth of stock. But, due to immensely negative sentiment in the oil sector, panic selling, margin call selling, and tax-loss selling, this stock is down by about 40% just from when this insider bought, even though this company has no direct exposure to oil prices and enough business (with the $4 billion+ contract backlog) to keep it busy for the next two years. It also does projects for the natural gas industry and investors seem to have overlooked that natural gas prices have remained solid.

I also see opportunity in Willbros Group (NYSE:WG) which trades for just over $4 now (down from a high of about $13 this year). It specializes in pipeline projects for the energy industry which includes oil and gas, petrochemicals, refining as well as electric power. This stock took a hit several weeks ago when the company announced it would restate earnings due to a charge on a pipeline project that was estimated to reverse about $8 million in previously reported pre-tax income. This caused the company to be delayed in filing the latest financial report and the market overreacted by knocking off about $160 million in market cap in just a few days after the restatement issue was announced. Willbros Group has a strong balance sheet and a $1.7 billion backlog which absolutely dwarfs the restatement numbers and the market cap of just about $215 million. It also recently announced plans for an asset sale that is estimated to generate up to $125 million. For more details, read my recent article on Willbros Group.

I expect that small cap stocks like McDermott and Willbros will rebound as tax-loss selling should fade by December 19th which is the Friday before the holiday season. This causes most traders and investors to have completed their tax planning issues before taking off for the holidays and that often leads to a significant “Santa Claus” and “January Effect” rally in beaten-down small caps.

Keep An Eye On Futures

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Oil Futures Structure Seen as Encouraging Traders to Store Crude. 

By Mohammed Aly Sergie

Brent oil in a contango will encourage traders to take delivery of crude and wait for higher prices, according to U.S. economist Dennis Gartman.

Brent for February delivery is $6.10 a barrel cheaper than the February 2016 contract. February Oman oil traded on the Dubai Mercantile Exchange is $8.30 cheaper than the year later contract after being $6 more expensive about six months ago.

“Not enough people pay attention to the importance of term structure,” Dennis Gartman, author of the Suffolk, Virginia-based Gartman Letter, said yesterday in a phone interview. “The market is saying it will pay traders to go into storage.”

Gartman said contango arbitrage is easier to trade on the broader benchmarks than the Oman contract because banks prefer to provide financing for markets that are more heavily traded. Investors can earn a “nearly riskless return” of 8 percent by selling crude futures and storing oil at current prices, Gartman said.

The cost of warehousing and lending has hindered popularity of the trade, Gartman said. Shipbroker Charles R. Weber said this month that oil tanker rates are too high to spur floating storage. There are 28.8 million barrels of oil being stored at Cushing, Oklahoma, about three million barrels above the 2014 average.

Why Cheap Oil May Be Here To Stay

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By
Kyle Spencer

Summary

  • Many investors are still skeptical that Saudi Arabia will hold firm on oil production.
  • Increased global consumption due to falling prices is unlikely to offset North American production.
  • US consumption is in a secular, structural decline due to increased efficiency and demographic changes. That’s unlikely to change any time soon.
  • The floor may not be where the Saudis think it is.

Investors are slowly waking up to the fact that Saudi Arabia is willing to take OPEC hostage to defend its market share, with Oil Minister Ali Al-Naimi declaring that –

In a situation like this, it is difficult, if not impossible, that the kingdom or OPEC would carry out any action that may result in a reduction of its share in market and an increase of others’ shares.

Alas, rather than embrace the cheap petroleum paradigm that has dominated most of the 20th century, many investors continue to cling to old shibboleths. Case in point: Brian Hicks, a portfolio manager at US Global Investors, recently noted that

The theme going into 2015 is mean reversion. Oil prices are below where they should be (emphasis mine), and hopefully they will start gravitating back to the equilibrium price of between $US80 and $US85 a barrel.

I emphasize the words “below where they should be” because the notion that oil (NYSEARCA:USO) prices belong somewhere – and it’s always higher, somehow – is the linchpin of the bullish thesis. But the question of why a high price regime should prevail over a low price regime is never satisfactorily explained.

Higher extraction costs? A sizable chunk of those costs are sunk costs that can simply be ignored in production decisions and lowering the effective breakeven price. A tighter focus on already drilled wells in areas with mature infrastructure could lower costs even further. Moreover, service sector costs fall as rigs are idled. Depleted reserves? Most resource-producing basins are experiencing an increasing yield over time despite the rapid depletion of individual wells. A lot of that is due to extraction efficiency, which is increasing at a phenomenal rate; in fact, one rig today brings on four times the amount of gas in the Barnett Shale than it did in 2006. Drill times in the Bakken are also falling, while new well production per rig is steadily rising since 2011.

Drill Times (Spud to Rig) 2004-2013

(SOURCE: ITG Research)

Technically oversold? Good luck catching that knife. Traders have been pounding the table on “oversold conditions” since $80. Proponents of the Oversold Hypothesis who like to point historical examples of oil’s extreme short-term volatility for validation are conveniently ignoring the vast number of counter-examples like this TIME Magazine headline from June, 1981, which almost reads as if it could have been written yesterday:

(Source: TIME Archives)

1981 is an intriguing date for another reason: It marked the first time in over a decade that Non-OPEC nations countries outproduced OPEC. Despite repeated cuts by OPEC, it took five years for capitulation to set in. Nor are lower prices guaranteed to lead to cuts. Indeed, when oil prices plummeted from $4/bbl to 35 cents in 1862, the Cleveland wildcatters didn’t idle their pumps; they pumped faster to pay the interest on their debt.

Don’t Iran and Venezuela require higher oil prices in order to balance their budgets and head off domestic upheaval? Please. The Saudis don’t care about Iran’s budget problems. Venezuela is a non-entity despite it’s immense reserves. In fact, Venezuela’s hell-in-a-handbasket status was one of the major reasons for Cuba’s recent defection to the US.

Asian stimulus? The only reason that Japanese consumers know that oil prices are lower is from Western news headlines. The share of a day’s wages to buy a single gallon of gas in Japan is 5.59% vs. 2.45% in the US. Nevertheless, the Japanese are riding high compared to the BRICS: In Brazil, it’s 17.62%; in Russia, 7.95%; in India it’s 114.92%; in China it’s 23.54%. Not the most fertile ground for a demand-side revolution; especially since oil is priced in dollars rather than yen, reals, rubles, or rupees.

What about the US? Won’t lower prices lead to higher consumption? Despite what you read about our “insatiable thirst” for oil, Americans don’t actually drink the stuff. Our machines do, and those machines are becoming more and more efficient due to CAFE standards and new transportation technologies, especially NGVs. Demographic changes are also leading a secular decline in consumption. Fig. 2 below highlights the steady march down for miles traveled per capita as the Baby Boomers retire to slower paced lives.

(Source: Citigroup, Census, CIRA)

The reality is that there’s little that an uptick in demand can do to offset oil’s continuing price collapse if the Saudis aren’t prepared to cut to the bone. The wildcatters certainly aren’t going to; on the contrary, they have every incentive (and no real alternative at this point) to pump like crazy to pay down debt and break OPEC’s back. Most doom and gloom prognostications for North American shale use full-cycle breakeven estimates like the ones presented in Figure 2.

Full-Cycle Breakeven Costs by Resource (Assuming Zero Efficiency Gains)

Unfortunately for the bulls, all-in sustaining cost (full-cycle capex) is a totally irrelevant metric for establishing a floor on commodity prices. Commodities prices are based on the marginal cost of production of the most prolific producers, not the full-cycle costs of marginal, high cost producers lopped in with the market leaders. As Seth Kleinman’s group at Citi has pointed out

…what counts at this stage is half-cycle costs, which are in the significantly lower band of $37 to $45 a barrel. This means that the floor is falling and may not be nearly as firm as the Saudi view assume(s).

Oil Bust Contagion Hits Wall Street, Banks Sit on Losses

https://i1.wp.com/www.bloomberg.com/image/iptmX9f9f1vc.jpgby Wolf Richter

Oil swooned again on Wednesday, with the benchmark West Texas Intermediate closing at $60.94. And on Thursday, WTI dropped below $60, currently trading at $59.18. It’s down 43% since June.

