Terrible Timing For An OPEC Failure

Friday March 31, 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. Oil prices fall ahead of credit redetermination

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- Creditors periodically review their portfolio of loans to energy companies, reassessing whether or not to adjust credit lines based on shifts in market conditions, the likelihood of oil reserves being produced, and the company's profitability.
- The credit redeterminations happen twice a year, once in April and again at the end of the 3rd quarter. The average borrowing base fell by 16 percent in 2016. Smaller companies operating on the margins could see much more severe reductions.
- Credit redetermination is about to get underway across the industry, just as oil prices lost roughly 10 percent of their value. A drop below $45 per barrel would likely lead to large credit reductions for many oil producers, according to Bloomberg.
- Lenders have been lenient for the most part during the past three years - cutting credit could pull the rug out from underneath the oil producers, leading to less likelihood that the lender gets paid back.

2. Saudi tax cuts for Aramco

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- The Saudi government just announced a tax cut intended to massively boost the value of Saudi Aramco. The tax will drop from 85 percent to 50 percent.
- The idea is to make the company more attractive to investors. Rystad Energy estimates that the tax change will add $1 trillion to the valuation of Aramco.
- Assuming a long-term oil price of $75 per barrel, the tax change takes the company's valuation from $0.4 to $1.4 trillion, according to Rystad. A separate report from Sanford C. Bernstein & Co. puts the figure at $1.5 trillion, up from $1 trillion before the tax cut.
- That should help the government raise more funds from the partial IPO of the company.
- However, it also raises questions about how the tax cut will affect state finances. A lower tax take will be huge blow to revenues.

3. OPEC deal falling short

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- OPEC met last weekend to monitor compliance on the group's production cuts. Five OPEC members including Kuwait voiced support for an extension of the deal. Oman (not an OPEC member) also supports an extension.
- The cuts of 1.2 million barrels per day, plus the nearly 0.6 mb/d reductions from non-OPEC members, has failed to balance the market thus far.
- Crude inventories have broken new record highs in the U.S several consecutive weeks in a row even as OPEC has slashed output.
- Many analysts think that OPEC has no choice but to extend the deal, for fear of a meltdown in prices. But OPEC also does not want to get burned by losing market share to U.S. shale with nothing to show for it.
- Notably, the latest meeting ended without a recommendation for an extension.
- "The market is tired of their verbal interventions," John Kilduff, a partner at Again Capital LLC, a told Bloomberg. "The extension is clearly in trouble since they didn't make a recommendation at this meeting."

4. Gasoline stocks drawing quicker

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- Weekly EIA reports are closely watched and have a great deal of influence over short-term oil price swings.
- Crude oil inventories continue to hover at all-time highs at 534 million barrels, a massive backlog that will prevent any meaningful increase in prices for quite a while.
- But gasoline stocks are drawing much more quickly than last year at this time, providing a glimmer of hope for oil bulls.
- Gasoline stocks fell by 3.7 million barrels in its latest report, bolstering data about U.S. demand.

5. Electricity prices down, putting the screws on coal

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- The competition in the electric power sector is fierce, with a glut of gas and coal combined with rising renewable energy generation leading to falling electricity price futures.
- President Trump's undoing of the Clean Power Plan will not save coal, but could extend the lives of aging coal-fired power plants. That could push down prices if the supply glut worsens.
- At the same time, U.S. demand is flat. Homes and appliances continue to become more efficient. Commercial and industrial consumers are also more efficient than they were years ago.
- Taken together, the executive order is "not much of a win for anyone given that soft prices arising from well-supplied or oversupplied markets don't seem to help any type of existing or new generator," Christine Tezak, an analyst for ClearView Energy Partners, told Bloomberg.

6. Dakota Access a boost for Bakken

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- Energy Transfer Partners (NYSE: ETP) says that it is filling up the Dakota Access Pipeline with oil, offering a new major outlet for Bakken crude.
- The $3.8 billion pipeline will add 470,000 bpd of takeaway capacity, and ultimately could run as high as 570,000 bpd.
- For years Bakken oil has traded at a discount to WTI because of transportation problems. Oil has been moved by train because of a shortage of pipelines.
- But beginning in March, the discount for Bakken oil has disappeared. Instead of trading at more than $1 per barrel less than WTI, Bakken has temporarily moved to a premium.
- Bakken prices are now at their highest since June of last year. The price movements show the importance of pipelines for a landlocked area like North Dakota.

7. Permian gas on the rise

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- The Permian Basin is where the bulk of new shale oil production is coming from. But natural gas production in the Permian Basin has surged more than 25 percent since the end of 2015.
- However, much of the credit goes to oil drillers, who are producing gas even though they are targeting oil.
- This "associated gas" is adding extra supply to an already well-supplied gas market. Even the bout of cold weather in recent weeks has done little to rally prices. Worse, medium-term natural gas prices are anchored around $3 per MMBtu.
- There are pipeline constraints in getting this gas to market along the Gulf Coast. The situation is a great one for pipeline builders, who have broken ground on new projects to take gas to Mexico. But it is bad news for gas drillers, as the new supply will put downward pressure on prices.

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