Oil Storage Levels Point to Lower for Longer

Friday, February 26, 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. OPEC's war on shale yields results

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- Much has been made about the ability of U.S. shale companies to weather the downturn in oil prices, and in turn, a lot of commentary has argued that OPEC's strategy since 2014 has failed.
- But the price crash has had an enormous impact on production figures. Not only has U.S. oil output declined from a peak of 9.6 million barrels per day (mb/d) in April 2015 to below 9.3 mb/d by November 2015, but a more important metric is to measure the decline against a business-as-usual case from mid-2014 when prices began to decline.
- If U.S. production had continued to climb at the pre-June 2014 rate, Reuters analyst John Kemp notes, U.S. production would have reached 11 mb/d by November 2015. In other words, the Saudi strategy of pursuing market share and forcing out high-cost producers knocked at least 1.6 or 1.7 mb/d of American oil offline, a very substantial volume.
- Moreover, output is still falling. The IEA sees U.S. production falling by another 600,000 barrels per day this year.
- In short, the U.S. shale industry has proven to be resilient, but OPEC dramatically altered the trajectory of American shale production.

2. Hedge funds step up bets on oil - in both directions

- Major investors have near record positions - both long and short - on crude oil benchmarks WTI and Brent. Combined long positions on the three main contracts on WTI and Brent have reached 688 million barrels, just 3 percent shy of a record.
- Short positions of 348 million barrels are also close to a record high.
- But investors are more bearish towards WTI than Brent. Shorts are more weighted towards WTI due to the fears over elevated storage levels in the United States.
- WTI is also in a steeper contango than Brent, a phenomenon in which front-month contracts are cheaper than crude oil contracts several months away. WTI's larger contango is also a reflection over near-term oversupply concerns, which has manifested itself in the record storage levels.

3. Oil glut lasts another year, but then turns negative in 2018

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- The IEA expects U.S. oil production to fall by 600,000 barrels per day in 2016, but the global supply/demand picture remains unbalanced through this year.
- The world was producing 2 mb/d more than demand in 2015. Supply will continue to outstrip demand in 2016. The "implied stock change," as the IEA calls it, will stand at 1.1 mb/d this year.
- In 2017, the adjustment will nearly zero out the glut, but inventories will have climbed so high that a strong rebound in prices may not occur.
- Cuts to upstream spending will lead to a supply deficit towards the end of the decade. In 2018 supply will fall short of demand by -0.4 mb/d; -0.7 mb/d in 2019; -1.0 mb/d in 2020; and -1.1 mb/d in 2021.
- The IEA warns that prices could spike as a result of this shortfall.

4. LNG exports from U.S. increasingly go to Asia

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- Cheniere Energy is about to ship out the first American LNG cargo from the Gulf of Mexico. More export facilities are expected to come online by the end of the decade.
- By volume, the LNG trade continues to grow strongly, although the market is about to hit a period of oversupply that could last for several years. Prices have crashed due to a wave of export capacity coming online and unusually weak demand in Asia.
- Nevertheless, LNG export terminals are long-term propositions, with investment cycles that last decades.
- ExxonMobil predicts that global natural gas demand will rise by 50 percent by 2040; LNG trade will triple. The U.S. and the Middle East will step up production, and most of that additional capacity will be sent to Asia.

5. Gasoline demand surges in the U.S.

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- U.S. gasoline demand surged in 2015 due to cheap gas, rising by 2.6 percent.
- That is equivalent to an increase in consumption of 240,000 barrels per day compared to 2014 levels, one of the largest increases in at least 40 years.
- Gasoline prices at the pump fell below $3 per gallon and more recently below $2 per gallon. That led to record auto sales, mostly for SUVs and light-duty trucks.
- Many analysts speculated that U.S. gasoline and driving demand were in structural decline, due to more efficient vehicles and a cultural shift towards less driving as younger people flocked to cities.
- But Americans set a new record for miles driven in 2015, collectively topping 3.1 trillion miles. That surpassed the previous driving record of 3 trillion miles in 2007. American motorists may not be permanently shifting away from the road as was once thought. They can still be lured out by cheap gasoline.

6. Oil majors continue to slash spending

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- The IEA sees U.S. oil production falling by 600,000 barrels per day in 2016 as shale drilling has ground to a halt.
- But the U.S. will regain its spot as the largest contributor to non-OPEC supply growth over the next five years. U.S. production is expected to climb by 1.3 mb/d by 2021, to a high of 14.2 mb/d. Part of that will come from shale, but some of it will also come from large offshore projects in the Gulf of Mexico.
- The IEA predicts that Brazil will add 0.8 mb/d over the same time period, although that prediction is looking highly optimistic given the massive problems with Brazil's state-owned oil company Petrobras. Petrobras has had to repeatedly downgrade its production estimate as the world's largest pile of debt has forced it to scale back exploration.
- Canada is also expected to add 0.8 mb/d, coming from oil sands projects that were greenlighted back when oil prices were much higher.
- Russia's aging oil fields finally take their toll, despite the country's ability to make some gains in 2015. Russia could lose 275,000 barrels per day over the next five years.

7. Oil tanker owners having best run since 2008

- It is not the best time to be an investor in the energy E&P space. But oil tankers are having their most profitable period since the collapse in oil prices in 2009 when tankers were used for storage.
- There are several reasons it is a great time to be an owner of an oil tanker. Low prices mean strong demand, which means more oil buyers are booking tankers. That pushes up rates.
- Tankers also benefit from low prices because their own fuel costs plunge. Bunker fuel is at the core of the operational costs for vessel owners.
- The good times may not last, as oil trade may "resume previous trends" towards the end of the decade, according to the IEA. Also more tankers are under construction in response to a spike in daily tanker rates. Those will take some time to be completed, but when they are, tanker rates will decline. The order book as currently at its highest level since 2011.
- In the short-run, however, oil vessels will see extra demand because of floating storage as the supply overhang persists through this year and inventories continue to build. Onshore storage is filling up, pushing up demand for storage offshore.

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