Yesterday, OPEC forecast that demand for its oil would further decline to 28.9 million barrels a day next year, after having decided over Thanksgiving to stick to its 30 million barrel a day production ceiling, rather than cutting it. It thus forecast that there would be on OPEC’s side alone 1.1 million barrels a day in excess supply.

Hours later, the US Energy Information Administration reported that oil inventories in the US had risen by 1.5 million barrels in the latest week, while analysts had expected a decline of about 3 million barrels.

So the bloodletting continues: the Energy Select Sector ETF (XLE) is down 26% since June; S&P International Energy Sector ETF (IPW) is down 34% since July; and the Oil & Gas Equipment & Services ETF (XES) is down 46% since July.

Goodrich Petroleum, in its desperation, announced it is exploring strategic options for its Eagle Ford Shale assets in the first half next year. It would also slash capital expenditures to less than $200 million for 2015, from $375 million for 2014. Liquidity for Goodrich is drying up. Its stock is down 88% since June.

They all got hit. And in the junk-bond market, investors are grappling with the real meaning of “junk.”

Sabine Oil & Gas’ $350 million in junk bonds still traded above par in September before going into an epic collapse starting on November 25 that culminated on Wednesday, when they lost nearly a third of their remaining value to land at 49 cents on the dollar.

In early May, when the price of oil could still only rise, Sabine agreed to acquire troubled Forest Oil Corporation, now a penny stock. The deal is expected to close in December. But just before Thanksgiving, when no one in the US was supposed to pay attention, Sabine’s bonds began to collapse as it seeped out that Wells Fargo and Barclays could lose a big chunk of money on a $850-million “bridge loan” they’d issued to Sabine to help fund the merger.

A bridge loan to nowhere: investors interested in buying it have evaporated. The banks are either stuck with this thing, or they’ll have to take a huge loss selling it. Bankers have told the Financial Times that the loan might sell for 60 cents on the dollar. But that was back in November before the bottom fell out entirely.

As so many times in these deals, there is a private equity angle to the story: PE firm First Reserve owns nearly all of Sabine and leveraged it up to the hilt.

The same week, a $220-million bridge loan, put together by UBS and Goldman Sachs for PE firm Apollo Group’s acquisition of oilfield-services provider Express Energy, was supposed to be sold. But investors balked. As of December 2, the loan was still being marketed, “according to two people with knowledge of the deal,” Bloomberg reported. If it can be sold at all, it appears UBS and Goldman will end up with a loss.

And so energy-related leveraged loans are tanking. These ugly sisters of junk bonds are issued by junk-rated corporations, and they have everyone worried [Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System]. Their yields have shot up from 5.1% in August to 7.4% in the latest week, and to nearly 8% for those of offshore drillers [“Yes, it Was a Brutal Week for the Oil & Gas Loan Sector”].

Six years of the Fed’s easy money policies purposefully forced even conservative investors to either lose money to inflation or venture way out on the risk curve. So they ventured out, many of them without knowing it because it happened out of view inside their bond funds. And they funded the fracking boom and the offshore drilling boom, and the entire oil revolution in America, no questions asked.

Energy junk bonds now account for a phenomenal 15.7% of the $1.3 trillion junk-bond market. Alas, last week, JPMorgan warned that up to 40% of them could default over the next few years if oil stays below $65 a barrel. Bond expert Marty Fridson, CIO at LLF Advisors, figured that of the 180 “distressed” bonds in the BofA Merrill Lynch high-yield index, 52 were issued by energy companies. And Bloomberg reported that the yield spread between energy junk bonds and Treasuries has more than doubled since September to 942 basis points (9.42 percentage points).

The toxicity of energy junk bonds is spreading to the broader junk-bond market. The iShares iBoxx High Yield Corporate Bond ETF fell 1.2% to $88.43 on Thursday, the lowest since June 2012. And at the riskiest end of the junk-bond market, it’s getting ugly: the effective yield index for bonds rated CCC or lower jumped from 7.9% in late June to 11.4% on Wednesday.

After not finding any visible yield in the classic spots, thanks to the Fed’s policies, institutional investors – the folks that run your mutual fund or pension fund – took big risks just to get a tiny bit of extra yield. And to grab a yield of 5% in June, they bought energy junk debt so risky that it now has lost a painfully large part of its value, and some of it might default.

Oil and gas are inseparable from Wall Street. Over the years, as companies took advantage of the Fed’s policies and issued this enormous amount of risky debt at a super-low cost, and as they raised money by spinning off subsidiaries into over-priced IPOs that flew off the shelf in one of the most inflated markets in history, and as they spun off other assets into white-hot MLPs, and as banks put now iffy bridge loans together, and as mergers and acquisitions were funded, at each step along the way, Wall Street extracted its fees.

Now the boom is turning into a bust, and the contagion is spreading from the oil patch to Wall Street. Energy companies are cutting back. BP, Chevron, Goodrich…. They’re not cutting back production by turning a valve. They’ll keep the oil and gas flowing to generate cash to stay alive, and it will contribute to the glut.

Instead, they’re cutting back on exploration and drilling projects. It will hit local economies in the oil patch and ripple beyond them. As energy companies slash their capex and their stock buybacks, they’ll borrow less, those that can still borrow at all, and there won’t be many energy IPOs, and there may not be a lot of spinoffs into MLPs or any of the other financial maneuvers that Wall Street got so fat on during the fracking and offshore drilling boom. The fees will dry up. And some of the losses will come home to roost on bank balance sheets.

The contagion is already visible on Wall Street. Susquehanna Financial Group downgraded Goldman Sachs to neutral on Wednesday, citing the mayhem in the oil markets and the impact it has on junk bonds and leveraged loans and the other financial mechanism by which Goldman’s investment and lending divisions sucked fees out of the oil patch and its investors. And this is just the beginning.

Bank of America Sees $50 Oil As OPEC Dies

“Our biggest worry is the end of the liquidity cycle. The Fed is done. The reach for yield that we have seen since 2009 is going into reverse”, said Bank of America.

https://i1.wp.com/media0.faz.net/ppmedia/aktuell/wirtschaft/759001933/1.2727518/article_multimedia_overview/umweltpolitisch-hoch-umstritten-hilft-fracking-hier-in-colorado-amerika-dabei-unabhaengiger-von-den-opec-mitgliedern-zu-werden.jpgBy Ambrose Evans-Pritchard

The OPEC oil cartel no longer exists in any meaningful sense and crude prices will slump to $50 a barrel over the coming months as market forces shake out the weakest producers, Bank of America has warned.

Revolutionary changes sweeping the world’s energy industry will drive down the price of liquefied natural gas (LNG), creating a “multi-year” glut and a much cheaper source of gas for Europe.

Francisco Blanch, the bank’s commodity chief, said OPEC is “effectively dissolved” after it failed to stabilize prices at its last meeting. “The consequences are profound and long-lasting,“ he said.

The free market will now set the global cost of oil, leading to a new era of wild price swings and disorderly trading that benefits only the Mid-East petro-states with deepest pockets such as Saudi Arabia. If so, the weaker peripheral members such as Venezuela and Nigeria are being thrown to the wolves.

The bank said in its year-end report that at least 15pc of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55. The high-cost producers in the Permian basin will be the first to “feel the pain” and may soon have to cut back on production.

The claims pit Bank of America against its arch-rival Citigroup, which insists that the US shale industry is far more resilient than widely supposed, with marginal costs for existing rigs nearer $40, and much of its output hedged on the futures markets.

Bank of America said the current slump will choke off shale projects in Argentina and Mexico, and will force retrenchment in Canadian oil sands and some of Russia’s remote fields. The major oil companies will have to cut back on projects with a break-even cost below $80 for Brent crude.

It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year,” said Sabine Schels, the bank’s energy expert.

Mrs Schels said the global market for (LNG) will “change drastically” in 2015, going into a “bear market” lasting years as a surge of supply from Australia compounds the global effects of the US gas saga.

If the forecast is correct, the LNG flood could have powerful political effects, giving Europe a source of mass supply that can undercut pipeline gas from Russia. The EU already has enough LNG terminals to cover most of its gas needs. It has not been able to use this asset as a geostrategic bargaining chip with the Kremlin because LGN itself has been in scarce supply, mostly diverted to Japan and Korea. Much of Europe may not need Russian gas at all within a couple of years.

