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High Storage Levels Point To Lower For Longer

Friday, February 12, 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. Contango widens again


- The oil market contango is back. A contango is a phenomenon in which front-month oil contracts are cheaper than oil delivered at some point in the future. A contango illustrates the near-term state of oversupply, as producers can’t find enough buyers for their crude today.
- The contango for Brent and WTI grew in recent weeks. The gap between front-month and year-ahead contracts – often called the 13th-1st month futures spread – increased to $7.75 per barrel in January for Brent, the highest in almost a year.
- But in February, the contango expanded even more. The WTI 13th-1st jumped to over $11 per barrel.
- A couple of takeaways: the rising contango is an effect of deeper state of oversupply. Storage is running low in key parts of the U.S., forcing near-term prices to suffer larger discounts.
- Also, floating storage becomes economical somewhere around $10 to $12 per barrel. More companies will be stashing oil at sea if the contango sticks around. Glencore, the mining giant, said in late January that it is storing oil at sea off the coast of Singapore.

2. Storage levels continue to grow

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- As noted above, storage levels have spiked. In February, crude oil storage levels in the U.S. surpassed 500 million barrels for the first time ever.
- The problem is a global one. OECD storage levels exceed 3 billion barrels, and in certain places of Europe and Asia, storage is running low.
- The EIA expects OECD storage levels to bounce around this year, perhaps not going much higher than current levels an. But the long plateau the agency is predicting in terms of “days of supply” – still well above the highs seen over the past five years – means that demand may not entirely catch up with supply through most of 2016.
- For oil prices, record high storage levels is very negative. It will take an extended period of time to work through the excess supplies.

3. Eagle Ford continues to decline


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- The Eagle Ford shale in South Texas continues to see some of the largest production losses in the United States.
- Once one of the most prolific shale basins, the Eagle Ford has seen drilling activity dry up abruptly. In March, the EIA projects that legacy production will continue to overwhelm new sources of output.
- Existing wells will see a drop in output of 110,000 barrels per day in March. New production will only add 60,000 barrels per day. As a result, the EIA expects that, on balance, production will fall by another 50,000 barrels per day in March compared to February.
- That would bring the region’s production to 1.22 million barrels per day, down from a peak of 1.73 mb/d in March 2015.

4. Drilling productivity defies gravity

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- Part of the reason that U.S. shale has remained resilient in the face of the downturn in oil prices and the plunging number of drilling rigs is the fact that drillers have improved their efficiency.
- The average production from a new well in a given shale basin has continued to improve, as drillers improve techniques and information about the basin grows.
- For nine consecutive years, the average first month’s worth of production from a new well in several shale basins – the Permian, Eagle Ford, Bakken, and Niobrara – has continued to increase. These “initial production rate” improvements have allowed U.S. shale to avoid a sharp decrease in output.
- Consider this: the rig count has fallen by more than 64 percent in the major shale regions tracked by the EIA since October 2014, but production has only declined by 8 percent over the same timeframe.
- Still, without enough new wells drilled, legacy production will start to overwhelm new sources of output, pushing absolute output down even while each new well produces more than similar ones from the past. The Eagle Ford, the Bakken, and the Niobrara are past their peaks and are in decline. The Permian hast yet to decline but output growth has slowed.

5. Baltic Dry Index hits new lows


- The Baltic Dry Index tracks the rates to ship dry goods such as coal or iron ore on large vessels. It is often used as proxy for global shipping activity, and thus, a loose indicator about the state of the global economy.
- The Baltic Dry Index has declined by 75 percent since the summer of 2015, and on February 8 it dropped below 300 for the first time ever.
- This is a symptom of a worsening global economy. Weak demand, especially coming from China, is creating cracks in global trade.
- But the collapse of the Baltic Dry Index is also due to a surge in shipbuilding, which has increased competition for ship-owners, leading to the collapse of daily rental rates. This is where the index becomes less useful as barometer for economic activity. Slowing trade, while real, is only part of the problem for shipping companies.
- Dry bulk shipping companies such as DryShips inc. (NASDAQ: DRYS) are trading in distressed territory as a result of slower trade and the unique state of oversupply in the shipping industry.

6. Energy spending falls in the U.S.


- The collapse if oil prices has been a boon for the U.S. economy. Energy expenditures as a share of GDP fell to their lowest level in decades in 2015.
- Cheap gasoline – which has recently fallen below $2 per gallon in many parts of the U.S. – has saved motorists more than $100 billion, or around $550 for every driver.
- But the fall in oil prices has been so severe in such a short period of time, the positive effects have been offset by layoffs and sharp cutbacks in investment from the oil and gas industry.
- In Jan. 2015, JP Morgan Chase predicted low oil prices would add 0.7 percent to GDP growth for the year. Now it thinks it got that wrong. The investment bank says that GDP probably expanded at 0.3 percentage points lower than it would have had oil not collapsed.
- The effects of cheap oil then, are probably mixed for the economy. One thing is clear is that energy’s share of U.S. GDP plunged last year and will stay below the long-run average for the next two years or so.

7. China’s oil production falling


- Although China is a massive oil consumer, it has also steadily ramped up oil production since the 1990s.
- But low prices are forcing cutbacks in investment, and as a result, China’s output is expected to fall this year by 100,000 to 200,000 barrels per day.
- China’s major oil producers, mostly state-owned, lower production targets for this year. Sinopec expects output to fall by 5 percent. PetroChina saw production fall by 1.5 percent in the first nine months of 2015. Cnooc, a smaller producer that focused on offshore fields, will see production fall by 5 percent.
- This offers some hope for oil investors, as the expected declines, which have not received much attention, take some excess supply off the market. China will have to import more to make up for the cutbacks.
- Imports make more sense, since many of China’s fields are old and have breakeven costs of at least $40 per barrel. One analysts said China’s aging fields are in “structural decline,” according to the WSJ.

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

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