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Oil Markets Can’t Ignore The Fundamentals Forever

Oil Markets Can’t Ignore The Fundamentals Forever

Storage withdrawals and falling rig count have been the main sources of hope that U.S. tight oil production will fall and that oil prices will rebound. That hope is fading as it is now clear that recent withdrawals from U.S. crude oil storage are because of price, not falling supply, and that the drop in rig count has stalled.

Figure 1 below shows the relationship between U.S. crude oil storage inventory and WTI price. The thinking around recent withdrawals from storage is that this reflects depleting supply. The data, however, reflects that traders were storing crude oil during the price collapse in order to realize higher prices later. With rising prices over the last month, traders are selling their stored volumes. The recent inventory build correlates almost perfectly with the fall in oil prices and the withdrawals from storage over that last 3 weeks correlate with the 35% increase in oil prices since late March. Related: Why Oil’s Rally Is Over

art1

Figure 1. Monthly change in U.S. crude oil inventory and WTI oil price (3-month moving average of inventory volumes). Source: EIA and Labyrinth Consulting Services, Inc.

(click to enlarge image)

Previous builds and withdrawals from inventory also correlate with price but generally price followed changes in inventory. In the recent case, price led inventory changes.

The other important point about Figure 1 is that inventory additions and withdrawals are seasonal. A Spring and Summer “de-stocking” is normal. In that sense also, the recent withdrawals from storage say less about oil supply than they do about northern hemisphere summer driving demand and the end of regularly scheduled refinery maintenance in the U.S. Related: OPEC Struggling To Keep Up The Pace In Oil Price War

Falling U.S. rig counts have been the main hope for a drop in U.S. oil production that might help balance the global market. This appears to have ended as shown in Figure 2 below.

Art2

Figure 2. Tight oil horizontal rig counts for key tight oil plays. Source: Baker Hughes and Labyrinth Consulting Services, Inc.

(click to enlarge image)

The Bakken rig count has stabilized between 78 and 80 rigs over the last month. Decreases in the Niobrara rig count ended at 28 in mid-April and it has been steady at 30 rigs for the last 3 weeks. The Eagle Ford play reached its low in early May at 102 and has been at 104 rigs for the last two weeks. The Permian trend remains lower although one rig was added last week for a total of 172 horizontal rigs. In many ways, these rig count trends reflect the economic attractiveness of the plays.

It is true that these rig counts remain substantially below 2014 highs and the lag from spud date to first production is about 5 months in the Bakken and 3 months in the other plays. In other words, the effects of lower rig counts have not yet been reflected in current production data which lags about 3 months itself. Published EIA production for February and April is an estimate. Related: Why Shale Gas Producers Could Rebound First

The third pillar of hope for decreased U.S. oil supply has been growth in demand because of low price. That support remains strong as March vehicle miles traveled data indicates the highest gasoline demand since 2007, just before the Financial Crisis began.

The recent 35% increase in WTI and 40% increase in Brent prices is based more on sentiment than real evidence and I expect that prices will fall unless tangible data appears to support present prices. A geopolitical risk premium or an OPEC production cut in early June would constitute a “hard” reason for higher prices.

Present data, however, suggests that the global over-supply has gotten worse, not better, that overall demand for liquids remains weak, and the world economic outlook is discouraging. At the same time, market movements are not always based on fundamentals. In the long run, however, fundamentals rule so I maintain my view that the current price surge is at best premature.