Bank of America said the oil price crash is worth $1 trillion of stimulus for the global economy, equal to a $730bn “tax cut” in 2015. Yet the effects are complex, with winners and losers. The benefits diminish the further it falls. Academic studies suggest that oil crashes can ultimately turn negative if they trigger systemic financial crises in commodity states.

Barnaby Martin, the bank’s European credit chief, said world asset markets may face a stress test as the US Federal Reserve starts to tighten afters year of largesse. “Our biggest worry is the end of the liquidity cycle. The Fed is done and it is preparing to raise rates. The reach for yield that we have seen since 2009 is going into reverse”, he said.

Mr Martin flagged warnings by William Dudley, the head of the New York Fed, that the US authorities had tightened too gently in 2004 and might do better to adopt the strategy of 1994 when they raised rates fast and hard, sending tremors through global bond markets.

Bank of America said quantitative easing in Europe and Japan will cover just 35pc of the global stimulus lost as the Fed pulls back, creating a treacherous hiatus for markets. It warned that the full effect of Fed tapering had yet to be felt. From now on the markets cannot expect to be rescued every time there is a squall. “The threshold for the Fed to return to QE will be high. This is why we believe we are entering a phase in which bad news will be bad news and volatility will likely rise,” it said.

What is clear is that the world has become addicted to central bank stimulus. Bank of America said 56pc of global GDP is currently supported by zero interest rates, and so are 83pc of the free-floating equities on global bourses. Half of all government bonds in the world yield less that 1pc. Roughly 1.4bn people are experiencing negative rates in one form or another.

These are astonishing figures, evidence of a 1930s-style depression, albeit one that is still contained. Nobody knows what will happen as the Fed tries to break out of the stimulus trap, including Fed officials themselves.

Capital Controls Feared As Russian Rouble Collapses

‘Funding problems are increasing dramatically.  We think Russia is now flirting with systemic problems,’ said Danske Bank

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The currency has been in free fall since Saudi Arabia and the Gulf states vetoed calls by weaker OPEC members for a cut in crude oil output. By Ambrose Evans-Pritchard, The Telegraph

The Russian Rouble has suffered its steepest one-day drop since the default crisis in 1998 as capital flight accelerates, raising the risk of emergency exchange controls and tightening the noose on Russian companies and bodies with more than $680bn (£432bn) of external debt.

The currency has been in free fall since Saudi Arabia and the Gulf states vetoed calls by weaker OPEC members for a cut in crude oil output, a move viewed by the Kremlin as a strategic attack on Russia.

A fresh plunge in Brent prices to a five-year low of $67.50 a barrel on Monday caused the dam to break, triggering a 9pc slide in the Rouble in a matter of hours.

Analysts said it took huge intervention by the Russian central bank to stop the rout and stabilize the Rouble at 52.07 to the dollar. “They must have spent billions,” said Tim Ash, at Standard Bank.

It is extremely rare for a major country to collapse in this fashion, and the trauma is likely to have political consequences. “This has become disorderly. There are no real buyers of the Rouble. We know that voices close to president Vladimir Putin want capital controls, and we cannot rule this out,” said Lars Christensen, at Danske Bank.

“Funding problems are increasing dramatically. We think Russia is now flirting with systemic problems,” he added.

Some Russian banks have already started limiting withdrawals of dollars and euros to $10,000, an implicit lock down for big depositors.

Rouble against the dollar since December 2012.

Russian premier Dmitry Medvedev said 10 days ago that capital controls are out of the question. “The government, myself, my colleagues and the central bank have repeatedly stated that we are not going to impose any special restrictions on capital flows,” he said.

Ksenia Yudaeva, the central bank’s deputy governor, said the authorities are battening down the hatches for a “$60 oil scenario” lasting deep into next year. “A long decline is highly probable,” she said.

Russia has lost its ranking as the world’s eighth biggest economy, shrinking in just nine months from a $2.1 trillion petro-giant to a mid-size player comparable with Korea or Spain.

In a further setback, Mr Putin gave the clearest signal yet that the South Stream gas pipeline – intended to supply Europe without going through Ukraine – may never be built. “If Europe does not want to carry it out, then it will not be carried out,” he said.

Oil and gas provide two-thirds of Russia’s exports and cover half of its fiscal revenues, a classic case of the “Dutch Disease” that leaves the country highly exposed to the ups and down of the commodity cycle.

Protracted slumps in crude prices crippled the Soviet Union in late 1980s, and caused Russia to go bankrupt in the late-1990s. “The Rouble will not stabilize until oil does,” said Kingsmill Bond, at Sberbank.

The bank said Russia faces a mounting deficit on its capital account. The country is no longer generating a big enough trade surplus to cover capital outflows. Sberbank warned that reserves are “likely” to fall to levels that ultimately require capital controls, unless Western sanctions are lifted.

While Russia has $420bn of foreign reserves, this war chest is not as a large as it seems for a country with chronic capital outflows that relies heavily on foreign funding. Lubomir Mitov, from the Institute of International Finance, said investors may start to fret about reserve cover if the figure falls to $330bn.

The Rouble’s slide has led to fury in the Duma, where populist politician Evgeny Fedorov has called for a criminal investigation of the central bank. Critics say the institution had been taken over by “feminist liberals” and is a tool of the International Monetary Fund. The office of the Russia general prosecutor said on Monday it was opening a probe.

The central bank has refused to intervene to defend the Rouble over recent weeks, letting the exchange rate take the strain rather than burning through reserves to delay the inevitable, as Nigeria and Kazakhstan are doing. It squandered $200bn of reserves in a six-week period in late 2008 and triggered an acute banking crisis, learning the hard way that currency intervention entails monetary tightening.

By letting the Rouble fall, it shields the Russian budget from the slump in global oil prices, though not entirely. Deutsche Bank said the fiscal balance turns negative at crude prices below $70.

Yet the devaluation is causing prices to spiral upwards in the shops and may at some point cause a self-feeding crisis if it evokes bitter memories of past currencies crashes. The finance ministry said it expects inflation to reach 10pc in the first quarter of 2015.

There is already a dash to buy washing machines, cars and computers before they shoot up in price, a shift in behavior that signals stress.

The Rouble slide is ratcheting up the pressure on Russian companies facing $35bn of redemptions of foreign debt in December alone, mostly in dollars. Yields on Lukoil’s 10-year bonds have jumped by 250 basis points since June to 7.5pc.

Most Russian companies have been shut out of global capital markets since the escalation of Western sanctions, following the downing of Malaysia Airlines Flight 17 in July. They are forced to pay back debt as it comes due, seek support from the Russian state or default. The oil giant Rosneft has requested $49bn in state aid.

Sberbank said companies must repay $75bn next year in dollar debt and cannot hope to roll over more than a tiny sliver of this. Nor can they expect more than $10bn of fresh capital from China.

The bank said there are companies that are profiting nicely from the devaluation, since they sell abroad yet their costs are local. These include the base metals groups Norilsk and Rusal, as well as steel producers, and fertilizer groups such as Uralkali and PhosAgro. “Some of these are making a lot of money right now, and their stocks are flying,” said one trader.

The Russian equity index is trading at 0.5pc of book value. Rarely has a market ever been so cheap.

The Real Reason Saudis Didn’t Cut Oil Production

https://i1.wp.com/www.touristmaker.com/images/saudi-arabia/medina-saudi-arabia.jpgby Martin Vleck

Summary

  • There have been plenty of explanations why OPEC didn’t cut production quotas.
  • Most of them make sense. But they fail to explain the whole strategic long-term picture.
  • There is a rarely mentioned strategic reason why – counter intuitively – oil prices falling and staying low in 2015 is in the best long-term interest of most oil exporters.
  • Moreover, the current status threatens OPEC’s influence over oil prices. OPEC will need to reform and include virtually all major oil producers in quota negotiations. Otherwise, OPEC will become irrelevant.
  • There is also an unexpected historical parallel for the current oil slump.

The conventional explanations for OPEC not cutting the production

The OPEC leaving production quotas unchanged has naturally been the top news last week and most investors have spent at least some time over the weekend to reflect on the implications of the move on their portfolios. There have been several theories and explanations as to why the OPEC didn’t cut. The obvious reasons stretch from the lack of agreement between OPEC members on whether to cut, by how, and most importantly, how much production each country sacrifices. Other explanations include the strategy of the dominant OPEC member, Saudi Arabia, to let the prices fall in order to squeeze out high-cost oil producers, such as Canadian oil sands and U.S. shale oil. The explanations or speculations also include some supposed secret deal between the U.S. and Saudi Arabia to damage Russia, Iran, ISIS and other “rogue” regimes or interest groups around the world. There are certainly many more theories for why OPEC didn’t cut.

