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Euan Mearns

Euan Mearns

"Euan Mearns is a geologist and geochemist. In recent years he was a principal at The Oil Drum, the worlds leading energy blog, until it…

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This Is Why $20 Oil Is A Possibility

This Is Why $20 Oil Is A Possibility

The day of reckoning has arrived for the oil price with the head and shoulders pattern I have been tracking for two months finally being completed in recent weeks. It became a rather drawn out affair with markets awaiting the outcome of the OPEC meeting of 4 December where OPEC elected to stay the course and do nothing. With WTI closing at $40 and Brent on $43 on Friday both are testing support levels. WTI in particular has had strong support at $40 in recent weeks. Should this support be broken then another major down leg is to be expected to the vicinity of $20. I can see nothing in the numbers presented below to provide hope that $40 may hold. The market remains over-supplied and awash in oil. Lower price is required to remove supply from the market.

- World total liquids production up 240,000 bpd to 97.09 Mbpd, a new record high.
- OPEC production down 20,000 bpd to 31.72 Mbpd (C+C)
- N America production up 260,000 bpd to 19.66 Mbpd.
- Russia and FSU up 90,000 bpd to 14.01 Mbpd
- Europe down 10,000 bpd to 3.40 Mbpd (compared with October 2014)
- Asia down 50,000 bpd to 7.99 Mbpd.
- Middle East rig count is rising. The international oil rig count is stable. The US oil rig count is falling.

Figure 1 The oil price has trended down this month in a saw tooth pattern to support levels and to complete the head and shoulders pattern. Friday’s close was just above the near term lows of $38.22 for WTI and $41.59 for Brent, both on August 24th. If these lows are broken traders and companies should be prepared for a plunge.

The October 2015 Vital Statistics are here. EIA oil price and Baker Hughes rig count charts are updated to the beginning of December 2015, the remaining oil production charts are updated to October 2015 using the IEA OMR data.

Figure 2 The bigger picture shows how the second shoulder has already breached the long-term trend line and the chart appears to be very bearish. Chart patterns alone do not tell the whole story, but it is difficult to find ANY near term bullish indicators in the production and rig count data.

Figure 3 The US oil rig count has resumed its fall but at a lower pace than the plunge post-October 2014. The blip represents 675 rigs on 28 August and has since fallen to 545 oil rigs on 4th December, a fall of 130 rigs in 14 weeks. At this rate the 200 count will arrive in 38 weeks, sometime in September 2016. A fresh plunge in the oil price may accelerate this process. 545 rigs still drilling, used to drill better wells in sweet spots, is sufficient to substantially offset declines which is why US production is trending down only slowly. In my analysis of US Shale Oil: drilling productivity and decline rates (June 2015) I forecast that LTO production would fall 830,000 bpd with about 630 rigs drilling. The fall in US production so far has been 540,000 bpd. A large backlog of drilled and uncompleted wells complicates this picture.

Figure 4 This expanded scale shows that the rate of decline in US oil directed drilling is muted compared with the big drop seen earlier this year. Gas drilling has flat lined at around 200 units. The total rig count was 737 on 4 December compared with a post-crash low of 876 seen on 20 June 2009. Hence, the current drilling slump is already worse than the post-crash slump and there is no respite in sight. Related: Why Is The U.S. Reluctant To Bomb ISIS Oil Fields?

Figure 5 The near-term peak in US production was 13.24 Mbpd in April 2015. The October figure was 12.70 Mbpd, down 540,000 bpd from that peak. US oil production has been amazingly resilient in the face of the collapse in drilling. In recent post, Art Berman points out The Problem With Oil Prices Is That They Are Not Low Enough. And that’s why I believe that another plunge in the oil price is required to thrust a dagger through the heart of US shale drillers and the banks that have supported them. To be clear, low oil prices are wonderful for the US economy and a nightmare for OPEC.

Figure 6 OPEC production stands at 31.72 Mbpd down 20,000 bpd on September which is effectively unchanged. This level was first attained in the summer of 2008, at the end of the great energy squeeze in the lead up to the financial crash. This appears to define a plateau level in OPEC production. There has been very little action in the OPEC producers, all pumping flat out, pouring gasoline on the bonfire of oil wealth destruction. Iran is waiting in the wings to introduce a further 720,000 bpd (IEA) when / if sanctions are lifted early 2016.

Figure 7 OPEC booked spare production capacity stands at 3.18 Mbpd with 2.01 in Saudi, 0.72 in Iran and 0.45 in the rest. One has to be skeptical about Saudi Arabia’s 2 Mbpd and OPEC, with the exception of Iran, is pumping flat out. There is of course degraded and unused capacity in Libya.

