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Dan Steffens

Dan Steffens

Dan Steffens is the President of Energy Prospectus Group (EPG), a networking organization based in Houston, Texas. He is a 1976 graduate of Tulsa University…

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Forget Doha. The Fundamentals Are Moving In The Right Direction

Forget Doha. The Fundamentals Are Moving In The Right Direction

I really don’t think it matters what happened at the OPEC + Russia meeting in Doha, Qatar on April 17. Agreements between those characters don’t have any enforcement provisions and the countries all have a long history of cheating. However, Saudi Arabia and Russia are losing so much money at today’s price of oil that maybe those two will take some action to cut back on production. They are the only two attendees that mattered anyway.

The meeting does send a clear message to the market that today’s low oil prices are unacceptable. Speculators that have been shorting oil futures should take notice.

Fundamentals Matter: The outcome of the meeting doesn’t matter because market forces are doing what they always do. Oil supply and demand will be back in balance by the end of this year regardless of what OPEC does. Saudi Arabia should take some action just to give the West an impression that they are in control. The Kingdom needs protection from the U.S. military, especially now that Iran is gaining more influence in the region. The last thing they need is for the U.S. navy to pull a carrier group out of the Persian Gulf.

On the demand side, the thirst for hydrocarbon-based liquid fuels, lubricants and feedstock is relentless. Demand increases by 1.0 to 1.5 million barrels per day each year. In 2015, demand increased by 1.8 million barrels per day. The only decline we’ve seen in decades was during the global economic meltdown of 2008-2009. In 2010, demand increased by 3.3 million barrels per day, getting it right back to the long-term trend line. Related: OPEC Report Suggests Massive Oil Price Rebound

In their April 14, 2016 Oil Market Report, the International Energy Agency (IEA) forecasts that world oil demand will be pushing 97.0 million barrels per day by year-end. That compares to 94.8 million barrels per day in the first quarter.

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Most energy sector investors are not aware of the fact that demand for oil is seasonal. The seasonality is relatively new. Back in the 1980’s the peak demand period was in the winter because a higher percentage of homes and businesses burned oil for space heating. Starting in the 1990’s most new homes in the United States and Canada began heating with natural gas or electricity. This trend has now “gone global” as more people become environmentally friendly and as more areas gain access to reliable sources of natural gas, electricity and solar.

I was born in 1954 and grew up in St. Louis, Missouri. Most of the homes in our neighborhood heated with coal and oil. We were one of the first homes to convert to natural gas in the late 1960s. I remember because when they hauled the big oil burner out of our basement, our play area was doubled.

Demand now spikes each summer as hydrocarbon-based liquid fuels provide most of our transportation fuels. Despite recent advancements in electric cars, this trend will continue for many years.

Crude oil demand also jumps about 500,000 barrels per day each spring because U.S. refiners cannot blend in as many natural gas liquids to make summer blend gasolines. The normal summer demand spike will be even bigger than normal this year because the warmer than normal El Nino winter softened heating oil demand. Look for steady declines of U.S. crude oil storage levels to begin in May.

Heading into 2016 there was concern that oil demand from China was slowing. Yes, the Chinese economy has slowed from its frantic pace, but they’ve added more oil to their Strategic Petroleum Reserve (SPR) to make up for it. Also, demand from India has accelerated. IEA estimates that India’s demand for liquid fuels will increase by 300,000 barrels per day this year. Jan Stuart, Credit Suisse Group AG Global Energy Economist, says oil demand growth appears to be re-accelerating after the warm winter.

Non-OPEC Oil Production is on Decline

My view is that the supply side is where the market is going to be surprised the most. In their Oil Market Report, IEA reported that OPEC crude oil production declined by 90,000 barrels per day in March. Ongoing outages in Nigeria, the UAE and Iraq more than offset a further increase from Iran and higher flows from Angola. Supply from Saudi Arabia dipped in March, but held near 10.2 million barrels per day. Related: This Is How Oilfield Services Are Surviving Low Oil Prices

Non-OPEC supply, which increased by 1.5 million barrels per day in 2015, is forecast by IEA to decline by 700,000 barrels per day in 2016. I believe Non-OPEC supply will fall by much more than that.

• The U.S. active drilling rig count has dropped off of a cliff to the lowest level in more than 70 years. On Friday, April 15 Baker Hughes (BHI) reported that there are only 351 rigs drilling for oil in the United States, compared to 1,609 in October, 2014.

• In Canada, only 10 rigs are now drilling for oil. There are no areas in Canada where drilling new wells makes sense at $40 oil.

• Most of the countries in Latin America are now reporting production declines.