Saudis are most probably thinking long term, so any explanation needs to include a combination of short term and long-term strategic goals. And the question also lingers whether OPEC still has enough power over oil prices.

Is this the real reason why Saudis didn’t cut?

There have been plenty of explanations why the OPEC didn’t cut production quotas. But there is one very long-term strategic reason why the price fall may be welcome by OPEC. This explanation has not been discussed too much, at least I haven’t seen it mentioned. Yet over the very long, very strategic time horizon, this would be the most probable explanation for letting the price of oil to fall now.

Who is the biggest competitor for the Saudis, or OPEC countries? Is it Canada? Is it the U.S.? Russia? Offshore Africa? The answer is no. Let me give you a hint. What is the biggest threat to not just Saudi Arabia, or OPEC, but to all oil producers? The answer is simple:

The biggest threat to all oil producers of the world is the high oil price. (No, that’s not a typo).

Alternative energy sources are the true competitor of all participants in the oil and gas industry.

High price of oil spurs faster development and implementation of alternative energy technologies. It is just a matter of time before solar, wind and other alternative sources of energy will become competitive or cheaper than oil and gas in many applications. In some places they already are. Sometimes even without any subsidies and including the benefits that oil and gas industry receives in the form of free negative externalities, such as the damage to the water and environment in general. To be fair, the negative environmental impact of the solar panel production and disposition is rarely mentioned.

Moreover, the cost of generating alternative energy has been falling and there is no reason why the cost should stop falling as the technological process keeps leaping ahead. It will probably take centuries before the world runs out of good sunny or windy spots (Sahara, Saudi desert – interestingly, Southern U.S. for solar and plenty of shores for wind are just some examples), so the costs to extract additional alternative energy megawatts will not rise. Plus, the sun rises every day, so the source of this energy is almost infinite and doesn’t deplete or deteriorate. It is like a fixed cost which will never rise over time.

On the other hand, the reserves of oil and gas are finite and the cost of extracting an additional barrel of oil has been rising – and will most probably keep rising – due to cheap sources of oil being always extracted first as well as due to generally rising overall costs associated with oil production.

Alternative energy space is rapidly developing

The recent technical development in the area of electricity storage (batteries, etc.) and alternative energy is surprisingly fast. Panasonic, Tesla and many others are investing in cheaper and more efficient large-scale batteries for economically viable electricity storage. The sales of electric cars, while still tiny, grow at rapid annual rates globally. Hydrogen fuel cell powered cars are emerging (Honda, Hyundai and Toyota already sold/leased some hydrogen models to the public, Audi has a fully functional prototype, many other brands are at similar stages but the technology is evolving rapidly). Ironically, hydrogen is usually produced from natural gas or methane. However, the efficiency is roughly 80%, which is extremely high, much higher than conventional combustion engines. Natural gas also has a much lower value for the oil and gas producers than the oil (lots of it is still just burnt on the spot). So the overall revenue for the oil and gas industry will be significantly lower from a hydrogen-powered car than from a conventional gasoline car. The same holds true for electric cars of course. The hydrogen fueling stations infrastructure is in its infancy, and only a true fan would buy/rent a hydrogen car now, but judging from the hydrogen car mileage and activities of car manufacturers, fuel cell infrastructure may be just 2-3 years behind the electric vehicle infrastructure. If some favorable legislation chips in, the gap could actually close very soon.

But cars are just one of many examples of how alternative energy sources threaten to replace significant volumes of oil in the future. On the other end of the spectrum are speculative developments, such as the fusion power which has been a fata-morgana for many decades. Even a working solution now would probably take five to ten years to make it commercially available. However, Lockheed Martin now claims to have made a breakthrough in fusion technology, offering no details though. So their claim may easily be just part of a creative PR campaign. (I am not suggesting they are lying, but I have to discount the information because there is no way to prove it)

Oil is here to stay for decades

Of course lots of oil will still need to be consumed, for many decades to come. But the market will be shrinking or stagnant in dollar terms. Actual physical volumes may moderately rise. The improvements in power consumption efficiencies are not exactly going to help the price and volume. On the other hand, growing global population and rising buying power of a global consumer is a major positive factor. All in all, I believe the current oil price weakness will continue only in the short run. The prices of WTI crude should stabilize in the medium term of several months or quarters at the level of $60-$80 per barrel.

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The only way many oil and gas exporting countries can survive in the long run

Oil and gas revenues are often a dominant source of income for the producing countries. To say many are very dependent on oil and gas revenues is a gross understatement. Preserving at least some oil and gas revenue is a matter of life and death for these countries. Therefore, the only way to survive the next few decades for most oil and gas producing countries is to cut the price of oil drastically NOW. That is their only chance to at least slow down the development and implementation of alternative energy sources into widespread usage, before it is too late from their point of view. If they fail, the price of oil will get stuck at much lower levels almost permanently.

OPEC will lose relevance if it doesn’t manage to reform and include virtually all major oil producers in quota negotiations

Higher-cost producers are planning to increase their oil/oil products exports to global markets. For example, Canada prepares to sign a free trade agreement with South Korea “in the coming months” which will cut crude oil and LNG duties by 3% and by 8% on refined products virtually immediately upon signing the deal, and this deal would serve as a “gateway to the wider Asia-Pacific region”). Similarly, the U.S. has been warming up to the idea of looser oil export policies and discussing a free trade deal with the EU. The fact that Saudi Arabia recently cut price for its Asian customers while raising them for the U.S. would give some more support the theory that the North American market and its producers are the prime target of its strategy. And this is probably the medium-term goal of the Saudis, according to my opinion.

The fact that oil prices topped in the middle of June, almost exactly on the date when the message about the planned free trade agreement with South Korea was officially released (June 16, 2014), is certainly an interesting coincidence. Or is it? Additionally, it is likely that the Saudis see the waning pricing power of OPEC due to flexible production from the U.S. shale oil fields which can be quickly boosted or cut in order to influence the total world production. This ability takes away the power over oil from the Saudis which have possessed this power to adjust production until recently. Therefore, the Saudis probably try to reign in all OPEC members and force them to respect the set quotas and share any potential cuts among all members, without the Saudis bearing most of the quota cut. But the falling oil price has an interesting historical parallel and implications.

Lower price of oil serves as an inverse oil price shock (the opposite of the 70’s)

Besides the conventional explanations for the current oil price slump, there is a surprising inverse historical parallel – the first and second oil price shock in the 70’s (1973 and 1979). Back then, prices of oil spiked rapidly and remained high and the time was generally characterized by booming population growth, young population, rapid inflation, high interest rates which subsequently caused a supply-side shock and a recession. But this period also spurred unprecedented innovation around the world with advances in robotics, miniaturization, semiconductors, and other fields which radically improved efficiencies which decreased energy and material intensity of production, especially in Japan.

The current situation is almost exactly the opposite. The price of oil is not rising but falling rapidly. Inflation is extremely low (parts of the world already experience deflation), aggregate demand is sluggish amid falling real income, almost non-existent population growth and aging population (in the U.S. and other developed countries). All this discourages investments in energy innovation and energy efficiency (low interest rates help a lot, though).

Existing alternative energy solutions are becoming more and more uneconomical compared to falling price of oil and gas, and the opportunity cost of using subsidized “green” energy is rising relative to cheaper oil. Existing subsidies suddenly may not be high enough to cover the costs to install further alternative energy capacities. Investments into further alternative energy R&D will be hard to obtain due to low potential ROI of the innovations if the future price of oil is expected to remain low. This will help conserve the status quo or at least slow down alternative energy advances. For the current oil producers – from all around the world, not only for Saudi Arabia or OPEC – lower prices are great news in the long run, even though they are painful now.

My oil price outlook

In the short run (several months and quarters), I am very bearish on oil prices because the oil producers have motivation to keep the price low until the highly leveraged, high-cost oil producers go out of business or are bought for pennies by their stronger competitors. Also, oil producing countries would need to maintain at least several quarters of weak oil to discourage long-term investments into alternative energy innovation, possibly until the current round of alternative energy R&D companies and some solar energy companies go out of business or consolidate.

