OPEC Deal Shaky While U.S. Shale Prospers

Friday March 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. Top shale companies finally cash flow positive

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- The U.S. shale industry is arguably healthier than it has ever been - a surprising argument given that they are just emerging from a nearly three-year bust.
- But shale drillers by and large were not generating positive cash flow even when oil prices were in triple-digit territory. The drilling frenzy between 2010 and 2014 was fueled by debt.
- Continental Resources (NYSE: CLR), for example, is expected to finally post positive cash flow in 2017 after years of running up debt on negative cash flow.
- But they are not in the clear yet. Oil prices could fall again if the newfound strength in the shale industry leads to a steep rise in output this year. As Bloomberg Gadfly notes, Continental's CEO Harold Hamm was uncharacteristically cautious in his comments to the industry crowd in Houston last week, warning drillers not to ramp up too quickly for fear of "killing" oil prices.

2. Contango strengthens

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- Oil prices have hit a rough patch again, and the contango has not only returned but has also become more pronounced. WTI dipped below $50 per barrel last week on renewed bearish sentiment.
- The discount for front-month contracts for Brent futures compared to contracts 12 months out narrowed sharply in January and February, and actually flipped into a temporary state of backwardation in late February.
- But the 1-13th spread is now very much back in contango, with a discount of about $1 per barrel. This suggests the market is once again concerned about oversupply.
- "The market has started to doubt that OPEC will prolong the cut deal into the second half of 2017 and hence maybe the stock draws that would follow will not happen," Torbjorn Kjus, chief oil analyst at DNB Bank ASA, told Bloomberg. "Hence, backwardation is changing to contango for that part of the curve."

3. Analysts still see rising oil prices

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- Despite warning signs about the potential unraveling of the OPEC deal, combined with higher oil production in the U.S. and record levels of inventories, the major Wall Street analysts are still bullish on crude.
- Goldman Sachs and Citibank both recommended buying crude investments once WTI dipped below $50 per barrel.
- Goldman told a rattled oil market to have "patience," and that the "re-balancing is still progressing."
- Bank of America sees crude rising to $64 per barrel later this year. Four major investment banks reiterated their bullish forecast for oil despite the recent backslide.
- "The case for further re-balancing in the rest of the year remains robust," said Martijn Rats, a managing director at Bank of America.

4. Surging natural gas production in the Permian

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- Natural gas production from the major shale basins is set to hit a record high in April, according to the EIA.
- Output will jump in the Marcellus (+167 million cubic feet per day), the Permian (+154 mcf/d), the Haynesville (+108 mcf/d), the Niobrara (+52 mcf/d) the Eagle Ford (+43 mcf/d) and the Utica (+34 mcf/d).
- The gains in production come after production hit a temporary peak last year, leading to a tightening of natural gas markets. Rising output combined with bouts of mild weather have once again left the U.S. with too much supply.
- On top of that, Tudor Pickering Holt & Co. predicts natural gas prices could fall below $2/MMBtu because of rising production.
- The Permian is particularly interesting because it has been a leader in oil; gas has been secondary. But the resurgence in drilling in West Texas is leading to a substantial increase in associated gas production.
- LNG exports are in low volumes and are not enough to shake the market out of a state of oversupply.

5. Saudi Arabia's surprise uptick in oil production

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- Saudi Arabia told OPEC that it ramped up oil production in February by an additional 263,000 bpd compared to January levels, taking output back above the 10 mb/d threshold.
- Saudi Arabia is still adhering to its 10.06 mb/d production target, but it has boasted on multiple occasions about cutting much more than was required. The uptick raises concerns about Riyadh's faith in fellow OPEC members and comes amid reports about Saudi frustration regarding lack of compliance from Iraq and Russia.
- OPEC reports two figures: direct communication (what countries directly report) and secondary sources (made up from a variety of third party analysts, such as S&P Global Platts), so the discrepancy has fueled some uncertainty. When March figures are published in a few weeks more will be known.
- Of the 10 OPEC countries involved in the deal, they have cut a collective 1.39 mb/d (under secondary sources), achieving a compliance rate of 111 percent. But including gains from Nigeria and Libya puts compliance at just 85 percent.
- The bottom line trend to watch is if countries like Iraq and Russia (non-OPEC) actually make steeper cuts, and if not, it will be important to watch the Saudi response.

6. Iraq slow to OPEC deal

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- Iraq has been the main thorn in Saudi Arabia's side, the one country that is falling short of its commitments in a large way.
- Iraq promised to cut its oil production from 4.561 mb/d in October to 4.351 mb/d for the January-June period. Iraq ramped up output in December just ahead of the deal to 4.642 mb/d. It reduced output to 4.476 mb/d in January and then 4.414 mb/d in February - so it is still producing more than it pledged.
- Iraq has promised that it would continue to ratchet down production in order to comply with the deal, but Saudi Arabia is growing frustrated.
- Moreover, Iraq's oil minister Jabbar Ali Al-Luiebi said that Iraq would boost production capacity to 5 mb/d later this year, a statement that could significantly undermine faith in the OPEC deal and complicate efforts to extend it for another six months.

7. Oil majors see output rising

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- The oil majors have been suffering from years of declining output, as new discoveries fail to offset maturing and depleting production.
- The collective output from Eni (NYSE: E), Royal Dutch Shell (NYSE: RDS.A) Chevron (NYSE: CVX), BP (NYSE: BP), ExxonMobil (NYSE: XOM), Statoil (NYSE: STO) and Total (NYSE: TOT) have declined from 20.31 million barrels of oil equivalent (mboe/d) in 2010 to 18.4 mboe/d in 2014.
- But Reuters estimates that figure is already rising and will rise to 22.68 mboe/d by 2021.
- However, much of that won't come in the form of crude oil. With major oil fields in decline, the majors are looking at natural gas as a way to diversify. Shell bought BG Group, a large bet on LNG. BP is looking at gas production in India. Eni is fast-tracking a large gas discovery in Egypt. Statoil is investing in renewables to hedge against oil.
- Still, the majors represent about one-fifth of total global oil production, so their fortunes have a substantial effect on the market. The IEA warns that insufficient investment today will lead to a shortage of supply in five years. The majors will go a long way in determining if that happens.

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