Have Oil Prices Hit The Sweet Spot?

Friday, June 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. Speculators held their breath ahead of OPEC meeting

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- Ahead of the OPEC meeting, speculators backed off trading, pausing to wait out the result. Both long and short positions fell to their lowest levels since January.
- OPEC meetings typically see large speculative movements, as traders position themselves to find a margin and exploit an expected price movement following the result of the group's decision.
- The calm ahead of the OPEC meeting on June 2 highlights the group's diminished importance for oil markets, as well as the market consensus that OPEC won't be able to agree on coordinated action.
- Also, the decline in speculation has occurred at a time of lower oil price volatility (which is not a coincidence). Oil prices have firmed up, scaring away speculative bets.
- "It's very clear that OPEC is less relevant than U.S. production data," Rob Thummel, a managing director and portfolio manager at Tortoise Capital Advisors LLC, told Bloomberg. "We're going to trade near $50, plus or minus five bucks, for quite a while."

2. Rig count bottomed out?

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- The U.S. oil rig count jumped by 9 for the week ending on June 3, the largest increase since December 2015.
- There is usually a three to four month lag between major movements in oil prices and the resulting effects on the rig count. The increase could be viewed as a response to the 85 percent rally in oil prices since February.
- But it was only when oil prices rose to the $40, $45, and $50 level that oil companies started to take notice. Citigroup calls oil trading at $50 to $70 a "sweet spot," that is, high enough to stimulate new drilling while not necessarily leading to drilling bonanza that might subsequently kill off the price recovery.
- The Permian Basin saw an uptick of 5 rigs last week, as West Texas offers some of the most profitable drilling at today's prices.
- But more drilling won't halt the production declines underway. The U.S. has already lost nearly 1 million barrels per day in output.

3. DUCs still high

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- The backlog of drilled but uncompleted wells (DUCs) as of early 2016 was very high, particularly in Texas, where there were well over 1,000 DUCs. Earlier this year Bloomberg Intelligence put the figure at over 4,000 across the country.
- The rise in oil prices to $50 per barrel raises the prospect that those wells will now be completed, bringing new supplies back online.
- DUCs could add 400,000 barrels per day in new production this year. A U.S. State Department official believes it could be as high as 500,000 barrels per day.
- Citigroup estimates that the DUC backlog will begin to get worked through at $50 per barrel. And at $60 per barrel, new drilling will start to pick up in earnest.
- One major problem facing oil producers and fracking crews is that the workforce has somewhat been dismantled, which may delay completions.

4. Contango shrinking

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- A market contango, in which front month oil futures trade at lower prices than contracts further off into the future, reflects concerns about near-term oversupply. In other words, traders are not very enthusiastic about buying oil today, relative to the future, because there is too much oil floating around.
- The contango widened to very sharp depths when oil prices crashed to multiyear lows, corresponding to moments when the markets grew acutely concerned about the glut.
- But the contango has nearly disappeared since March and April as short-term supply disruptions in Canada and Nigeria erased the global supply overhang.
- As Reuters notes, the markets have arrived back into balance, and the small contango of roughly $2 per barrel witnessed today is consistent with a relatively balanced market. Between 2005 and 2014, the average contango was $1.50 per barrel for WTI.

5. Gasoline demand hits new peak in U.S.

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- U.S. gasoline demand is already at a record high for this time of year, and is likely going to hit a new record high this summer. On an annualized basis, gasoline demand will likely break new highs in 2016 as well.
- Gasoline demand will rise to 9.5 million barrels per day in the second and third quarters of this year.
- That comes despite a very strong rally over the past three months. Even with oil prices up 85 percent since February, gasoline prices are still projected to be at their lowest levels in twelve years this summer.
- The exploding demand for gasoline comes after a record year for miles driven in the United States. In 2015, American motorists drove 3.148 trillion miles, destroying the 2007 record of 3.003 trillion miles according to the U.S. Department of Transportation. That is equivalent to 337 round trips from Earth to Pluto.

6. Iran offset by outages

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- Iran increased oil production by roughly 600,000 barrels per day since March, following the removal of international sanctions at the beginning of the year.
- If not for Iran's huge supply additions, the estimated unplanned outages from OPEC would be at their highest levels in years.
- There are at least 2.5 mb/d of supply outages from OPEC, according to the EIA, but that figure likely understates the problem. Nigeria has lost more than 1 mb/d, not the 0.75 mb/d estimated by the EIA. The chart also doesn't account for Venezuela's depleting production, which may not technically be categorized as an "outage," but is falling nonetheless. Venezuela's output is down by nearly a hundred thousand barrels per day, with more declines expected. Other countries are also seeing production decline.
- Other chronic outages come from Libya (~1 mb/d), while Iraq, Kuwait, and Saudi Arabia each have several hundred thousand barrels per day offline.
- The outages come as Canada (not an OPEC country) lost more than 1 mb/d for several weeks.
- All told, the world has more than 3 mb/d of oil supply unexpected offline, which appears to be enough to zero out the global surplus. Canada's production is coming back online, but there is little prospect of any solution to the OPEC outages.

7. Natural gas breakeven prices have increased

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- The breakeven price for natural gas, unlike for oil, has climbed over the past two years.
- That largely comes down to the collapse in oil prices, which has cut the revenues for associated gas and natural gas liquids, such as ethane and liquid petroleum gas. 
- Also, creditors have raised the cost of finance because of lower returns and the heightened risk of default. The most indebted companies have been entirely shut out of credit markets.
- Suppliers and oilfield service companies have cut their rates, however, helping natural gas economics. 
- But altogether, the average breakeven price for a typical natural gas well in the northeast U.S. has jumped from $1 per million Btu in 2014 to above $2/MMBtu in 2016. That will improve as oil prices rise, but it is unclear if the economics will go back to the glory days of 2014.

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