However, over the medium to long term (years and decades), I am neutral to moderately bullish on oil prices as I believe the markets and industry will find a decent equilibrium around $60-80 per barrel. However, I don’t expect long-lasting spikes above $90-100 per barrel (barring the global security situation getting out of hand) because the flexible U.S. shale producers currently hold a permanent “call option” on the oil market. Every time the price spikes, they will quickly add more production, balancing the market. It is quite similar to the Bernanke put option, just working the opposite way and in oil.

Investment implication

I opened a long position in United States Oil ETF (NYSEARCA:USO) (selling covered calls to help mitigate contango issues) and Seadrill (NYSE:SDRL) late last week. I am also considering establishing a long position in British Petroleum (NYSE:BP). Furthermore, for long-term investors with high risk tolerance, I recommend smaller positions in more speculative and risky oil and gas services small-cap stocks which I analyzed in the past few weeks. These include Tidewater (NYSE:TDW), TGC Industries (NASDAQ:TGE), Dawson Geophysical (NASDAQ:DWSN), GulfMark Offshore (NYSE:GLF), Ion Geophysical (NYSE:IO) and CGG Industries (NYSE:CGG). I don’t hold any positions in any of these due to my preference for a highly concentrated portfolio but may decide to open long positions depending on future situation.

OPEC Refuses to Cut Production, Oil Plunges off the Chart

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   Oil rig in North Dakota. Increased US drilling is a factor in the current decline in prices.  This article by Wolf Richter

The global oil glut, as some call it, is caused by the toxic mix of soaring production in the US and lackluster demand from struggling economies around the world. Since June, crude oil prices have plunged 30%. It drove oil producers in the US into bouts of hand wringing behind the scenes, though they desperately tried to maintain brittle smiles and optimistic verbiage in public.

But everyone in the industry – particularly junk bondholders that have funded the shale revolution in the US – were hoping that OPEC, and not the US, would come to its senses and cut production.

So the oil ministers from OPEC members just got through with what must have been a tempestuous five-hour meeting in Vienna, and it was not pretty for high-cost US producers: the oil production target would remain unchanged at 30 million barrels per day.

“It was a great decision,” Saudi Oil Minister Ali al-Naimi said with a big smile after the meeting.

Saudi Arabia and other Gulf states were thus overriding the concerns from struggling countries such as Venezuela which, at these prices – and they’re plunging as I’m writing this – will head straight into default, or get bailed out by China, at a price, whatever the case may be.

Venezuelan Foreign Minister Rafael Ramirez emerged from the meeting, visibly steaming, and refused to comment.

The US benchmark crude oil grade, West Texas Intermediate, plunged instantly. Even before the decision, it was down 30% from its recent high in June. As I’m writing this, it crashed through the $70-mark without even hesitating. It currently trades for $68.51. Chopped down by a full third from the peak in June.

This is what that Thanksgiving plunge looks like:

US-WTI_2014-11-27

Nigerian Oil Minister said OPEC and Non-OPEC producers should share responsibility to stabilize the markets. I don’t know what he was thinking; maybe some intervention by central banks around the world, such as the coordinated announcement of “QE crude infinity” perhaps?

Ecuadorian Oil Minister called the decision a rollover. However, the Iranian Oil Minister, whose country must have a higher price, kept a positive face, saying, “I’m not angry.”

The next OPEC meeting will be held in June, 2015. So this is going to last a while. And there is no deus ex machina on the horizon.

It seems OPEC, or rather Saudi Arabia and some of the Gulf States, decided for now to live with the circumstances, to let the markets sort it out. High-cost producers around the world will spill red ink. Governments might topple. Junk bondholders and shareholders of oil-and-gas IPOs that have blindly funded the miraculous shale revolution in the US, lured by ever increasing hype, will watch more of their money go up in thick smoke.

And the bloodletting in the US fracking revolution will go on until the money finally dries up.

OPEC’s Prisoner’s Dilemma Unfolding

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by Marc Chandler

Summary

  • OPEC faces internal and external challenges.
  • A large cut in output is unlikely.
  • Prices may have to fall by another $10 a barrel or so to begin having impact on production.

Prisoner’s Dilemma Unfolding. The oil producing cartel will be 55 years old next year. It is not clear, but it may be experiencing an existential crisis. It’s share of the world oil production has fallen with the rise of non-OPEC sources, like Russia, Norway, the UK, Canada, and significantly in recent years, increasingly the US.

In addition to the external threat, OPEC faces internal challenges, There is a divergence of perceptions of national interest by the political elite. Indeed, Middle East politics is arguably incomprehensible without appreciating the tension between Saudi Arabia and Iran.

Generally speaking, OPEC countries have tended to fall into one of two groups. The first has greater oil reserves relative to population. Saudi Arabia and Kuwait are the obvious examples. The second have relatively less oil and more people. Iran and Iraq are examples. This has often created conflicting strategies. The former wants to protect the value of their reserves by discouraging alternatives, which means relatively low prices. The latter want to maximize their current value.

OPEC, like all cartels, have governance or enforcement challenges. It long faced difficulty ensuring that the production agreements and quotas are respected. By OPEC’s own reckoning, there is often production in excess of the prevailing agreement. Last month, while oil prices were falling, OPEC says that it produced 30.25 mln barrels a day, which is 250k barrels a day over the production agreement. This may under-estimate OPEC’s production. Iran, for example, appears to be selling greater amounts of (condensate) oil than the sanctions allow.

The prisoner’s dilemma is both within OPEC and without. For the Saudis to continue to act as the swing producer, it would mean the surrender of revenue and market share to its rival Iran. Iran would very likely use the proceeds for purposes that would frustrate Saudi Arabia’s strategic interest. In a similar vein, a substantial cut in OPEC output, even if it could be agreed up, would benefit non-OPEC producers and only encourage the expansion of US shale development.

https://i2.wp.com/static2.businessinsider.com/image/54748126ecad04c815222db7/russia-doesnt-have-a-great-reputation-with-opec.jpg

Putin with Igor Sechin (right)

Contrary to the some conspiracy theorists who claim Saudi Arabia is doing US bidding by allowing the price of oil to fall to squeeze Russia, it has its own reasons not to want do Russia favors. Putin’s support for Assad in Syria and the Iranian regime puts Russia in opposition to Saudi Arabia. If the Saudis pick up the mantle again as the swing producer, Russia would a beneficiary. A recovery in oil prices would allow Putin to replenish his coffers, which would make its foreign assistance program even more challenging.

Moreover, and this is a key point, given OPEC’s reduced leverage in the oil market, a large cut in the Middle East production of mostly heavy sour crude might not be sufficient to support prices. It could lead to a loss of both revenue and market share. It could also lead to new widening of the spread between Brent, the international benchmark, and WTI, the US benchmark.

The significant drop in oil prices over the last several months has not deterred the expansion of US output. In the week ending November 7, the US produced nine mln barrels a day, which was the most in more than two decades. Output slipped in the week through November 14 by less than 60k barrels a day, but we would not read much into that.

Industry estimates suggest that more than three-quarters of the new light oil production next year is expected to be profitable between $50 and $69 a barrel. The press reports that rather than be deterred by the decline in prices, some companies, like Encana (NYSE:ECA) plan to dramatically increase the number of wells in the US Permian Basin (Texas) next year.

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Reports do suggest that parts of nearly 20 fields are no longer profitable at $75 a barrel. There has been a very modest reduction of oil rigs. However, this has been largely offset by the rise in productivity of the existing wells. For example, in the North Dakota Bakken area, the output per well has risen to a record. In addition, industry reports suggest that the costs of shale and horizontal drilling is falling.

Although the price of oil has fallen below budget levels for many oil producing countries, the situation is not particularly urgent. Seasonally this is a high demand period. Most countries have ample reserves to cover the shortfall in the coming months. Around March, the seasonal factors shift and demand typically eases. That is when some key decisions will have to be made. It may not sound like a significant tell, but when the next OPEC meeting is scheduled may be indicative of a sense of urgency. A meeting in the February-March period may indicate higher anxiety than say a meeting in the middle of next year.

