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Evan Kelly

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Oil Correction Stalls On Strong Dollar, Rising Rig Count

Oil prices reversed on Friday morning after a strong rally on Wednesday and Thursday while U.S. oil production continued to fall after a few weeks of respite.

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Friday, August 5, 2016

Oil briefly dropped below $40 per barrel this week but rebounded following the surprise drawdown in gasoline inventories, a robust decline of 3.3 million barrels. Oil traders were more than happy with that result, ignoring the 1.4 million barrel build in crude oil stocks. As a result, oil traded up 3 percent on Wednesday and posted an additional 2.5 percent gain on Thursday. Some of those gains could have been the result of speculators closing out short positions and pocketing profits, however. "With WTI testing $40 lately and without follow through selling, short positions are likely booking profits and we could see range bound prices after this," Chris Jarvis, analyst at Caprock Risk Management, told Reuters.

Bear market to be brief. Citigroup, Bank of America Merrill Lynch, Wood Mackenzie, and other investment banks predicted that the bear market will be over quickly, citing a dearth of oil supply that is profitable below $40 per barrel. Some analysts are even concerned that today’s cutbacks are too severe, setting up the market for a supply crunch down the line. "We think what's happening in the market is very seasonal. Supply is actually going down pretty quickly, demand is moving higher, and this is going to move the market into a deficit,” said Francisco Blanch, the head of global commodities and derivatives research at Bank of America Merrill Lynch. He says the supply drop off will lead to a “multi-quarter deficit,” which means oil prices will move “quite a lot higher.” But in the short-term, oil traders are not optimistic. On top of the massive volumes of oil and gasoline sitting in storage, the consistent gains in the rig count in recent weeks is giving the market some reason to worry.

Floating storage getting more profitable. In a worrying sign that the oil markets are still oversupplied, the economics of stashing oil at sea to sell at a later date are improving. The contango has widened sufficiently in recent weeks to make floating storage profitable. Bloomberg reports that cargoes for delivery at a later date sell for $2.78 per barrel higher than front-month contracts, enough to pay for storage for half of a year. This market contango is indicative of too much near-term supply, and it is a bearish signal for oil prices.

Emerging markets gain on central bank moves. The Bank of England cut interest rates to 0.25 percent this week, the lowest rate on record. That would presumably strengthen the dollar at the expense of oil, but the move also effectively zeros out any chance that the U.S. Fed would increase rates. The result has been to boost emerging market stocks and currencies to their highest levels in a year as investors hunt for yield.

Chevron to sell $5 billion in Asian assets. The WSJ reports that Chevron (NYSE: CVX) is looking at selling up to $5 billion of its assets in Asia, including offshore positions in China. Its joint venture with China’s Cnooc could help raise $1 billion, and it could potentially take in $2 billion from geothermal holdings in Indonesia. Globally, Chevron hopes to raise $10 billion from asset disposals, after posting a huge loss late last month. The oil major also announced its decision to lay off 8,000 jobs, or about 12 percent of its workforce. Chevron could use the cash – not only is it racking up debt, but a few weeks ago it greenlit a $37 billion expansion with its partners in the Tengiz oil field in Kazakhstan.

EOG boosts well completion target. EOG Resources (NYSE: EOG), a Texas shale driller, posted a second quarter loss but also increased its expected number of well completions for the year, raising the target from 270 to 350. EOG says that it expects a 10 percent compound annual increase in oil production through 2020. The company lost $292 million in the second quarter, down from a small profit of $5.3 million a year earlier.

Continental Resources raises production target. One of the top shale drillers in the Bakken and Oklahoma has increased its production guidance for 2016. Continental Resources (NYSE: CLR) increased its output target by 5,000 boe/d to 210,000-220,000 boe/d because it had better-than-expected production results from its wells in the first half of this year. Continental said its wells in the STACK play are performing particularly well. Continental said that it would hold off on working through its backlog of drilled but uncompleted wells until oil prices started to rise a bit closer to $60 per barrel.

Natural gas inventories decline. In a surprising development, U.S. natural gas inventories declined last week, according to the EIA. That is the first drop off during summer months in about a decade. Analysts had expected a small inventory build – inventories have been growing slower than average this summer – but the EIA said that stocks fell by 6 billion cubic feet. U.S. consumption of natural gas in the electric power sector hit a record in July. That, combined with the fall in production because of low prices has led to the smaller-than-expected inventory builds.

BP discharged waste into Lake Michigan. BP’s (NYSE: BP) gargantuan Whiting Refinery discharged five times the allowed volume of industrial waste into Lake Michigan last week because of an operational issue. The problem led to a disruption of gasoline production at the refinery, which caused regional gasoline prices to temporarily rise. The Whiting facility is the largest refinery in the Midwest.

By Evan Kelly of Oilprice.com

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