U.S. Oil Data Has Markets Confused

The oil market continues to stagger forward without direction, and the EIA data is offering little clarity.

Just last week, the EIA reported a sharp build up in crude oil inventories, raising concerns about over supply. But inventories have seesawed back and forth for much of this summer, muddying the waters for analysts. Just this week, the agency reported a huge drawdown in stocks, restoring some bullish sentiment, and helping to push oil prices up more than $2 per barrel on Wednesday.

"One of the signs of a bullish market, in our view, is that prices prove resilient to highly bearish data, and can surge on moderate improvements," Standard Chartered wrote in a note. "The oil market currently fits that description; prices recovered from last week's extremely bearish data, and have risen on more encouraging signs this week." The investment bank publishes a "bull-bear index" each week, factoring in the reams of data that come out of the EIA. Last week's index hit "-100," or the weakest result in years.

This week, the index jumped to -28.5, not bullish by any means, but a sharp improvement from last week.

The crude inventory decline of 5.8 million barrels is the first thing that jumps out from the EIA report. The drawdown was sharper than analysts had predicted, and came a week after a huge 6.8-million-barrel increase.

Last week's jump in inventories corresponded with a flood of imports. Similarly, the sharp inventory decline in the most recent data is largely the result of a steep drop in imports at a time when refineries continued to run at elevated levels.

That meant that lots of crude oil was taken out of inventory and processed into refined products. It's no surprise then that gasoline stocks rose, and the build was counter-seasonal, which pushed gasoline stocks above the five-year average. But analysts aren't concerned that this is a bearish signal. "We expect the refinery maintenance season to begin soon, correcting product oversupply," Standard Chartered wrote in a note. Related: Oil Rallies, But This Country Can't Sell Its Crude

Oil production rose again, pushing U.S. output back up to 11 million barrels per day (mb/d). However, the EIA's new practice of rounding off production figures to the nearest 100,000 bpd makes it tricky to discern production trends. The latest data suggests that there was an uptick in output from Alaska, not necessarily from U.S. shale in the Lower-48.

In fact, problems in the Permian are likely to act as a drag on growth for the near future. Pipeline bottlenecks are compounded by a strain on services, equipment and labor, forcing some shale drillers to pivot away from West Texas to other shale basins. In fact, data from S&P Global Platts finds that the Permian is no longer the most profitable shale basin in the country. Permian returns have fallen below that of the Bakken and even the Eagle Ford and the STACK. The drilling frenzy continues but the profits might not be what companies expected.

Meanwhile, a lot of shale companies have locked themselves into hedges anyway. Much of this year's hedged production was secured last year when oil prices were lower. So even if the Permian discounts had not

"Current hedged prices of $60/bbl for 2019 are slightly below oil strip prices of ~$63/bbl for 2019. While this may provide some level of restraint (in addition to greater focus on capital discipline) to ramping activity…E&Ps on average raised their 2018 capital budgets by 7% on average with 2Q results," Goldman Sachs wrote in a note. Related: Chinese Oil Futures Remain High-Risk Endeavour

Higher spending levels may not translate into more production this year. In fact, investors are groaning on news that shale companies are boosting spending without much to show for it. But it may just be a case of delayed gratification. Pipeline bottlenecks in the Permian are leading to deferred completions. A massive backlog of drilled but uncompleted wells (DUCs) continues to grow, particularly in West Texas. There is no sense in bringing that output online only to sell it at a steep discount. As such, drillers are delaying completion, even as they continue to ramp up operations.

Some companies, such as Pioneer Natural Resources, continue to add rigs to the Permian, and have announced spending increases. But the production that stems from the increase in activity may not show up in the data until next year.

This dynamic has global implications. U.S. shale continues to grow, but it is likely to suffer from a lull in growth for the next year or so. The supply story, then, is arguably a bullish one, at least for the next 12 months or so: U.S. shale is slowing down at a time when Iran's supply could be disrupted, Venezuela's production continues to fall, and output in places like Nigeria and Libya is unstable. The demand side of the equation is a whole different story, to be sure, and a major reason why oil prices have declined this summer.

But in the near term, U.S. shale might end up being a bullish factor if it undershoots expectations.

By Nick Cunningham of Oilprice.com

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