One study by Bloomberg found that only two OPEC quota cuts have been for less than one million barrels. A Bloomberg’s survey found that the respondents were evenly split between expecting a cut and not, few seem to be actually anticipating a significant cut. This suggests the scope for disappointment may be limited. That said, there is gap risk on the US oil futures contract come Friday, when they re-open after Thursday’s holiday.

As a consequence of lower oil prices, some oil producers may have to draw down their financial reserves to close the funding gap. Some will assume this will translate into liquidation of US Treasuries. However, it is not as easy as that. According to US Treasury data, in the first nine months of this year, OPEC increased its holdings of US Treasuries by $41 bln. In some period last year, it had sold about $17 bln of Treasuries. Could OPEC countries also be unwinding the diversification of reserves into euros, with yields so low and officials explicitly seeking devaluation (something not seen in the US since Robert Rubin first articulated a “strong dollar” policy almost two decades ago).

There may be political fallout from a continued decline in oil prices. An agreement between Baghdad and Kurds may be more difficult. Pressure in Libya and Nigeria is bound to increase, for example.

Back in 2009 when some observers began warning that higher food prices were the result of the extremely easy and unorthodox monetary policy. We argued that the shock was more on the supply side than the demand side and that commercial farmers would respond to the price signal by boosting output. Oil is similar but opposite. Oil prices will bottom after producers respond to the price signal by cutting production because they have to, not because they want to. Fear not greed will be the driver. It does not look like this can happen until Brent falls below $70 a barrel and WTI is nearer $60-$65.

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How Low Can the Price of Oil Plunge?

https://i0.wp.com/www.gulf-times.com/NewsImages/2014/10/27/30d677e0-63da-4004-ac67-2ce174ec36a9.jpgby Wolf Richter

It is possible that a miracle intervenes and that the price of oil bounces off and zooms skyward. We’ve seen stocks perform these sorts of miracles on a routine basis, but when it comes to oil, miracles have become rare. As I’m writing this, US light sweet crude trades at $76.90 a barrel, down 26% from June, a price last seen in the summer of 2010.

But this price isn’t what drillers get paid at the wellhead. Grades of oil vary. In the Bakken, the shale-oil paradise in North Dakota, wellhead prices are significantly lower not only because the Bakken blend isn’t as valuable to refiners as the benchmark West Texas Intermediate, but also because take-away capacity by pipeline is limited. Crude-by-rail has become the dominant – but more costly – way to get the oil from the Northern Rockies to refineries on the Gulf Coast or the East Coast.

These additional transportation costs come out of the wellhead price. So for a particular well, a driller might get less than $60/bbl – and not the $76.90/bbl that WTI traded for at the New York Mercantile Exchange.

Fracking is expensive, capital intensive, and characterized by steep decline rates. Much of the production occurs over the first two years – and much of the cash flow. If prices are low during those two years, the well might never be profitable.

Meanwhile, North Sea Brent has dropped to $79.85 a barrel, last seen in September 2010.

So the US Energy Information Administration, in its monthly short-term energy outlook a week ago, chopped down its forecast of the average price in 2015: WTI from $94.58/bbl to $77.55/bbl and Brent from $101.67/bbl to $83.24/bbl.

Independent exploration and production companies have gotten mauled. For example, Goodrich Petroleum plunged 71% and Comstock Resources 58% from their 52-week highs in June while Rex Energy plunged 65% and Stone Energy 54% from their highs in April.

Integrated oil majors have fared better, so far. Exxon Mobil is down “only” 9% from its July high. On a broader scale, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is down 28% from June – even as the S&P 500 set a new record.

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So how low can oil drop, and how long can this go on?

The theory is being propagated that the price won’t drop much below the breakeven point in higher-cost areas, such as the tar sands in Canada or the Bakken in the US. At that price, rather than lose money, drillers would stop fracking and tar-sands operators would shut down their tar pits. And soon, supplies would tighten up, inventories would be drawn down, and prices would jump.

But that’s not what happened in natural gas. US drillers didn’t stop fracking when the price of natural gas plunged below the cost of production and kept plunging for years. In April 2012, it reached not a four-year low but a decade-low of about $1.90 per million Btu at the Henry hub. At the time, shorts were vociferously proclaiming that gas storage would be full by fall, that the remaining gas would have to be flared, and that the price would then drop to zero.

But drillers were still drilling, and production continues to rise to this day, though the low price also caused an uptick in consumption that coincided with a harsh winter, leaving storage levels below the five-year minimum for this time of the year.

The gas glut has disappeared. The price at the Henry hub has since more than doubled, but it remains below breakeven for many wells. And when natural gas was selling for $4/MM Btu at the Henry hub, it was selling for $2/MM Btu at the Appalachian hubs, where the wondrous production from the Marcellus shale comes to market. No one can make money at that price.

And they’re still drilling in the Marcellus.

Natural gas drillers had a cover: a well that also produced a lot of oil and natural gas liquids was profitable because they fetched a much higher price. But this too has been obviated by events: on top of the rout in oil, the inevitable glut in natural gas liquids has caused their prices to swoon too (chart).

Yet, they’re still drilling, and production is still rising. And they will continue to drill as long as they can get the moolah to do so. They might pick and choose where they drill, and they might back off a smidgen, but as long as they get the money, they’ll drill.

Money has been flowing into the oil and gas business like a tsunami unleashed by yield-desperate investors who, driven to near insanity by the Fed’s policies, do what the Fed has been telling them to do: close their eyes and hold their noses and disregard risk and hand over their money, and borrow money for nearly free and hand over that money too.

Oil and gas companies have issued record amounts of junk bonds. They’ve raised record amounts of money via a record number of IPOs. They’ve raised money by spinning off assets into publicly traded MLPs. They’ve borrowed from banks that then packaged these loans into securities that were then sold. The industry has taken this cheap money and has drilled it into the ground.

This is one of the consequences of the Fed’s decision to flood the land with free liquidity. When the cost of capital is near zero, and when returns on low-risk investments are near zero as well, or even below zero, investors go into a sort of coma. But when they come out of it and realize that “sunk capital” has taken on a literal meaning, they’ll shut off the spigot.

Only then will drilling and production decline. As with natural gas, it can take years. And as with natural gas, the price might plunge through a four-year low and hit a decade low – which would be near $40/bbl, a price last seen in 2009. The bloodletting would be epic. To see where this is going, watch the money.

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OPEC Forecasts $110 Nominal Price Through End Of This Decade:

OPEC’s World Oil Outlook And Pivot To Asia

https://i0.wp.com/www.sweetcrudereports.com/wp-content/uploads/2013/06/OPEC-conference.jpgby Jennifer Warren

Summary

  • OPEC published its recent global oil market outlook, which offers a slightly different and instructional viewpoint.
  • OPEC sees its share of crude oil/liquids production reducing in light of increases in U.S. and Canada production.
  • OPEC also indicates a pivot toward Asia, where it sees the greatest demand for its primary exports in the future.

In perusing through OPEC’s recently released “World Oil Outlook,” several viewpoints are noteworthy. According to OPEC, demand grows mainly from developing countries and U.S. supply slows its run up after 2019. After 2019, OPEC begins to pick up the slack, supplying its products more readily. In OPEC’s view, Asia becomes a center of gravity given global population growth, up nearly 2 billion by 2040, and economic prosperity. The world economy grows by 260% versus that of 2013 on a purchasing power parity basis.

During the period 2013-2040, OPEC says oil demand is expected to increase by just over 21 million barrels per day (mb/d), reaching 111.1 mb/d by 2040. Developing countries alone will account for growth of 28 mb/d and demand in the OECD will fall by over 7 mb/d (p.1). On the supply side, “in the long-term, OPEC will supply the majority of the additional required barrels, with the OPEC liquids supply forecast increasing by over 13 mb/d in the Reference Case from 2020-2040,” they offer (p.1). OPEC shaved off 0.5 million barrels from their last year’s forecast to 2035. Asian oil demand accounts for 71% of the growth of oil demand.

Morgan Stanley pulled out the following items:

The oil cartel released its World Oil Outlook last week, showing OPEC crude production falling to 29.5 million barrels per day in 2015 and 28.5 million barrels per day in 2016. This year’s average of 30 million barrels per day has helped flood the market and push oil prices to multi-year lows.