• The U.S. Energy Information Administration’s Drilling Productivity Report, which tracks activity in the seven largest producing regions of the country, says oil production from these key areas will fall by 114,000 barrels per day from April to May. Since there is now very little drilling activity outside of these key areas, it safe to say that from April to December oil production just in the onshore U.S. may decline by 1,000,000 barrels per day. Oil production in the Gulf of Mexico is expected to increase this year by 150,000 to 200,000 barrels per day to soften the overall U.S. rate of decline.

• U.S. oil production peaked at 9.7 million barrels per day in April, 2015. By January, 2017 we’ll be fortunate to be producing 8.0 million barrels per day. Kiss those dreams of Energy Independence good bye.

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Many investors are still concerned that Iran is going to rapidly increase production. The fact is that they will increase production by 400,000 to 500,000 barrels per day by the end of 2016. They may add a another 100,000 to 200,000 barrels per day in 2017, but these are not much more than rounding errors in a world that will be consuming over 98 million barrels per day in 2017. Related: Will China's Slowing Economy Stall The Silk Road Project?

Iran needs over $100 billion of new investment to raise production back to pre-sanction levels. I doubt many companies will be running over to invest in Iran when the next U.S. President may tear up the Obama/Kerry agreement with Iran the day they take office. Those chants of Death to America do not go over big with the electorate.

Conclusion

Market forces do work. All oil wells go on decline shortly after they are placed on production and we are not completing enough new wells to offset the decline. Demand for refined products is going to spike in the 3rd quarter. Increasing demand and falling supply is a good recipe for higher oil prices. Oil traders see this coming, which is why the price has bounced off the double bottom in February. How high the price of oil goes is speculation, but sub-$50 oil is unsustainable if we are expected to develop the new supplies necessary to meet this world’s unending thirst for oil.

I talked to Raymond James energy team based in Houston on April 12. They are sticking with the forecast they published on January 4, 2016 that West Texas Intermediate (WTI) will average $60/bbl in the 3rd quarter. Credit Suisse now forecasts $50/bbl WTI in mid-May.

By Dan Steffens for Oilprice.com

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Leave a comment
  • JeeryTell on April 18 2016 said:
    Let me summaries the Bulls view in this article: Supply will go down, demand will go up. There, I've saved you 5 mins of reading bull boilerplate.
  • Natronic on April 18 2016 said:
    Article guy,

    Iran's exports have crossed the 2Mbpd mark already. I think it's temporary because they are unloading their floating storage but the output is there and it is real. There has been a rapid increase in storage capacity but even that won't last forever.
  • Mark on April 20 2016 said:
    What you all cant see is that there is a huge paranoia going on among oil producers since one will get any share one can still get and while price is still up! What you don't see are the open talks (Germany) about prohibition of cars within internal combustion engines. As matter a fact the only discussion left is time when last should happen. Why do you think in USA just reached highest production numbers and why Bulgaria is to begin to drill as well, because of high oil price, no because of selling it till it's still worth some money!! "Tesla" is comming and its comming faster than you may think. Nobody needs billions of barrels "per day" for e-cars... That is why now market share war is up! Forget the "oil peak" the "oil consumption peak" is here...
  • Ziggy on April 21 2016 said:
    Yeah, sure..and what about ships? Will they again use sails? What about trucks? Horses? Maybe we won't need transportation any more. What about other industries which are using it to make plastics, textiles, pharmaceuticals, chemicasl? You do not get only fuels from crude. Save your green propaganda for yourself.
  • AXEMAN on April 21 2016 said:
    I agree with Mark, OPEC is disintegrating and no one cares. The entire membership is inherently corrupt and even the Saudis are sick of being the swing producer. With Russia participating in the meeting the level of corruption goes up!
    The liquid fuel industry is in trouble and these jokers are trying to get their last hurrahs in these next few remaining decades. As for demand there is a enough to go around and fear mongers are always going to try to push this price up.
    By 2050 50% of all vehicles( cars and light trucks ) in the USA will be EV 'S.
    By 2050 50% of all vehicles( cars and light trucks ) in the western Europe will be EV 'S.
    Tesla is proving that this can be done ,this is feasible.
    Toyota, Hyundai, Honda, Ford, GM ,VW, Mercedes, BMW, Audi, almost every car maker on the globe is designing, planning and manufacturing their prototypes and sales models. AND THEY WILL COME FAST AND FURIOUS!
    This will displace 4-5million bbls/day of crude oil production.
    The naysayers to EV's have a lot to learn.
    Yes crude oil and hydrocarbons in general will be with us for the next hundred years, however their market share in the liquid fuel industry will decrease

    All these oil producers inside OPEC manufacture nothing ,zero, zippo! They are id deep ______ and the Kingdom of Saudi Arabia is trying to reinvent themselves as a global investment fund manager for their future livelihood. Well maybe they should hire a few hedge fund managers from Wall street!

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