What's Wrong With Brent Oil Futures?

Friday, May 8, 2020

1. ExxonMobil posts first quarter loss

- ExxonMobil (NYSE: XOM) reported a $610 million loss in the first quarter, the first loss in more than three decades.
- The supermajor said it would idle 75 percent of its rigs in the Permian basin, where it will concentrate its cuts because of the short-cycle nature of drilling. Spending will fall by 30 percent.
- ExxonMobil and Chevron (NYSE: CVX) will shut in a combined 800,000 bpd in response to the market collapse.
- Exxon maintained its dividend and has taken on billions of dollars in debt to finance the spending gap, contributing to a credit downgrade in recent weeks. Exxon needs oil prices at about $75 per barrel to breakeven and to finance shareholder payouts. Its peers only need around $50 per barrel.

2. Brent curve too flat?

- Standard Chartered says that the futures curve is out of whack. "Prices during the first phase of the transition need to be low enough to encourage demand and keep shut-in supply from returning too quickly; in later phases they need to keep demand growth within bounds while providing incentives for supply to increase," the bank wrote in a report.
- The price signals need to encourage shut-ins, but "also regulate activity levels in US shale oil so that production does not plunge too dramatically due to a lack of new well completions," Standard Chartered analysts said.
- But at current prices and activity levels, production declines "will become precipitous."
- The investment bank said that the Brent curve is too flat, meaning that longer-dated prices need to rise more. The bank says that 2021 Brent prices should be about $8-per-barrel higher, while prices for 2022-2025 should be $12-per-barrel higher.
- Another way of viewing this is that today's supply destruction will create upside price potential in the years ahead. "We think the market is underestimating the extent of permanent supply damage," Standard Chartered concluded.

3. Natural gas depressed in 2020, rallying in 2021

- U.S. natural gas prices are rallying for 2021, as investors bet that the collapse of U.S. oil production will significantly curtail associated gas output.
- "We thought a rollover in natural gas production would be supportive of 2021 prices, and the associated natural gas outlook has since deteriorated even further," Bank of America Merrill Lynch wrote in a report. "There is limited support in the front of the gas curve though, especially with the entire global gas market converging."
- U.S. gas production has declined by 4 bcf/d since November, when it peaked at 95 bcf/d. But storage is still up 55 percent year-on-year, providing little near-term reason for bullishness.
- Around 20 LNG cargoes have been canceled in June. Bank of America says they are "unlikely to get placed by other entities since export economics are so far out of the money."
- There is upside potential for gas in 2021, but Bank of America says it is too soon to say. The bank increased its price forecast for Henry Hub to $2.75/MMBtu for 2021, up from $2.45/MMBtu previously.

4. Second quarter bottom

- The worst of the oil demand destruction may be ending. U.S. gasoline demand ticked up last week, and more states are beginning to reopen. The same is true in Europe.
- U.S. gasoline cracks increased by $10 per barrel within five days, as Bloomberg New Energy Finance notes.
- BNEF says the second quarter could see a global oil supply surplus of around 17.3 mb/d, but in the second half of the year, the market goes into a deficit - of 3.2 mb/d in 3Q and 6.3 mb/d in 4Q.
- Others see similar trends. "But demand in the US is on its way back and demand will by June most definitely be better than it is now. Maybe down only 2-3 m bl/d YoY (which is still exceptionally weak)," SEB said in a report. "[I]f US demand is back up to within 2-3 m bl/d versus normal in June and supply in the US and Canada is down by 3.5 to 4.5 m bl/d already in May, then there shouldn't be a massive wall of oil banging on the door of Cushing Oklahoma."

5. DUC list coming down, but still large

- The number of drilled but uncompleted wells (DUCs) in U.S. shale has declined over the past year.
- The DUC Backlog initially grew between 2017 and 2019 because of the frenzied pace of drilling ran up against bottlenecks for fracking crews, labor and pipelines.
- The DUC list began to decline last year as those bottlenecks eased, plus companies slowed the pace of drilling to improve cash flow.
- Completions are now on a freeze because of the oversupply crisis. But the number of DUCs - at 7,576 as of March - is still enormous. "In the event of any more pronounced price rise, these could be quickly put into operation," Commerzbank wrote in a note.

6. After savage cuts, refineries begin a rebound

- U.S. refinery runs have increased for two consecutive weeks, rising from a low of 12.456 mb/d on April 17 to 12.976 mb/d on May 1.
- The slight increase in gasoline demand (and the smaller build in total petroleum product stocks) have added a small dose of optimism to the market.
- But some of the data is still bearish - inventories continue to rise. Gasoline stocks have decreased for two consecutive weeks, which, on its face, may seem like demand is increasing. However, stocks are falling also because refining remains depressed.
- Other products are also not showing dramatic improvement. "Diesel demand remains very weak pushing up distillate inventories, and we expect freight weakness caused by recession to continue well after gasoline demand rebounds," Standard Chartered wrote in a report.
- Marathon Petroleum (NYSE: MPC) reported a $9.2 billion loss in the first quarter after taking a $12.4 billion writedown.

7. OPEC production to fall 2.7 mb/d in 2020

- OPEC countries could see oil production fall by 2.7 mb/d lower in 2020. Saudi Arabia would shoulder cuts of 500,000 bpd, according to a forecast from Rystad Energy.
- Meanwhile, Iraq said that it may struggle to abide by the agreement, which poses a risk to supply cuts. The Iraqi government said it has yet to come to an agreement with international oil companies operating in the country, including ExxonMobil (NYSE: XOM), BP (NYSE: BP), Eni (NYSE: E) and Lukoil.
- "We can't say talks hit deadlock. We expect a breakthrough to be reached soon," a spokesman with the Basra Oil Co. told Reuters. "It's a mess at the moment," a Reuters source said.
- OPEC production could average 29.2 b/d this year, before growing to 34 mb/d by 2025.