In the period to 2019, this chart illustrates where the barrels will flow:

Prices

With regard to price, OPEC acknowledges that the marginal cost to supply barrels continues to be a factor in expectations in the medium and long term. This sentiment has been echoed by other E&P CEOs in various communiques this year. OPEC forecasts a nominal price of $110 to the end of this decade:

On this evidence, a similar price assumption is made for the OPEC Reference Basket (ORB) price in the Reference Case compared to that presented in the WOO 2013: a constant nominal price of $110/b is assumed for the rest of the decade, corresponding to a small decline in real values.

Real values are assumed to approach $100/b in 2013 prices by 2035, with a slight further increase to $102/b by 2040. Nominal prices reach $124/b by 2025 and $177/b by 2040. These values are not to be taken as targets, according to OPEC. They acknowledge the challenge of predicting the world economy as well as non-OPEC supply. The Energy Information Administration (EIA) forecast a price for Brent averaging over $101 in 2015 and West Texas Intermediate (WTI) of over $94 as of their October 7th forecast. (This will have likely changed as of November 12th after the steep declines of October are weighed into their equations.) WTI averaged around the $97 range for 2013 and 2014. Importantly, U.S. supply may ratchet down slightly (green broken line) in response to price declines, if they continue.

It’s also the cars, globally

In 2013, OPEC says gasoline and diesel engines comprised 97% of the passenger cars total in 2013, and will hold 92% of the road in 2040. The diesel share for autos rises from 14% in 2013 to 21% in 2040. Basically, the number of cars buzzing on roads doubles from now to 2040. And 68% of the increase in cars comes from developing countries. China comprises the lion’s share of car volume growing by more than 470 million between 2011-2040, followed by India, then OPEC members will attribute 110 million new cars on the road. These increases assume levels similar to advanced economy (OECD) car volumes of the 1990s. In spite of efficiency and fuel economy, oil use per vehicle is expected to decline by 2.2%.

Commercial vehicles gain 300 million by 2040 from about 200 million in 2011. There are now more commercial vehicles in developing countries than developed.

U.S. Supply and OPEC

According to OPEC, U.S. and Canada supply increases through the period to 2019, the medium term. After 2017, they believe U.S. supply tempers from 1.2 million barrels of tight oil increases between 2013 and 2014 to 0.4 million in 2015, and less incremental increases thereafter. This acknowledges shale oil’s contribution to supply, with other supply sources declining, i.e., conventional and offshore.

OPEC Suggests:

The amount of OPEC crude required will fall from just over 30 mb/d in 2013 to 28.2 mb/d in 2017, and will start to rise again in 2018. By 2019, OPEC crude supply, at 28.7 mb/d, is still lower than in 2013.

However, the OPEC requirements are expected to ramp back up after 2019. By 2040, they expect to be supplying the world with 39 mb/d, a 9 million barrel/d increase from 2013. OPEC’s global share of crude oil supply is then 36%, above 2013 levels of about 30%. A select few firms like Pioneer Natural Resources (NYSE:PXD), Occidental Petroleum (NYSE:OXY), Chevron (NYSE:CVX) and even small-cap RSP Permian (NYSE:RSPP) are staying the course on shale oil production in the Permian for the present. After the first of the year, they will evaluate the price environment.

How does this outlook by OPEC inform the future? From the appearances in its forecasts, OPEC has slightly lower production in the medium term (to 2019), a decline of 1.3 million b/d in 2019 from the 2014 production of 30 million b/d. Thus, the main lever for an increase in prices for oil markets is for OPEC to restrict production, or encourage other members to keep to the current quota of 30 million b/d. Better economic indicators also could help. However, Saudi Arabia, the swing producer, has shown interest in maintaining its market share vis-à-vis the price cuts it has offered China, first, and then the U.S. more recently.

The global state of crude oil and liquids and prices has fundamentally changed with the addition of tight oil or shale oil, particularly from the U.S. While demand particulars have dominated the price regime recently, the upcoming decisions by OPEC at the late November meeting will have an influence on price expectations. In an environment of softer perceived demand now because of global economics and in the future because of non-OPEC supply, it would seem rational for OPEC to indicate some type of discipline among members’ production.

Source: OPEC “2014 World Oil Outlook,” mainly from the executive summary.

Don’t Count On A Major Slowdown In U.S. Oil Production Growth

https://i1.wp.com/upachaya.com/wp-content/uploads/2014/05/fracking.jpgby Richard Zeits

Summary

  • The presumption that North American shale oil production is the “swing” component of global supply may be incorrect.
  • Supply cutbacks from other sources may come first.
  • Growth momentum in North American unconventional oil production will likely carry on into 2015, with little impact from lower oil prices on the next two quarters’ volumes.
  • The current oil price does not represent a structural “economic floor” for North American unconventional oil production.

The recent pull back in crude oil prices is often portrayed as being a consequence of the rapid growth of North American shale oil production.

The thesis is often further extrapolated to suggest that a major slowdown in North American unconventional oil production growth, induced by the oil price decline, will be the corrective mechanism that will bring oil supply and demand back in equilibrium (given that OPEC’s cost to produce is low).

Both views would be, in my opinion, overly simplistic interpretations of the global supply/demand dynamics and are not supported by historical statistical data.

Oil Price – The Economic Signal Is Both Loud and Clear

The current oil price correction is, arguably, the most pronounced since the global financial crisis of 2008-2009. The following chart illustrates very vividly that the price of the OPEC Basket (which represents waterborne grades of oil) has moved far outside the “stability band” that seems to have worked well for both consumers and producers over the past four years. (It is important, in my opinion, to measure historical prices in “today’s dollars.”)

(Source: Zeits Energy Analytics, November 2014)

Given the sheer magnitude of the recent oil price move, the economic signal to the world’s largest oil suppliers is, arguably, quite powerful already. A case can be made that it goes beyond what could be interpreted as “ordinary volatility,” giving the hope that the current price level may be sufficient to induce some supply response from the largest producers – in the event a supply cut back is indeed needed to eliminate a transitory supply/demand imbalance.

Are The U.S. Oil Shales The Culprit?

It is debatable, in my opinion, if the continued growth of the U.S. onshore oil production can be identified as the primary cause of the current correction in the oil price. Most likely, North American shale oil is just one of several powerful factors, on both supply and demand sides, that came together to cause the price decline.

The history of oil production increases from North America in the past three years shows that the OPEC Basket price remained within the fairly tight band, as highlighted on the graph above, during 2012-2013, the period when such increases were the largest. Global oil prices “broke down” in September of 2014, when North American oil production was growing at a lower rate than in 2012-2013.

(Source: OPEC, October 2014)

If the supply growth from North America was indeed the primary “disruptive” factor causing the imbalance, one would expect the impact on oil prices to become visible at the time when incremental volumes from North America were the highest, i.e., in 2012-2013.

Should One Expect A Strong Slowdown in North American Oil Production Growth?

There is no question that the sharp pullback in the price of oil will impact operating margins and cash flows of North American shale oil producers. However, a major slowdown in North American unconventional oil production growth is a lot less obvious.

First, the oil price correction being seen by North American shale oil producers is less pronounced than the oil price correction experienced by OPEC exporters. It is sufficient to look at the WTI historical price graph below (which is also presented in “today’s dollars”) to realize that the current WTI price decline is not dissimilar to those seen in 2012 and 2013 and therefore represents a signal of lesser magnitude than the one sent to international exporters (the OPEC Basket price).

(Source: Zeits Energy Analytics, November 2014)

Furthermore, among all the sources of global oil supply, North American oil shales are the least established category. Their cost structure is evolving rapidly. Given the strong productivity gains in North American shale oil plays, what was a below-breakeven price just two-three years ago, may have become a price stimulating growth going into 2015.

Therefore, the signal sent by the recent oil price decline may not be punitive enough for North American shale oil producers and may not be able to starve the industry of external capital.

Most importantly, review of historical operating statistics provides an indication that the previous similar WTI price corrections – seen in 2012 and 2013 – did not result in meaningful slowdowns in the North American shale oil production.

The following graph shows the trajectory of oil production in the Bakken play. From this graph, it is difficult to discern any significant impact from the 2012 and 2013 WTI price corrections on the play’s aggregate production volumes. While a positive correlation between these two price corrections and the pace of production growth in the Bakken exists, there are other factors – such as takeaway capacity availability and local differentials – that appear to have played a greater role. I should also note that the impact of the lower oil prices on production volumes was not visible in the production growth rate for more than half a year after the onset of the correction.

