Refining Margins Improve As Oil Hits $45

Friday, April 29, 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. Gasoline refining margins improve

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- Downstream units at many integrated oil companies have been the lone bright spot for much of the down market since mid-2014, with very high margins for much of 2015. However, the margins for refineries - which buy crude and process it into gasoline, diesel, and other products - collapsed late last year.
- Only recently have refining margins improved, as evident in the Reuters chart above. There are not clear cut answers for why margins are improving, but generally speaking, they are an indication of rising gasoline demand and falling crude oil production in the U.S.
- Put simply, motorists are consuming more and more gasoline, so refiners are purchasing more crude in order to meet that demand. That is providing a demand pull on crude oil, putting a floor beneath the price of WTI. At the same time, upstream production is falling.
- Although there has been a surge in speculative interest in oil contracts, the real world changes of supply and demand are improving. And that is reflected in the spike in gasoline refining margins.

2. Natural gas prices collapse in Europe

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- A natural gas war is starting to play out in Europe as Russia floods the continent in cheap gas in order to hold onto market share.
- Russia's Gazprom is hoping to maintain its grip on the European market as gas prices start to slide. Gazprom is hoping to make up for lower revenues with higher volumes. Gazprom is set to export a record level of gas to Europe this year, close to 45 billion cubic meters.
- Another way of viewing the trend is that Russia is facing increasing competition in Europe. U.S. LNG just hit the market and Russia is hoping to box out American gas exporters by undercutting them. Officially Gazprom says it is merely compensating for falling European domestic production, but it appears that Gazprom may choose to suffer through a period of low prices in order to make it unprofitable for American exporters to send LNG to Europe.
- Natural gas prices in the UK have declined 37 percent in the past year. The price war is not unlike Saudi Arabia's strategy in the oil market - keeping production elevated in the face of oversupply in order to force out higher-cost producers.
- "They are trying to defend market shares because they see -- like everybody else -- that failure to do so is going to allow more LNG -- not just U.S. LNG but any LNG -- to displace their pipeline supplies," Jonathan Stern, chairman of the gas research program at the Oxford Institute for Energy Studies, said in an interview with Bloomberg.

3. Long slide in productivity for oil majors

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- The collapse in oil prices put an end to the boom years when the oil majors threw money at expensive and remote oil projects. Even when oil sold for more than $100 per barrel, the oil majors piled on more debt and spent money at record rates.
- Shell's operating costs hit $14.70 per barrel in 2015, or more than double the $6 per barrel it spent on operations in 2005. BP's operating costs tripled from $3.60 per barrel in 2005 to $10.40 per barrel in 2015.
- But low oil prices tend to focus minds. The oil majors halted the rise in spending in 2015 - Shell's costs plunged by 15 percent and BP's declined by 19 percent.
- Oil and gas production per employee declined steadily since 2008, but BP and Total managed to reverse course last year by cutting staff and other operational costs.
- The big question is whether or not the oil majors can maintain dividends. Goldman Sachs' Jeff Currie recently warned that the majors, including ExxonMobil, will have to cut dividends if oil prices stay in the range of $50 to $60 per barrel. They can cut expenses and hold onto dividends in the short run, but if oil prices don't substantially rebound, the payouts could be on the chopping block. Exxon defied this prediction by announcing a slight increase to its dividend this week, raising it by 2 cents per share.

4. Contango disappearing

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- The chart above depicts the difference between oil price futures: the difference of front-month deliveries to three months out (1-3), one to six months out (1-6), and one to thirteen months out (1-13).
- The differences have been negative for quite a while, which means oil for delivery in the near-term is cheaper than for delivery several months from now. That is an indication of a short-term supply glut. But the differentials are converging towards zero, illustrating the growing bullishness in the market - demand is rising and supply is falling, trends that are starting to erase the supply overhang.
- For example, the Brent 1-13 spread narrowed from $5.07 per barrel in the beginning of April to just $3.23 per barrel by April 22. For WTI, the 1-13 spread narrowed from $6 to $3.57 per barrel over the same timeframe.
- As we reported a few weeks ago, the contango has at times temporarily shifted into backwardation, in which front-month deliveries are more expensive than contracts several months out. Supply disruptions in Kuwait, Nigeria, Iraq, and potentially Venezuela are going a long way to shrinking the contango.
- A full-on backwardation seems unlikely in a sustained way for now, given the massive volumes of oil sitting in storage. The contango could widen again if the supply outages are resolved (the Kuwait workers strike, for example, was only temporary).

5. Credit lines getting cut

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- Wall Street is a very big reason why the U.S. shale boom took off. Now the banks are starting to rein in their lending. The major banks - JPMorgan Chase, Wells Fargo, Bank of America and Citigroup - have a combined $190 billion in outstanding energy loans to oil and gas companies, according to Bloomberg.
- Of the 57 independent North American oil and gas companies surveyed by Bloomberg, they were collectively cash flow negative for all of 2015.
- So far, 59 companies have declared bankruptcy since early 2015. The bankruptcies involved $27 billion in debt.
- Major banks are starting to cut credit lines, with the latest credit redetermination period underway. Collectively, banks cut off $5.6 billion in credit across 36 oil and gas companies so far this spring.

6. Oil states see rise in delinquencies for consumer debt

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- U.S. states dependent on oil, gas, and coal production are seeing an uptick in bad consumer credit as job losses mount, according to the WSJ.
- About 1.7 percent of all credit card users in Oklahoma were more than 90 days late on payments in the first quarter of 2016, a jump of 0.22 percentage points from the same period in 2014. For Texas, the delinquency rate is 1.8 percent. Louisiana tops the list at more than 2 percent.
- About 2.25 percent of all consumers with auto loan debt in Louisiana are more than 60 days behind payments, up from just 1.5 percent in 2012.
- The deteriorating position for many ex-oil and gas workers is putting regional banks at risk. For instance, the delinquency on auto loan debt for Wyoming-based Pinnacle Bank surged 1 percent in the fourth quarter.
- Foreclosure rates in Oklahoma have posted seven consecutive monthly increases, year-on-year.

7. Venezuela's shattered economy

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- Venezuela has seen its economy collapse along with oil prices. The South American OPEC member suffers from an inflation rate exceeding 500 percent, a GDP set to shrink 8 percent this year, cash reserves rapidly falling to zero, and a rising pile of debt. Venezuela has $14 billion in bond payments due over the next year.
- The problem for Venezuela is that aside from war-torn Libya, Venezuela arguably needs the highest oil price in order for its budget to work out of all other OPEC members. RBC Capital Markets estimates that it needs $121.06 per barrel. Needless to say, oil prices are far below that level.
- An electricity shortage has crushed the economy even further, as falling water levels at a massive dam has led to blackouts. A shortage of electricity could cut into Venezuela's oil production, potentially in the next few weeks. RBC rates Venezuela as OPEC's "most at-risk producer."
- Oil production could fall to 2.25 million barrels per day by the end of 2016, down more than 100,000 barrels per day from current levels. However, the risk is on the downside, with sudden supply disruptions a real risk as the economy continues to fall apart.

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