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OPEC Is Driving Prices Up, But Where Is The Limit?

Rigs

Friday May 19, 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. OPEC extension flattens futures curve

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- OPEC is on the verge of extending its production cuts for another nine months, a move intended to drain high levels of oil inventories.
- In order to do that, OPEC is taking aim at the oil futures curve, hopping to flatten it out and ultimately push longer-dated futures lower than the spot price or front-month oil price.
- The idea is that storage then becomes uneconomical, forcing traders to drain inventories.
- More importantly, it could hamper shale production since shale companies would not be able to hedge their production a year or two out. Also, executives would hold back on drilling if they expected oil prices to fall in the future.
- That is the key for OPEC to balance the oil market. The futures curve flattened quite a bit after the announcement from Saudi Arabia and Russia that they were seeking a nine-month extension.

2. OPEC’s deal to drain inventories

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- If extended for nine months, the OPEC/non-OPEC cuts will probably be enough to drain inventories back to average levels by the end of the first quarter of 2018, according to Bloomberg estimates.
- Inventories surged above typical levels in January as shale production rose and OPEC ramped up exports just ahead of the implementation of its deal.
- That has delayed the rebalancing, forcing the cartel to consider an extension.
- One possible reason for optimism for OPEC is that global inventories are potentially falling much faster than everyone thinks. Because data is only readily available in OECD countries (and mainly the U.S.), the goal is to bring OECD (rather than global) inventories back to average levels.
- But OECD countries tend to have cheap storage, meaning they are the first to fill and the last to drain.
- As a result, it is possible that global stocks are already falling quickly and that the OECD is only now catching up to that trend. That suggests the market could be tightening more than analysts expect.

3. Bankruptcies fall to low levels

- The collapse of oil prices beginning in 2014 led to an estimated 114 bankruptcies in the North American oil and gas industry.
- But the FT reports that many of them continued to produce through bankruptcy in an attempt to keep the business alive. That resulted in resilient U.S. oil production through the downturn.
- The FT says that of the 10 largest shale companies to have filed for bankruptcy, eight emerged from that process with less debt while oil production remained largely unscathed.
- Meanwhile, over the past year, the number of bankruptcies has plunged to very low levels, as the market downturn cleared out the weakest players and the rest have become more efficient.

4. California rains cut into gas consumption

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- Well-stocked reservoirs from ample rain have California leaning on hydroelectric power plants much more in 2017 than in years past.
- The ongoing installation of solar power is also contributing to a record high share for renewable energy. Solar generation in the first four months of the year is up 27 percent from 2016 levels.
- That has led to a dramatic fall in natural gas consumption in the California Independent System Operator (CAISO) region.
- Natural gas consumption this year is well below the lowest point of the five-year average range.
- Meanwhile, renewables briefly captured more than 60 percent of the CAISO electricity market.

5. Energy worst performing stocks

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- The energy industry has offered investors some of the worst returns of the year so far.
- Oil stocks have declined by a combined 6.4 percent, the only sector to fall in the MSCI All-Country World Index, according to Bloomberg.
- “We don’t think the oil price will go much higher so there isn’t enough room for energy stocks to rally,” Simon Wiersma, an investment manager at ING Bank NV, told Bloomberg. Wiersma cited the muted price impact from Saudi Arabia’s latest announcement and questions surrounding OPEC compliance going forward.
- However, declines offer entry points for investors. After all, when oil prices plunged below $30 per barrel last year, a well-timed investment at a point when the energy world was in turmoil would have led to juicy returns in 2016.

6. OPEC can’t impact production from these countries

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- Oil analysts have long-focused on the battle between OPEC and U.S. shale.
- However, while OPEC can shut off shale taps, the OPEC cuts will have little impact on projects that are years in the making.
- The overlooked production gains from Brazil and Canada in particular could undermine their efforts. Those two countries are expected to add the most production outside of the U.S. in 2017.
- Canadian oil sands and deep-water pre-salt drilling in Brazil are multi-year projects that do not stop and start at a moment’s notice. Projects planned before 2014 are starting to come online now.
- Canada is expected to add 200,000 bpd this year, while Brazil will add 212,000 bpd, according to the WSJ.
- Over the next five years Canada is expected to add 900,000 bpd while Brazil could add as much as 1.1 mb/d, according to IEA estimates. The combined output from these two countries could exceed the gains from U.S. shale through 2022.

7. U.S. exports to Asia surging

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- There is a flotilla of oil tankers carrying an estimated 10 million barrels of U.S. crude currently on its way to Asia, according to Reuters.
- The shipments are carrying the first ever cargo from a medium-sulfur blend in deepwater Gulf of Mexico as well as the first cargo from Alaska’s North Slope in over eight months.
- U.S. crude is trading at a competitive price for Asian buyers as OPEC cuts back on shipments to the Far East. As countries like China scramble to replace falling OPEC supplies, they have turned to the U.S.
- WTI is trading at a $3 discount to the Dubai benchmark.
- Last week, U.S. crude exports averaged 1.09 mb/d, the third highest total on record.
- When the Dakota Access Pipeline is fully operational, exports could rise further, allowing Bakken oil to reach the Gulf Coast.

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




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