(Source: Zeits Energy Analytics, November 2014)

Leading U.S. Independents Will Likely Continue to Grow Production At A Rapid Pace

Production growth track record by several leading shale oil players suggests that U.S. shale oil production will likely remain strong even in the $80 per barrel WTI price environment. Several examples provide an illustration.

Continental Resources (NYSE:CLR) grew its Bakken production volumes at a 58% CAGR over the past three years (slide below). By looking at the company’s historical production, it would be difficult to identify any impact from the 2012 and 2013 oil price corrections on the company’s production growth rate. Continental just announced a reduction to its capital budget in 2015 in response to lower oil prices, to $4.6 billion from $5.2 billion planned initially. The company still expects to grow its total production in 2015 by 23%-29% year-on-year.

(Source: Continental Resources, October 2014)

EOG Resources (NYSE:EOG) expects that its largest core plays (Eagle Ford, Bakken and Delaware Basin) will generate after-tax rates of return in excess of 100% in 2015 at $80 per barrel wellhead price. EOG went further to suggest that these plays may remain economically viable (10% well-level returns) at oil prices as low as $40 per barrel. The company expects to continue to grow its oil production at a double-digit rate in 2015 while spending within its cash flow. EOG achieved ~40% oil production growth in 2012-2013 and expects 31% growth for 2014. While a slowdown is visible, it is important to take into consideration that EOG’s oil production base has increased dramatically in the past three years and requires significant capital just to be maintained flat. Again, one would not notice much impact from prior years’ oil price corrections on EOG’s production growth trajectory.

(Source: EOG Resources, November 2014)

Anadarko Petroleum’s (NYSE:APC) U.S. onshore oil production growth story is similar. Anadarko increased its U.S. crude oil and NLS production from 100,000 barrels per day in 2010 to close to almost 300,000 barrels per day expected in Q4 2014. Anadarko has not yet provided growth guidance for 2015, but indicated that the company’s exploration and development strategies remain intact. While recognizing a very steep decline in the oil price, Anadarko stated that it wants “to watch this environment a little longer” before reaching conclusions with regard to the impact on its future spending plans.

(Source: Anadarko Petroleum, October 2014)

Devon Energy (NYSE:DVN) posted company-wide oil production of 216,000 barrels per day in Q3 2014. While Devon will provide detailed production and capital guidance at a later date, the company has indicated that it sees 20% to 25% oil production growth and mid‐single digit top‐line growth “on a retained‐property basis” (pro forma for divestitures) in 2015.

The list can continue on.

In Conclusion…

Based on preliminary 2015 growth indications from large shale oil operators, North American oil production growth in 2015 will likely remain strong, barring further strong decline in the price of oil.

No slowdown effect from lower oil prices will be seen for at least six months from the time operators received the “price signal” (August-September 2014).

Given the effects of the technical learning curve in oil shales and continuously improving drilling economics, the current ~$77 per barrel WTI price is unlikely to be sufficient to eliminate North American unconventional production growth.

North American shale oil production remains a very small and highly fragmented component of the global oil supply.

The global oil “central bank” (Saudi Arabia and its close allies in OPEC) remain best positioned to quickly re-instate stability of oil price in the event further significant decline occurred.

Exclusive – Privately, Saudis tell oil market: get used to lower prices

By Ron Bousso and Joshua Schneyer

An employee pumps gas into a car at a gas station of the state oil company PDVSA in Caracas December 16, 2013. REUTERS/Carlos Garcia Rawlins

(Reuters) – Saudi Arabia is quietly telling oil market participants that Riyadh is comfortable with markedly lower oil prices for an extended period, a sharp shift in policy that may be aimed at slowing the expansion of rival producers including those in the U.S. shale patch.

Some OPEC members including Venezuela are clamoring for urgent production cuts to push global oil prices back up above $100 a barrel. But Saudi officials have telegraphed a different message in private meetings with oil market investors and analysts recently: the kingdom, OPEC’s largest producer, is ready to accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two, according to people who have been briefed on the recent conversations.

The discussions, some of which took place in New York over the past week, offer the clearest sign yet that the kingdom is setting aside its longstanding de facto strategy of holding prices at around $100 a barrel for Brent crude in favor of retaining market share in years to come.

The Saudis now appear to be betting that a period of lower prices – which could strain the finances of some members of the Organization of the Petroleum Exporting Countries – will be necessary to pave the way for higher revenue in the medium term, by curbing new investment and further increases in supply from places like the U.S. shale patch or ultra-deepwater, according to the sources, who declined to be identified due to the private nature of the discussions.

The conversations with Saudi officials did not offer any specific guidance on whether – or by how much – the kingdom might agree to cut output, a move many analysts are expecting in order to shore up a global market that is producing substantially more crude than it can consume. Saudi pumps around a third of OPEC’s oil, or some 9.7 million barrels a day.

Asked about coming Saudi output curbs, one Saudi official responded “What cuts?”, according to one of the sources.

Also uncertain is whether the Saudi briefings to oil market observers represent a new tack it is committed to, or a talking point meant to cajole other OPEC members to join Riyadh in eventually tightening the taps on supply.

One source not directly involved in the discussions said the kingdom does not necessarily want prices to slide further, but is unwilling to shoulder production cuts unilaterally and is prepared

OPEC ANGST

With most other members of the cartel unable or unwilling to reduce their own output, the group’s next meeting on Nov. 27 is set to be its most difficult in years. OPEC has agreed to cut production only a handful of times in the past decade, most recently in the aftermath of the 2008 financial crisis.

On Friday, Venezuela – one of the cartel’s most price-sensitive members – became the first to call openly for emergency action even earlier. Foreign Minister Rafael Ramirez said “it doesn’t suit anyone to have a price war, for the price to fall below $100 a barrel.”

On Sunday, Ali al-Omair, oil minister of Saudi Arabia’s core Gulf ally Kuwait, appeared to be the first to articulate the emerging view of OPEC’s most influential member, saying output cuts would do little to prop up prices in the face of rising production from Russia and the United States.

“I don’t think today there is a chance that (OPEC) countries would reduce their production,” state news agency KUNA quoted him as saying.

Omair said that prices should stop falling at around $76 to $77 a barrel, citing production costs in places like the United States, where a shale oil boom has unexpectedly reversed dwindling output and pushed production to its highest level since the 1980s.

Saudi oil officials have made no public comments on the deepening swoon in markets. Senior officials did not reply to questions from Reuters about recent briefings.

to tolerate lower prices until others in OPEC commit to action.

DON’T BE SURPRISED BELOW $90

Global benchmark Brent crude oil futures have fallen steadily for almost four months, dropping 23 percent from a June high of over $115 a barrel as fears of a Mideast supply disruption ebbed, U.S. shale production boomed and demand from Europe and China showed signs of flagging. [O/R]

Until recently, Gulf OPEC members have been saying that the price dip was a temporary phenomenon, betting on seasonal demand in winter to prop up prices. But a growing number of oil analysts now see the latest slide as something more than a seasonal downswing; some say it is the start of a pivotal shift to a prolonged period of relative abundance.

Rather than fight the decline in prices and cede market share in the face of growing competition, Saudi Arabia appears to be preparing traders for a sea change in prices.

The Saudis want the world to know that “nobody should be surprised” with oil under $90 a barrel, according to one of the people. Another source suggested that $80 a barrel may now be an acceptable floor for the kingdom, although several other analysts said that figure seemed too low. Brent has averaged around $103 since 2010, trading mostly between $100 and $120.

While the latest discussions are the bluntest efforts yet to signal the shift in Saudi strategy, early signs had already begun sending shivers through the oil market. In early October the kingdom cut its official selling prices more sharply than expected in a bid to maintain customers in Asia, widely seen as the opening shots in a price war for Asian customers.

“Riyadh’s political floor on oil prices is weakening,” Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, wrote in a note to clients following a trip to Saudi last month.

McNally said he is not aware of any specific Saudi price or timing strategy, but told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the U.S. shale oil sector.”

As that message began to dawn last week, the price rout quickened, with Brent lurching to its lowest level since 2010.

“Until about three days ago the absolute and total consensus in the market was the Saudis would cut,” said McNally. That is no longer a foregone conclusion, he said. “The market suddenly realizes it is operating without a net.”