A New Era In The Oil Industry

Friday November 3, 2017

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Oil majors covering dividends

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- BP (NYSE: BP) posted about $1.8 billion in earnings in the third quarter, twice as much as the same quarter in 2016.
- The results allowed the British oil giant to cover both its spending and its dividends with cash flow, a remarkable turnaround from the company that was piling on debt for much of the past three years.
- BP says it can breakeven at roughly $47 per barrel. It also announced an end of its scrip dividend program, as well as the introduction of share buybacks as a way of rewarding investors.
- Other oil majors posted similar numbers - many of them are able, or close to being able, to cover their dividends with cash flow.

2. Anadarko offers a way forward

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- Growing oil production as fast as possible is out, and giving your extra cash to shareholders is in. Anadarko Petroleum (NYSE: APC) announced in September that it would spend $2.5 billion on share buybacks, which led to a spike in its share price.
- That puts Anadarko at "the vanguard" of shale companies who are focusing on a shift in strategy "from growth to value," as Bloomberg Gadfly frames it.
- Production growth has been the key metric for the shale industry for years. The faster one could grow, the more Wall Street rewarded the company's stock.
- Anadarko's CEO said this week that oil production growth is the consequence of its capital-planning process, not the target upon which it bases its spending plans. This is a significant shift in thinking.
- Anadarko will also weigh changes in executive compensation, another issue that will force companies to emphasize profits over growth.

3. WTI at backwardation

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- Brent crude has made headlines in recent months with its shift towards backwardation in the futures market, a situation in which near-term oil contracts trade at a higher price than contracts dated further out into the future.
- Backwardation is a sign of market tightening. The gist is that oil is more precious in the near-term, and the lower price in the future makes storage unprofitable, so it also foreshadows more inventory drawdowns. Lower prices in a year's time also prevents shale companies from locking in hedges.
- WTI has been stuck in contango - the opposite of backwardation - for a long time. However, some parts of the WTI curve recently opened up into a state of backwardation as well.
- Because the U.S. had such a high level of inventories, WTI futures have been lagging behind Brent. The shift to backwardation for WTI is a very strong signal that the oil market is progressing towards rebalance, and that there is some room for higher prices.

4. Wind and solar undercutting nuclear and coal

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- Wind and solar have been cutting into the business case for coal and nuclear for quite a while. And the fact that renewable energy has captured the lion's share of new electricity capacity additions for the past few years is proof that clean energy can compete - and win - in today's market. That cost parity was reached a few years ago in lots of geographic areas in the U.S.
- But the threat to coal and nuclear is mounting. According to Lazard Ltd., new wind and solar projects are starting to outcompete existing coal and nuclear plants. That is an eye-popping conclusion given that already-built coal and nuclear plants have been the backbone of U.S. electricity for decades.
- Lazard says building and operating a new utility-scale wind or solar farm can have lifetime costs of between $30 and $60 per megawatt-hour. Or $14/MWh if subsidies are included.
- But coal can cost $26 to $39 per MWh just to operate. Nuclear costs $25 to $32 per MWh.

5. Gasoline stocks draining at rapid clip

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- Demand is very strong and OPEC has successfully restrained output close to its 1.2 mb/d target for much of this year. While it was difficult to see in the first half of the year, 2017 is turning out to be a turning point for the oil market.
- Inventories are draining at a quick pace, helping to erase in imbalances and bolster crude oil prices.
- Gasoline inventories have declined by more than 23 million barrels in the U.S. so far in 2017, twice the 12 million-barrel average for this point in the year, according to Reuters.
- The market for refined products has tightened, which has boosted refining margins. That means refiners will step up their operations, which, in turn, will draw down on crude stocks.

6. Investors are confident in crude

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- Falling inventories, stronger demand, geopolitical tension and the high likelihood of an OPEC extension at the November 30 meeting - this all points to bullishness in the oil market.
- Hedge funds and other money managers staked out the largest long positioning in months at the end of October, while also keeping their short bets in check.
- That has corresponded with Brent moving above $60 per barrel, and WTI edging closer to $55.
- But higher prices also raise the risk of profit-taking, which exposes crude prices to a correction on the downside.
- On top of that, we are entering a time of year when demand dips a bit - peak driving season is behind us and winter demand has yet to kick in. "November has a history of being very, very cruel to these markets," Tom Kloza, global head of energy analysis at Oil Price Information Service, told CNBC.

7. Saudi cedes U.S. market to Iraq

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- Saudi Arabia has deliberately tried to cut crude oil exports to the U.S. as a way of trying to accelerate U.S. inventory drawdowns. The logic is that the U.S. has the most transparent oil inventory data, and because of that, it has outsized influence on prices.
- But oil is fungible, and cutting exports to the U.S. was always going to lead to someone else stepping into the void. Saudi oil exports to the U.S. dropped from 1.2 million barrels per day in the first half of 2017 to about half that amount currently.
- Iraq has taken the opportunity to step up oil shipments to the U.S., averaging 600,000 bpd this year, up 50 percent from 2016 and three times as high as 2015 levels, as Bloomberg Gadfly points out.
- As a result, Iraq has temporarily surpassed Saudi Arabia in terms of the amount of oil shipped to the U.S.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.