Figure 8 In October Saudi production rose by 50,000 bpd to 10.23 Mbpd. NZ = neutral zone which is neutral territory that lies between Saudi Arabia and Kuwait where production from the Wafra heavy oil field is now effectively zero. Related: Eni Could Prove Mexico’s Energy Reform Successful

Figure 9 The ME OPEC oil rig count is on a rising trend with operational cycles superimposed. In October, ME OPEC rig count began inching up once more with the main action in UAE that added 8 oil rigs. This is a sure sign that ME OPEC are pumping at capacity and need to drill new wells to cancel declines and to maintain plateau production. This also underlines the determination of the big ME OPEC producers to maintain production levels that is BAD news for the OECD producers and Russia.

Figure 10 The international oil rig count has been stable for 6 months. Total international rigs are down 17 to 854. This number is still substantially above the 2008 peak of 832 units (dashed line). While the international oil industry is racking up huge losses, the level of drilling activity still exceeds the previous high of 7 years ago. I suspect that the pause in the fall will shortly reverse as it did in the USA and we will see many more rigs layed up in the first half of 2016.

Figure 11 Russia and other FSU produced 14.01 Mbpd in October, up 90,000 bpd on September but little changed for 3 years.

Figure 12 The cycles in European production data are down to summer maintenance programs in the offshore North Sea province. To get an idea of trend it is necessary to compare production with the same month a year ago. The dashed line shows that European production has been essentially flat for three years. The post-peak declines have been arrested. Compared with Oct 2014, European production is down 10,000 bpd to 3.4 Mbpd. Declining North Sea production was one of the drivers behind the rise in oil prices since 2002. Arresting and reversing those declines has removed that driver.

- Norway Oct 2014 = 1.93 Mbpd; Oct 2015 = 1.91 Mbpd; down 20,000 bpd YOY
- UK Oct 2014 = 0.88 Mbpd; Oct 2015 = 0.95 Mbpd; up 70,000 bpd YOY
- Other Oct 2014 = 0.60 Mbpd; Oct 2015 = 0.54 Mbpd; down 60,000 bpd YOY

Figure 13 This group of S and E Asian producers has been trending sideways since 2010. The group produced 7.99 Mbpd in October, down 50,000 bpd on the revised September figure. Related: Why Is The U.S. Reluctant To Bomb ISIS Oil Fields?


Figure 14 N American production looks like it topped in April at 20.12 Mbpd:

- USA Sep 2015 12.73 Mbpd; Oct 2015 12.70 Mbpd; down 30,000 bpd
- Canada Sep 2015 4.08 Mbpd; Oct 2015 4.35 Mbpd; up 270,000 bpd
- Mexico Sep 2015 2.59 Mbpd; Oct 2015 2.61 Mbpd; up 20,000 bpd

Group production up 260,000 bpd from September to 19.66 Mbpd in October. Group production down 460,000 bpd from the April peak. Canadian production dipped in September but bounced back in October.

Figure 15 Total liquids = crude oil + condensate + natural gas liquids + refinery gains + biofuel. October production was 97.09 Mbpd up 510,000 bpd on the revised September figure. The October figure sets a new global production record, up 10,000 bpd on the prior July 2015 high. Global production remains 3 Mbpd above the 2004-15 trendline and has a long way to fall to restore balance to the market.

Figure 16 This great chart from Art Berman brings it all together. The oil price crash is simply explained by supply and demand. What we are witnessing is “unprecedented” over supply. Huge supply growth momentum was built during the era of record high price that also acted as a drag on the global economy. Low price will at some point result in the situation reversing and the price will turn very quickly. Predicting when that will happen is gold dust. But before that can happen, the production momentum needs to be switched off and I dare say that requires sharply lower oil price in the near term.

Concluding Comments

After a year of “Oil Price Crash” in October the world managed record production of 97.09 Mbpd. Production momentum built in the period of high price, 2007 to 2014, is proving very difficult to switch off. It must be switched off and it seems to me the most likely scenario is sharply lower oil price in the near term. The geo-political backdrop also has mounting hazards and uncertainty with the USA, Russia, The UK, France and Germany all operating in the same combat arena, chasing a phantom menace.

By Euan Mearns

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Leave a comment
  • Robkep on December 08 2015 said:
    This article has several great charts, but i still have no idea why the author believes that $20 is possible. A dozen charts have been thrown up showing oversupply, without any talk about hedges, half cycle breakeven costs, increasing demand, incentives for storing oil should it drop another 10-15%, or the fact that u.s. drillers have been focusing on the sweet spots as of late (part of the reason production is steady while the rig count is very low). The article abruptly moves from a chart trend discussion to comments from an oil expert regarding price. I respect the hell out of art berman, but I've watched many of his presentations and he always provides a "disclaimer" that he's not an expert on pricing, and doesn't make price projections. He's an amazing geologist, but not a price analyst.
  • Lee Irvin on December 11 2015 said:
    Oh I can see why $20 a barrel is possible. It's called Karma. Big oil squeezed the America public for every greedy cent they could get, thanks to American's Oil Administration. Now that the fox isn't guarding the oil house…$20 per barrel oil. I hope it goes to $10.

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