Bad News For Floating Storage As The Supply Glut Appears To Ease

Friday, March 25, 2016

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. Canadian dollar rebounds against U.S. dollar

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- Currencies from oil-producing countries, including Canada, suffered substantial losses in value in 2015, touching lows earlier this year as the crash in crude prices deepened.
- Not only were the economies of oil exporters deteriorating, but the pending interest rate hikes from the U.S. Federal Reserve also pushed down international currencies relative to the U.S. dollar.
- Since oil prices bounced off of their January lows, however, currencies from commodity exporters have also rebounded. Oil prices surged by 50 percent since early February, lifting an array of currencies.
- Additionally, the Federal Reserve has taken a more dovish stance on interest rates recently, putting downward pressure on the U.S. dollar.
- The Canadian dollar rose to 77 cents to the greenback on March 17, the highest level since October.

2. U.S. oil increasingly comes from shale

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- The U.S. is quickly becoming a predominantly shale oil and gas producer, compared to production coming disproportionately from conventional sources in the past.
- In 2015, roughly 48 percent of oil production came from wells drilled within the previous two years. That is up from a 22 percent share in 2007. Relatedly, about 50 percent of total U.S. oil production came from shale in 2015.
- Shale oil production increased from 0.5 million barrels per day (mb/d) in 2009 to 4.6 mb/d in 2015.
- Shale drilling is a "short-cycle" event - quick to ramp up and down. Production falls off quickly, so now that the U.S. leans more on shale, continuous drilling will need to proceed at a steady pace to keep production from falling.

3. Floating storage not profitable

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- One of the trends that developed during the oil price downturn was storing oil at sea. The business case hinged on a market "contango," in which front-month contracts were cheaper than oil delivered at some point in the future.
- For floating storage to work, oil prices for immediate delivery had to be several dollars per barrel cheaper than oil futures for delivery six or twelve months out, a discount wide enough to cover the cost of storage.
- Bloomberg concludes that floating storage is a losing proposition, and increasingly so. A trader that puts 2 million barrels in a tanker for six months beginning in March would lose $7.6 million on the trade, a loss that is twice as large as it would have been in February.
- The front-month to seven-month futures gap shrank to just $2.79 per barrel this week, down from the $5.07 per barrel gap seen at the end of January.
- There are two developments behind this trend: rising cost of renting an oil tanker, and also the shrinking contango. The latter phenomenon suggests that the near-term glut is easing, or at least that is how the markets are seeing it.

4. Natural gas prices plunge, to coal's detriment

- Natural gas prices in the U.S. have plunged below $1.90 per million Btu in 2016, bouncing around lows not seen in more than a decade and a half.
- Natural gas competes with coal in the electric-power sector in the U.S., and has been a major factor in coal's demise.
- Prices are especially low now because of near record production levels and inventories are 36 percent above the five-year average for this time of year.
- Natural gas is now cheaper than coal on a kilowatt-hour basis (see FT chart above). The last time that occurred was in 2012. Coal is expected to capture a smaller market share than natural gas in the U.S. electric power sector in 2016 for the first time.

5. Oil field decline rates to exceed new sources of supply

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- Using data from Rystad Energy, Bloomberg put together the chart above, which details the coming oil supply deficit in 2017, 2018, and beyond.
- Oil fields have always suffered from natural decline as they age. The world loses several million barrels per day in production every year due to depletion. New fields must be brought online to make up for the shortfall.
- But low oil prices have hollowed out upstream investment. In 2016, the world will lose 3.3 mb/d to depletion, while only 3 mb/d will come online from new sources.
- The deficit widens in the years ahead, ballooning to 1.2 mb/d in 2017. Oil prices could spike in several years due to decisions by companies today to defer investment.
- The IEA agrees. "There's danger as we are reaching a point where we are barely investing upstream. If investment doesn't resume in 2017 and 2018, we can see a spike in oil prices as oil supply can't meet demand," the IEA's head of Oil Industry and Markets Division, Neil Atkinson, said in Singapore on March 23.

6. Renewables overtaking fossil fuels in electric power sector

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- Wind led the U.S. electricity market last year in terms of new additions, adding more than 8 gigawatts of new capacity. Wind accounted for 41 percent of new additions, with natural gas capturing 30 percent, and solar surging to take 26 percent of the market.
- Wind doubled its capacity from 2014. And those figures were up from the dismal year in 2013 when the industry came to a standstill following the expiration of the production tax credit (PTC). With tax credits now secured through the end of the decade, renewable energy is set to take off.

- Texas, the wind powerhouse of the U.S., accounted for 42 percent of the 8 GW of wind installations in 2015.
- California, on the other hand, leads the nation in solar. In 2015, California added more than 1 GW of utility-scale solar and also, more impressively, around 1 GW of rooftop solar. The Golden State accounted for 42 percent of solar additions last year.
- 2016 promises to be even better for renewables. Wind will dip a bit to 6.8 GW, but solar more than makes up for it with an expected 9.5 GW of new installations. That is enough for clean energy to capture more than 60 percent of the expected 26 GW of new electric power capacity additions in 2016.

7. Junk bonds increasingly correlated with oil prices

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- The high-yield market increasingly reflects the fortunes of oil, oil prices, and energy companies with junk ratings.
- The correlation between the yield on energy junk bonds and oil prices is at a record high, according to Bloomberg. But the correlation is not necessarily justified - 88 percent of the high-yield market is not in the energy sector. Non-energy junk bonds have rallied with oil prices, but could be due for a correction, and the current correlation with oil prices probably won't last.
- Defaults from energy companies are indeed rising, and energy bonds have lost more than $150 billion in value since 2014.
- But high-yield investors have become too focused on oil. The fate of other junk bonds has much more to do with macroeconomic factors - particularly GDP growth and policy changes from the U.S. Federal Reserve - than it does with oil.

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