OPEC Meeting Sparks Oil Price Volatility

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 no decision - to revisit production levels

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- OPEC surprised the oil markets by coming to no decision on a change in policy. But they did acknowledge current production levels, and said that while no official figure was settled on, they would agree on current "actual" production levels.
- Again, despite confusing media reports on a target increase from 30 million barrels per day (mb/d) to 31.5 mb/d, OPEC instead agreed not to officially change the target, but acknowledged current "actual" production levels. Actual production levels are at 31.8 mb/d.
- OPEC said it couldn't agree on a target increase because Iran is slated to re-enter global markets. OPEC will revisit the official target over the next few months. Ostensibly, the target stays at 30 mb/d, even though actual levels are above that.
- OPEC has consistently produced above its production target, and that is not a new phenomenon (see chart).
- OPEC has adjusted output in the past to address market changes. A few examples: an increase in '08 during the run up in prices; a decrease once the financial crisis hit; and an increase when prices shot above $100 per barrel from 2011 to 2014. Only in late 2014 did OPEC abandon this approach, refusing to cut in the face of oversupply.
- The latest (Dec. 4, 2015) move continues on this path, increasing the ceiling by 1.5 mb/d even though markets are in a glut.

2. Spending on Natural Gas Falling

- Oil companies are slashing spending, but so are natural gas companies.
- Spot natural gas prices at $2.17 per MMBtu are the lowest levels since early 2012.
- Production has risen almost uninterrupted for years, but has stalled in 2015 as oil drillers slow down.
- Gas rig counts continue to fall - down to just 189, or about half of the level from a year ago. With spending cuts, production could begin to fall.
- Chesapeake Energy, second largest natural gas producer in U.S., recently cut capital spending for second time this year. The company posted $10 billion in impairment charges, and swung to a net-loss in the third quarter. The company's troubles highlight the pain that gas drillers are going through, even though most of the media's attention stays focused on oil companies.

3. Deep Utica could be another bonanza

- The Utica Basin, located in Western Pennsylvania, Eastern Ohio, and Northern West Virginia holds significant natural gas and natural gas liquids.
- The basin has been well-known for years, and continues to produce significant volumes of dry gas. But only recently have wells been drilled to deep extents. And the deep Utica could turn out to be massive.
- Companies like EQT Corporation (NYSE: EQT), Consol Energy (NYSE: CNX), Range Resources (NYSE: RRC), Southwestern Energy (NYSE: SWN), and Antero Resources (NYSE: AR) are some of the most active.
- EQT's Scotts Run well produced a gusher this year, and as WSJ noted, it counterintuitively sent the company's share price tumbling as the markets grew concerned that the deep Utica could be extraordinary - normally a good thing, but a development that could keep prices depressed.
- It remains to be seen, but there is a possibility that the deep Utica could be as prolific as the Marcellus, which was one of the principle drivers of the shale gas revolution. EQT is cancelling drilling everywhere else and focusing on the deep Utica.

4. Oil futures higher than front-month

- Oil futures for several months out trade higher than near-term contracts, illustrating the short-term glut. The markets are discounting immediate oil deliveries, placing a premium on storage and delivery at a future date.
- This "contango" situation mirrors the growing crude oil inventory levels from around the world.
- If the contango is large enough, floating storage actually becomes a profitable enterprise.
- Most estimates put floating storage breaking even if the six-month futures price is at least $7 per barrel higher than the front-month price. Right now, the spread is just $4, so floating storage is not quite profitable yet.
- As the oil glut eases, the futures curve should flatten.

5. Oil price volatility rising

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- Oil market volatility spiked ahead of the OPEC meeting.
- Net-short positions are at a multiyear high and nearing the record level of 297 million barrels, setting up the markets for highly volatile trading in the coming days.
- High net-short positions indicate market pessimism, but also lay the groundwork for a sharp upward correction as short traders cover their positions.
- The last time the markets saw such a large net-short position was in August 2015, when prices spiked by 25 percent over three days as short traders closed out their positions.
- OPEC's non-decision merely acknowledging current production levels, but confusion over the outcome of the meeting sent oil prices downwards.
- With so much volatility, and a high build up in short positions, the market could see a short-term correction upwards next week.

6. Energy forecasts consistently unreliable

- The Wall Street Journal illustrated the inevitable inaccuracies from the three most important energy forecasting bodies - the IEA, EIA, and OPEC.
- Since 2010, the three entities have missed the year-ahead demand forecasts by an average of 600,000 barrels per day. Late last year, for example, the EIA expected demand to grow by 900,000 barrels per day in 2015, but in reality, demand will probably climb by 1.4 million barrels per day.
- In that context, future predictions should be taken with a grain of salt. Most energy forecasters believe oil markets will balance next year, but given the poor track record, investors should not trust such predictions. On either side of the "balancing in 2016" theory are bearish predictions that prices remain depressed through the rest of the decade, as well as bullish predictions that underinvestment could lead to a price spike within the next year or two.
- "It's an art more than a science in many ways-that's economics," Matt Parry, senior oil market analyst at the IEA, told the WSJ.

7. Crude by rail deliveries sharply down

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- Crude-by-rail deliveries are down even though domestic oil demand in the United State continues to rise.
- Part of the reason is due to the completion of pipelines that untied some of the bottleneck in key oil areas.
- Another reason is the stalling of oil production in key states like North Dakota. The discount between WTI and Brent narrowed as a result of stagnating production.
- With a smaller WTI discount, importing crude oil from abroad on the U.S. eastern seaboard is relatively more attractive. Delivering crude by rail is expensive, so the extra cost is not worth it for refineries on the east coast.
- East coast refineries are shunning North Dakota crude in favor of imported oil from South America and West Africa.

8. ISIS oil fields in eastern Syria

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- The above map from the FT shows the oil fields in eastern Syria under ISIS control.
- The fields and nearby refineries have become prime targets of airstrikes from the U.S., France, Russia, and just this week, the UK.
- Estimates are spotty, but the FT said in October that ISIS produces probably between 34,000 and 40,000 barrels per day. Airstrikes are likely cutting that number down.
- The largest field is the al-Tanak along the border with Iraq in eastern Syria, which produces 15,000-17,000 barrels per day.
- Oil sales earned the militant group $1.5 million per day. That number is also likely down now that airstrikes have become more frequent following the Paris attacks in November.

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