By Art Berman for Oilprice.com

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  • Karl Yong on May 25 2015 said:
    Firstly, Oil demand and price is not merely dependent on US Market.
    Secondly, despite all the claim that we are floating in oil, China requested increment of oil from Saudi, they can't.
    Thirdly, Middle East war situation will spread and only guess worse, another legacy issue created and left by US. It will be interesting when the situation spread into Iran and Saudi, even then I guessed the contributor will still maintain his view.
    Finally, does investment banks and experts like the contributor suffer anything giving constantly wrong advise? Of course nothing! Don't it remind investors of the expert advise and rating given by experts or industry authorities during the CDOs era?
    Since he is such an expert, he must know a significant of the oil reserve, even though booked in, the oil still in the well. By the way, he also failed to mention that looming interest rate increase will be severely damaging to the capital intensive shales companies.
    Article like this is extremely misleading as it doesn't present his argument with all the facts. Intention? Please the livelihood of those workers in the shale companies a thought. It is not big secret certain Hedge Funds and Investment Bank are shorting oil.....
  • Rick on May 25 2015 said:
    Art, I'm confused. You guys say US production increased, and is still increasing, when state published numbers show significant decreases. Texas and North Dakota look like they peaked in December. Last Wednesday, a story from Reuters reported that Saudi Arabia declined a request from China for an increase in shipments.

    Yet this is your second article bemoaning that the world is awash in oil. Fundamentals are weak. Demand is weak and getting weaker. The stock build you mention is largely from imports, Brecken wrote about it on this website. Maybe you should read that one.
  • Rushabh shah on May 25 2015 said:
    I believe the market overshot to the downside based on psycology more than fundamentals, so the recent surge in prices is probably just reflecting that. Also David Hughs pointed out that drilling in areas such as the Bakken have to have at least 1500 wells drilled per year just in order to maintain production. They are well below that as you pointed out in your article " We Are Witnessing A Fudamental Change In The Oil Sector". Due to the significant drop off in production of these shale wells it seems to me that production most likely is already declining faster than the EIA data suggest. So there could be a large increase in oil prices due to the unexpected drop off in supply that the market did not expect. The market has never before had experience with unconventional oil production on, including the EIA. Therefore it seems probable that the EIA forecast models are incorrect. In the long run however we must remember that conventional oil production has already peaked out. Oil prices will have no choice but to rise due to increasing extraction costs.
  • Charles on May 25 2015 said:
    So does that mean we should not buy energy companies ?
  • SweetCrudeOil.com on May 25 2015 said:
    Karl, how do you know there are looming interest rate increases. (Funny, my captcha word here now is "oil").
  • Len B on May 26 2015 said:
    With all due respect the rise in price has more to do with $$$ fall AND the fact that ALL of the bear opinions from inventory over flow to demand collapse to production ramp continuing have been proven 100% false.....the media propaganda which drove prices to levels unsupportive to current prod levels got reversed.
  • joe rice on May 26 2015 said:
    I got an idea.. how about only let the real supply and demand set the price and not banks like Goldman Sachs who artificially inflate the demand by treating the oil markets like drunken sailors at the black jack table...The idea that a bank can influence the price of a commodity dictating the entire stability of the economy is assenine. Only allow real buyers and sellers in the market and not gambling attic speculaters(which make up 80% of the markets) and look for any reason to bet the price up...
  • Irven liu on June 23 2015 said:
    You are totally wrong.
  • ferdi on May 07 2016 said:
    1. The decreased rigs count will result in decreased production of shale oil
    2. Once the superficial oil has been extracted the deep shale oil is very expensive to extract, at least $70/barrel and its amount is limited
    3. The Iran and Libya oil are the two unknown quantities. Is Iran going to produce only 500,000 barrels a day or will it be able to go up to 4 millions? Will Libya political situation stabilize and will they flood the market with 1 or 2 million barrels a day?
    4. Oil consumption is increasing around 1 million barrels/day/year
    5. Will the concern about global warming push the nations to cut oil consumption and resort to new forms of energy?
    6. Last and least the Saudis manipulate the oil price by rising or decreasing output based on their economic and geopolitical interests. And this causes fluctuations in price.
    These are facts and questions. Of course there are other facts and questions. If you have no preconceived ideas you can see why it is difficult to make any predictions. My best guess for now is that Iran will not be able to build the infrastructures needing to produce oil, that the Saudis will continue to pump oil to destroy fracking and Iran, that oil consumption will continue to rise and the combination of all these factors will keep oil between $40 and $50 for a while. I am ready to change my mind if things change.

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