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Evan Kelly

Evan Kelly

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Oil Rally Stalls After Iran Declines to Commit to Freeze

When we take a look at the latest oil prices, we see that this week's rally clearly fizzled out and oil sunk back between the $30 mark. 

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(Click to enlarge) Related: Storage Problems Could Cause A Rout In Oil Prices

The oil markets are still trying to digest the implications of the OPEC production freeze announced earlier in the week. Several days of strong gains in oil prices gave way to more cautious skeptical trading sessions on Thursday and Friday. WTI and Brent were down to close out the week.

OPEC-Russia production freeze. Iran’s response to the deal, while couched in positive language, was decidedly non-committal. Few expect Iran to participate in the freeze deal, and its top energy officials have said as much in the days leading up to the negotiations. Iran will continue to increase production as much as it can as it seeks to regain ground that it has lost over the past four years. As a result, with participating nations producing pretty much flat out, the freeze deal will have little material effect on the fundamentals of the oil market. The one potential positive is that the freeze might build trust, potentially creating the conditions for further negotiations.

Pressure mounts on oil-producing countries. As a result, with supply continuing to outstrip demand for at least half of this year, oil prices may not budget off their lows for a few months. That is very bad news for several oil-producing countries, with Nigeria, Iraq, and Venezuela topping the list of countries in crisis. “You’ve got half of OPEC in existential crisis as to whether they can be viable governments at this point,” Allen Gilmer, CEO of energy consulting firm Drilling Info Inc., told Bloomberg.

Oil storage levels rise again. Crude oil inventories continued to climb this week (see chart above), defying expectations. The U.S. saw stocks build by another 2.1 million barrels for the week ending on February 12. The key storage hub of Cushing, OK, was flat at 64.7 million barrels, or about 90 percent full. That weighed on the markets following the OPEC-Russia deal as the realization of persistent oversupply regained prominence. Related: Gasoline Glut Sends Oil Prices Tumbling

Production slightly down, but major projects coming online. U.S. oil production fell by another 50,000 barrels per day, according to EIA weekly estimates, a sign that low oil prices are cutting into U.S. supply, albeit at a glacially slow rate. But the losses are starting to pick up pace. The problem, though, is that the oil industry is set to bring several major oil projects online, projects that took years to develop and began before the downturn in prices.

For example, Tullow Oil has an offshore field off the coast of Ghana that is set to begin operations. Chevron has the Jack/St. Malo field in the Gulf of Mexico. And Cenovus will start up an oil sands project in Alberta. All told, according to Rystad Energy, an additional 3 million barrels per day will come into operation in 2016, plus another 1.5 mb/d in 2017. The project pipeline, so to speak, has dried up, but the industry is still working through these previously sanctioned projects. The timing is good for individual companies, but could not be worse for the market as a whole.

On the other hand, it is important to remember that all oil fields suffer from natural depletion, meaning that existing fields will suffer a collective loss of about 3 mb/d globally, Rystad Energy predicts. But on balance, the new projects will slow the necessary adjustment in supply and demand, although the IEA is still predicting more of a balance in late 2016.

Distressed oil companies. A new report from Deloitte finds that about one-third of oil companies are at risk of bankruptcy this year. The consulting firm reviewed 500 publicly-traded oil and gas companies from around the world and concluded that about 175 of them are in trouble, owing more than $150 billion in debt. While they have been able to tap the debt and equity markets in the past, those are avenues have been mostly closed off. Also, asset sales are no longer reliable as the asset valuations have plummeted. "These companies have kicked the can down the road as long as they can and now they're in danger of kicking the bucket," William Snyder, head of corporate restructuring at Deloitte, told Reuters in an interview. "It's all about liquidity." Related: Why Is Well Decommissioning So Slow In Canada?

OK earthquakes. Regulators in Oklahoma ordered drillers in the state to reduce the injection of wastewater by 40 percent, affecting 250 injection wells. The order was months in the making, coming in response to a wave of earthquakes that have hit the state in recent years. But it also came just after a 5.1-magnitude earthquake struck the state on February 13, the third strongest in Oklahoma’s history. Meanwhile, the Sierra Club is suing Devon Energy (NYSE: DVN), Chesapeake Energy (NYSE: CHK), and New Dominion for responsibility over those earthquakes. Oklahoma’s seismic activity has spiked over the past few years from just a few dozen in 2012 to more than 900 in 2015.

Japan’s LNG demand falls substantially. Japan’s LNG demand fell the most in six years for the month of January, dropping 14.1 percent compared to the same period in 2015. Warm weather, a stagnant economy, plus the return of three nuclear reactors all cut into Japan’s LNG import demand. Last year marked the first year since 2009 in which Japan’s LNG demand declined from the previous year. Japan, the world’s largest importer of LNG demand, is contributing to the collapse of LNG prices by more than half. More LNG export terminals are expected to come online this year, exacerbating the growing imbalance between supply and demand. Moving forward, Japan could continue to see consumption decline. Generous policies for solar power and energy efficiency are keeping demand flat. More ominously from the perspective of an LNG supplier is the fact that Japan’s utilities could bring back a total of 21 out of the country’s 43 nuclear reactors by 2017.

By Evan Kelly of Oilprice.com

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