Bulls Optimistic, But Pitfalls For Oil Remain

Friday February 10, 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. 91% OPEC compliance, but Nigeria and Libya undermine deal

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- According to the latest data from S&P Global Platts, OPEC achieved a 91 percent compliance rate in January, exceeding market expectations.
- The seriousness from OPEC members is good news for oil prices, as the group cut more than 1 million barrels per day (mb/d), not far off from the 1.2 mb/d promise the group made at its November meeting.
- However, the efficacy of the deal is undermined by a few OPEC members. Libya has added 162,000 bpd since the deal was announced; Nigeria has added a more modest 12,000 bpd; and Iran has brought back 110,000 bpd.
- As such, the net OPEC cuts are closer to 800,000 bpd. Meanwhile, Libya and Nigeria, both of which are exempt from the deal, are planning to restore even more idled capacity.

2. Nigeria a major risk to oil prices

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- Nigeria's oil production fell sharply in 2016 because of attacks from groups like the Niger Delta Avengers. Output declined from a peak of 2.2 mb/d in 2015 down to a low point of 1.4 mb/d in the summer of 2016.
- Production has only improved modestly since then, rising to about 1.6 mb/d as of January.
- There are a lot of reasons why Nigeria could struggle to restore lost output, but the government has reinstituted an amnesty program for militants, paying them to lay down their arms. That could help improve security, allowing damaged pipelines and export terminals to come back online.
- The Forcados export terminal is one key piece of infrastructure. If it can be restored, its more than 200,000 bpd capacity could help Nigeria.
- But that could also upset the market, undermining the OPEC deal. Improved security in Nigeria could push down oil prices in 2017.
- Nigeria alone has 0.5 mb/d sitting on the sidelines because of militant attacks.

3. Refining no longer helping oil majors

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- BP (NYSE: BP) reported some disappointing earnings this week, weighed down by more charges related to the 2010 Deepwater Horizon disaster.
- But BP was also hurt by lower refining earnings, as margins shrunk in 2016. Since the collapse of oil prices in 2014, refining has been one of the few bright spots for the majors.
- But as 2016 wore on, margins narrowed. BP's downstream profit fell by 28 percent to $877 million.
- Oil prices are expected to trade higher this year compared to 2016, so upstream profits should improve just as refining earnings deteriorate.
- "Almost all of the majors have missed earnings estimates and the big theme for the quarter has been weaker refining," Brendan Warn, an analyst at BMO Capital Markets, told Bloomberg.

4. Dividends safe…probably

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- The oil majors reported disappointing earnings but also strike an optimistic note for 2017.
- Despite the losses and the worst full-year earnings reports in over a decade in some cases, cash flow improved for a handful of companies. Royal Dutch Shell (NYSE: RDS.A), the second most indebted oil company in the world, posted two consecutive quarters of positive cash flow and it even managed to lower its debt. The improved 2017 guidance suggests that worries over dividends are starting to pass.
- But dividend yields are still uncomfortably high, most notably for BP (NYSE: BP).
- BP revised up its expected breakeven oil price, a worrying sign for a company trying to get back on the growth path. Instead of needing $50 to $55 per barrel to breakeven, as BP said last year, it now needs $60 per barrel. The company's share price fell 4 percent on the news.
- As it stands, BP's dividend yield is at 7 percent, a sign that investors are skeptical that the British oil giant can keep dividend payments secure.

5. U.S. oil inventories surge

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- U.S. oil inventories increased by a near record 13.8 million barrels in the first week of February, taking stocks up close to an all-time high.
- The surge in inventories is a red flag for the oil market, suggesting oversupply problems, but there is an alternative explanation. OPEC ratcheted up production and exports in December just before their deal to cut output took effect in January.
- U.S. oil imports shot up by more than 1.1 mb/d in early February as OPEC barrels reached U.S. shores after several weeks in transit. The additional OPEC output in December is pushing up U.S. inventories today.
- U.S. crude stocks rose by 29 million barrels in the first month of 2017, compared to the 10-year average of less than 13 million barrels for that period.
- The implication is that the increase in crude inventories could be temporary - OPEC cut output in January by about 1 mb/d, so U.S. import levels should fall in the weeks ahead.

6. Refining runs higher than usual

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- One worrying sign for oil prices is the elevated levels of gasoline sitting in storage. At over 256 million barrels, gasoline stocks are above the five-year average for this time of year.
- Oil prices faltered in recent weeks on signs that U.S. gasoline demand was low. At the end of January the four-week gasoline demand figures dropped to 8.2 million barrels per day, the lowest figure in five years.
- But demand seems to have rebounded in February according to the latest EIA data.
- In fact, one reason that gasoline inventories are so high is because refineries are operating at higher-than-usual rates. Outages from refining maintenance is 160,000 bpd lower than the five-year average, according to Goldman Sachs.
- In other words, refiners are pumping more than expected, which pushed up inventories. That should dissipate in the coming weeks, and the resulting fall in inventories could help buoy crude oil prices.

7. Wall Street opens wallet again

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- The shale drilling boom was made possible by the flood of financing from Wall Street. The collapse of oil prices in 2014 sparked a contraction in credit and new equity issuance as the world of finance retreated from the sector.
- But in 2017, Wall Street could be back and bigger than ever. Bloomberg says that Wall Street is pouring the most money into U.S. energy firms since at least 2000.
- In January alone, energy companies raised $6.64 billion in new equity issuance. A larger-than-expected share - 22 percent - came from oilfield services companies, who have been hit the hardest from the downturn. Oilfield services companies are starting to profit from the uptick in drilling and are even commanding higher prices for their services.
- Much of the financing is pouring into the Permian Basin.

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