Fundamentals Point To Higher Oil Prices…But is that Enough?

Friday, June 17, 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. A repeat of 2015 oil price rally?

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- In 2015 oil prices rallied in the first half of the year only to fall back again. There are concerns that this year's rally could run out of steam too.
- The 2016 oil price rally has lasted longer than the 2015 rally, 140 days in counting vs. the 2015 total of 112 days.
- Oil prices gained 19 cents per day on average during the 2015 rally, similar to the 18 cents/day rally on average this year.
- The fear is that speculators, once again, have bid up prices higher than is justified. The supply outage in Canada is temporary, so more production will start coming back online. Plus the rig count in the U.S. has ticked up and companies will start working through the backlog of drilled but uncompleted wells.
- Prices are on much sounder footing in 2016 compared to last year as the fundamentals look much stronger. But there is no guarantee the rally will persist.

2. Oil speculators pause as rig count rises

- Speculators backed off their bullish positions for the week ending on June 7. Two consecutive weeks of rig count increases raised the prospect of new drilling, pushing down oil prices and scaring some oil bulls away.
- Short bets on WTI rose by 24,324 futures and options, the largest percentage gain in 11 months. Long bets only rose by 17,065 contracts, meaning that the overall net-long position fell by 3 percent.
- Oil has climbed 90 percent since February, and hedge funds and major money managers are starting to wonder if the rally could run out of steam, especially if new drilling picks up in the $50s per barrel.
- "Everyone is questioning the price when U.S. rigs come back," Paul Sankey, an energy analyst at Wolfe Research LLC, said June 10 on Bloomberg Radio. "At $55-to-$60 we would return to growth in the U.S."

3. China's oil production falling

- China's oil production fell by 7.3 percent in May from year ago levels. That is the largest decline in over 15 years.
- China's top state-owned oil companies such as CNPC, Cnooc and Sinopec have slashed spending because of low oil prices.
- Output in the first quarter fell by about 150,000 barrels per day, but the declines appear to be picking up pace. Earlier this year PetroChina, a subsidiary of CNPC, said it would shutter wells that have "no hope" of being profitable.
- Overall, analysts had projected that China's oil production would fall by a little more than 5 percent this year, a projection that could be understated if the current pace of decline continues. Any fall in output is bullish for the global market.
- "Lower domestic oil production means that China will rely more and more on imports from Middle East and Russia," said Gordon Kwan of Nomura Holdings in Hong Kong in an interview with Bloomberg.

4. Global electricity demand from electric vehicles skyrockets

- The rapid rise of electric vehicles beginning in the next decade through 2040 could add 2,700 TWh of electricity demand annually in 2040, or roughly 8 percent of total demand worldwide.
- This will offset energy efficiency measures and throw a lifeline to embattled utilities and power generators who could see demand fall in industrialized countries.
- The costs for battery technology is expected to fall 76 percent, helping to make EVs competitive with the internal combustion engine.
- EVs will make up about 35 percent of all new light-duty vehicle sales in 2040, according to a new assessment from Bloomberg New Energy Finance.

5. Electricity generation increasingly clean

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- In addition to a rise in EVs, Bloomberg New Energy Finance finds that those EVs will be recharging with increasingly clean electricity.
- BNEF finds that electricity will reach "peak fossil fuels" in 2025. Thereafter, global electricity markets will begin to shed generation from coal, gas and oil.
- Solar and wind takeover. Renewables attract $7.8 trillion in investment through 2040. Fossil fuels will only attract $2.1 trillion. Even more jaw-dropping is BNEF's projection that solar, by itself, will attract $3.4 trillion in new investment over the next 25 years, beating the entire fossil fuel industry.
- By the middle of the next decade solar and wind will be cheaper than even existing coal and gas power plants, forcing a growing number of them to shut down. In other words, the middle of the 2020s is a tipping point, after which the declining market share for fossil fuels starts to accelerate.

6. Oil storage levels no longer growing

- The growth in oil storage levels to record highs has threatened to keep prices depressed for an extended period of time.
- Storage levels have finally begun to drawdown. In May, inventories fell by 8 million barrels after building by 19 million barrels on average for January and February and 12 million barrels on average for March and April.
- At 532 million barrels as of early June, U.S. crude stocks are still near 80-year highs.
- Across the whole OECD, oil and refined product stocks rose slightly to 3,046 million barrels in April, or about 338 million barrels above the five-year average. That equates to about 66.4 days of supply, 7.1 days higher than the five-year average.

7. OPEC holds onto market share

- Analysts differ over the wisdom of OPEC's strategy to pursue market share, given the huge hole in the budgets of most OPEC members because of collapsing oil revenue.
- But the strategy has largely succeeded in achieving one key objective: OPEC has indeed held onto market share at the expensive of non-OPEC countries.
- As of May 2016, OPEC captured 34.2 percent of the global oil market, up 1.8 percentage points from the 32.4 percent that it held in November 2014 when it first embarked on this strategy. And that rising share comes even as the global market has grown by nearly 2 million barrels per day over that timeframe.
- Despite the confidence from the U.S. shale industry as well as from countless headlines talking about the death of OPEC, the cartel has held onto its market share while U.S. oil production has declined almost 900,000 barrels since last year.
- OPEC may have inflicted damage on its own members, but it dealt a bigger blow to the shale boom.

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