Oil Prices Could Rise Further On Short-Covering

Friday, August 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. Natural gas production falling

- Natural gas consumption in the U.S. electric power sector broke a new record on June 21, hitting 40.9 billion cubic feet. The rapid decline of coal in the power sector is leading to much stronger demand for gas.
- At the same time, natural gas production is declining in the U.S., with all major shale basins posting declines.
- Only a few months ago, natural gas markets looked extraordinarily oversupplied, with inventories rising to their highest levels in decades.
- But the combined effect of rising demand and falling supply has suddenly tightened gas markets. The EIA reported a storage drawdown in August - the first draw on inventories during summertime in a decade - which suggests that prices could rise sooner than many had expected. Autumn months sees less demand, but the peak winter season could bring higher prices.

2. Surge in commodity investment comes to a halt

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- The bust in commodities that began in 2014 caused capital inflows into the sector to plummet in 2015, but the downturn in investment bounced back this year as investors tried to call the bottom.
- Capital inflows into the commodities sector has surpassed $51 billion so far this year, the most since 2009.
- Supply cutbacks should spark a continued revival as mines shut down and the market tightens. The Bloomberg Commodity Index, which tracks 22 different commodities, has gained 6.9 percent this year.
- But investors have soured on the sector this summer. The recent downturn in oil prices mirrored the sudden slowdown in investment across all commodities. Capital inflows reached only $2.4 billion in July, the least since December, according to Bloomberg.

3. Oil major's debt climbs sharply

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- The collapse of oil prices combined with the refusal to cut dividends has put serious pressure on the financials of the oil majors.
- Debt for the oil majors has jumped to a combined $138 billion this year, more than double the debt levels of 2013. And by way of comparison, the majors had only $13 billion in debt in 2008 before the financial crisis.
- There is little chance that the debt problems will go away anytime soon. The oil majors are taking on billions each quarter to cover shareholder dividends.
- "The debt traffic light is yellow," Skip York of Wood Mackenzie told Bloomberg. "In the absence of an oil price uptick or sizable asset sales, commitments to maintain the dividend will face even more pressure." Debt is rising by 11.5 percent per year.

4. Crude's effect on stocks and bonds

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- The downturn in oil prices since June is largely the result of stubbornly high levels of crude oil and gasoline inventories. But collapsing crude prices can infect the broader financial markets if investors get spooked.
- This happened in January when WTI and Brent fell below $30 per barrel. The correlation between oil prices and the S&P 500 hit a multiyear high on January 21 at 0.97, when oil dropped to its lowest level in more than a decade. Oil prices has traditionally moved inversely to stocks.
- The negative relationship resumed towards the end of the first quarter as oil prices started to rebound. By July, the correlation dropped to -0.77.
- But the correlation narrowed to -0.36 on August 5, which reflects growing concerns about the carnage in the oil markets spilling over into debt and equity markets.

5. $158 billion in capex cuts in 2017

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- The U.S. Lower 48 oil and gas industry is expected to see $250 billion in spending cuts through 2020, a full quarter of the $1 trillion in capex cuts expected worldwide over that timeframe, according to Wood Mackenzie.
- Between 2016 and 2017, the global industry will slash $370 billion, and $150 billion will come from the Lower 48. That is more than three times the total seen in any other country.
- Half of the U.S. cuts came from the Bakken and the Niobrara.
- Wood Mackenzie estimates that the world will lose 4.2 million barrels per day because of the spending reductions by 2020, and 70 percent of those losses will come from the U.S. The Bakken and the Eagle Ford will bear the brunt of those losses.

6. Saudi oil production at record high

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- Saudi Arabia's oil production rose to a record high in July, hitting 10.67 million barrels per day, or about 300,000 barrels per day higher than the same month a year earlier.
- Saudi Arabia burns crude oil, residual fuel oil and diesel for power generation, and since demand tends to spike in the summer because of air conditioning needs, production is typically ramped up seasonally as well.
- The country burned 850,000 to 900,000 barrels of crude oil per day in the summer of 2015 for domestic electricity.
- Last month's record level of crude oil production is not necessarily a problem for oversupplied global markets because most of the additional barrels are likely being burned domestically. Saudi Arabia and much of the Middle East is suffering from a sweltering heat wave, and while data is hard to come by, the country is probably burning all the extra production for air conditioning.

7. Huge accumulation of short positions opens up possibility of rally

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- The overwhelming accumulation of short positions on crude oil recently has created the conditions for a short-covering rally.
- As John Kemp of Reuters notes, the latest short cycle has gone deeper than previous cycles, all of which ended with a liquidation of shorts and a shift to long bets, sparking a rally in oil prices.
- Three previous cycles since 2015 had durations of about 3 months. The current cycle is about 9 weeks old. And with the current cycle's short positions of about 219 million barrels already exceeding the totals of the previous three cycles (178 million barrels, 163 million barrels, and 201 million barrels), the current cycle is already very mature.
- That suggests short positions could soon be liquidated and oil prices could rebound.

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