High Diesel Demand Could Cause An Oil Price Spike

Friday September 29, 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. More light oil, less heavy oil

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- The uptick in oil production since March 2017 has come largely from lighter forms of oil, more than offsetting declines in medium and heavier oils, according to the EIA.
- This is the result of a rise in shale production at a time when OPEC is cutting back. But outages and declines in Mexico, Canada and Venezuela have also taken heavier barrels off of the market, while production increases in Libya and Nigeria have added new lighter barrels to global supply.
- Lighter oil typically trades at a premium to heavier oil, but the increase in supply of lighter oil and the cutbacks in heavier oil have led to a narrowing of the price spreads between them.
- The premium for Louisiana Light Sweet (LLS) over heavy Maya has declined significantly from $9 per barrel in March to just $5 per barrel in August. Similarly, WTI's $13 premium to Western Canadian Select has narrowed to $10 per barrel over the same timeframe.

2. EVs beat oil-fueled cars on maintenance

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- Electric cars continue to gain ground on incumbent technologies (gasoline and diesel powered vehicles), and one key advantage that they have is dramatically lower maintenance costs.
- According to UBS Group AG, EVs require almost no maintenance. An EV motor has just three moving parts, compared to the 133 moving parts in a four-cylinder internal combustion engine.
- That makes EVs particularly suited for high usage - i.e. the more driving it does, the stronger advantage it has over traditional vehicles.
- That means the future of autonomous vehicles will almost certainly be in EVs rather than gasoline or diesel.
- The average Uber vehicle drives a third more than a typical European family car, which means "the oil price at which it makes sense to switch to electric is $30 per barrel lower," Laszlo Varro, chief economist at the International Energy Agency, told Bloomberg.

3. Strong diesel demand driving oil market

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- Global oil demand has looked strong as of late, with demand for diesel particularly hot.
- Meanwhile, diesel supply at refineries around the world took a hit, from outages in Europe as well as damage from Hurricane Harvey on the U.S. Gulf Coast.
- As a result, diesel inventories are down sharply, at a time when they typically build up ahead of winter.
- European diesel benchmark prices are up 25 percent since July, surging above $550 per metric ton.
- If another outage occurs, or winter temperatures drop exceptionally low, another price spike is likely, according to Bloomberg.

4. Asia gobbling up U.S. crude exports

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- After the lifting of the crude oil export ban in late 2015, U.S. crude exports started to tick up. But they have taken off in 2017.
- While initial cargoes went to a smattering of places, including Latin America and Europe, more recently China has emerged as a big buyer.
- As the OPEC cuts have reduced supplies to East Asia, "U.S. crude is becoming more and more popular," Wang Pei, an executive at the trading unit of Sinopec, the world's biggest refiner, told Bloomberg. "Our refining system really likes U.S. crude."
- Since the start of the year, one in three U.S. barrels sent abroad has gone to Asia.
- The recent disparity between Brent and WTI prices will likely accelerate this trend, with more U.S. oil slated to go to Asia.

5. Permian DUC backlog continues to grow

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- The backlog of drilled but uncompleted wells (DUCs) continues to grow in the U.S. shale patch, which foreshadows a substantial increase in production.
- A certain number of DUCs is routine in the shale industry, with some wells set aside until fracking crews work their way to the site.
- But the DUC backlog has surged over the past year, increasing to 2,297 in the Permian alone in September, up from just 1,226 a year earlier.
- The spike in DUCs is in part a symptom of a strain on oilfield services in West Texas. The flurry of drilling activity is straining the ability of fracking crews, forcing producers to stall completion.
- Alexandre Andlauer, an analyst at AlphaValue SAS, told Bloomberg that the DUC backlog could add another 400,000 to U.S. supply in the next four months.

6. Associated gas to surge, questions for oil

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- The production of natural gas as a byproduct of oil drilling, called "associated gas," is surging, particularly in the Permian. Part of that is a function of more drilling.
- But the ratio of gas-to-oil (GOR) will rise in the coming years. Newer oil wells produce relatively more oil than older wells. But as they age, the GOR rises.
- Goldman Sachs predicts that the GOR will fall in the next two quarters, aided by a wave of new wells coming online. But thereafter, the GOR rises through the end of the decade.
- In the coming years, the Permian's production profile will shift towards natural gas and away from oil.
- Earlier this summer, the unexpected jump in the GOR for Pioneer Natural Resources (NYSE: PXD) set off alarm bells for investors, who became concerned about the growth projections for oil output.

7. Natural gas surge in Marcellus & Utica comes at expense of Haynesville

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- The Haynesville Shale in Texas and Louisiana was one of the early leaders in the shale gas revolution. But in the decade since its boom, shale gas production has shifted to Pennsylvania and West Virginia, where the Marcellus Shale really drives new shale gas production.
- A resurgence in output in the Haynesville has come because of an injection in investment from private equity players, who invested in E&Ps and had them ramp up drilling ahead of planned IPOs.
- But the Haynesville has a breakeven price at about $2.90/MMBtu, according to Goldman Sachs, making it not a growth market if prices stay where they are.
- That means that the rig count will decline again, leaving the Marcellus as the giant among shale gas plays over the long-term.

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