Oil continued to trade lower on Tuesday as traders fear today and tomorrow's inventory data reports from the API and EIA.
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• The free cash flow picture for U.S. onshore oil and gas companies is improving.
• Capex still exceeds cash flow, but the gap is shrinking.
• Still, the improvement comes because drilling is at a virtual standstill. The financing gap has narrowed, but only because spending is so low. Cash flow for the industry in the first quarter was at a five-year low.
• E&Ps may need less external sources of financing moving forward, but capex budgets will likely increase if drilling picks up, presenting financing challenges once again.
Market Movers
• Barron’s says that Royal Dutch Shell (NYSE: RDS.A) is “the world’s best big oil stock,” citing cost declines and divestments. Barron’s writer Jack Hough says the company’s moves have increased confidence in the stability of its 6.6 percent dividend yield.
• Around 400 union workers in the North Sea working on oil platforms for Royal Dutch Shell voted for a 24-hour strike, with a few shorter strikes to follow in the coming weeks. The workers oppose cost cutting measures that will hurt wages.
• Tesoro (NYSE: TSO) has reached a $425 million settlement with the U.S. Justice Department over air quality violations in six western U.S. states. Tesoro will have to invest $403 million in new equipment to control emissions.
Tuesday July 19, 2016
Oil prices are still hovering around levels at the close of last week – WTI sitting just above $45 per barrel and Brent around $47 per barrel. High levels of refined products are weighing on the market (more below), and while all major analysts see the market continuing down the path towards supply/demand balance, there is disagreement over how quickly that will arrive. In the very short-term, there do not seem to be a lot of bullish catalysts on the horizon, although weekly EIA data could provide a lift if stock drawdowns are stronger than expected.
Three weeks of rig count increases. The rig count increased for a third consecutive time for the week ending on July 15, rising to 357. That brings the total increase to 41 rigs since the end of May, a clear sign that more than a few companies feel that they can get back to work. However, since the rig count data lags behind the oil markets, it often reflects conditions from weeks prior. The increase likely has more to do with $50 oil in June than it does with $45 oil in July.
High inventories move to forefront. After rallying to $50 per barrel in June, and then faltering, the markets have recently sent conflicting signals about what to expect in the coming months. Now, after several weeks of new data, the problem of excess inventories for gasoline and diesel are taking center stage as the elephant in the room for any price rally. Elevated levels of refined products are found not just in the U.S., but in Europe and Asia as well – a global problem of too much supply. A glut of refined products is increasing the incidence of tankers being used for floating storage, a sure sign of a near-term glut. New York saw some gasoline tankers backed up because onshore storage was at a premium. Reuters reports that some floating storage is cropping up off the coast of the UK. Oil prices will run into a price ceiling until these inventories are drawn down. Related: Energy Is The Reason Europe Is Still Backing Erdogan
Seasonal changes raise concerns. The high levels of refined product stocks come even though we are in the midst of peak demand season. In the U.S., driving peaks in the summer, and in places like Saudi Arabia, crude oil demand hits a seasonal peak in the summer because of higher air conditioning needs. However, peak summer demand is doing very little to whittle down inventories. That raises some concerns as summer starts to come to a close, which could result in a knock to global demand. On top of that, refiners could also begin to slow down production – a move that comes both because of seasonal maintenance and because there is already too much volume on the market. Lower refinery runs will dampen demand for crude oil. In other words, seasonal changes could see lower demand for oil in the coming months.
More oil companies hedging. Bloomberg reports that more oil companies are hedging their production for 2016 and 2017 at today’s prices, not gambling on hopes for a stronger price rally. Locking in sales at $40 to $50 will hurt if the markets rally much higher, but it will protect companies from downside risk. And after a false rally in 2015, oil producers are not taking any risks.
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U.S. fuel efficiency projection revised lower because of cheap gas. U.S. government forecasters lowered their projection for fleet-wide vehicle efficiency as more motorists purchase trucks and SUVs, a trend that is taking place because of cheap gasoline. Regulators estimate the fleet efficiency will hit 50 to 52.6 miles per gallon in 2025 instead of the previous estimate of 54.5 mpg. As a result, the auto industry is arguing that the fuel efficiency regulations will be more difficult to meet and are pushing for a change. At the same time, the silver lining for government regulators is that they also underestimated how fast the cost of batteries would fall for electric vehicles.
North Sea oil companies benefit from Brexit. The Brexit vote has pushed the British pound to a 31-year low, helping to reduce the costs for oil companies operating in the North Sea. Oil companies in the North Sea tend to pay costs for salaries and equipment in pounds, but sell their oil in dollars, so a weaker pound cuts down on expenses. “I don’t really see any negatives, other than general market uncertainty,” said Tony Durrant, CEO of Premier Oil PLC (LON: PMO), according to the WSJ. Premier said that on one of their projects, named Catcher, the company is saving $100 million on development costs because of the exchange rate movements. The share prices of BP (NYSE: BP) and Shell (NYSE: RDS.A) jumped to 14-month highs after the Brexit vote. Not everyone is convinced, however. Wood Mackenzie says the uncertainty surrounding North Sea investments because of the Brexit could accelerate the decommissioning of old oil fields and platforms.
ExxonMobil offers $2.5 billion for InterOil. ExxonMobil (NYSE: XOM) has been patient during the oil price downturn, not leaping to make any acquisitions even while rival Royal Dutch Shell spent a fortune for BG Group. But Exxon offered $2.2 billion plus debt for InterOil a few days ago, a move made to boost its LNG position in Papua New Guinea. The offer surpasses that of Oil Search, which is backed by Total (NYSE: TOT). Importantly, as Reuters notes, the potential acquisition presents two benefits to Exxon – making a purchase at the bottom of a commodity cycle, and acquiring a company that could provide long-term returns.
Saudi Arabia to make largest tanker fleet. Arab Petroleum Investment Corp. and National Shipping Co. of Saudi Arabia will create the largest fleet of oil tankers in the world. The move will help boost Saudi crude oil exports. The companies setup a $1.5 billion investment fund to add 15 very large crude carriers (VLCCs) on top of its existing 46 VLCCs.
By Evan Kelly of Oilprice.com
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