The most likely case is that WTI will remain stuck in the upper $40 to lower $50 range through December 2017.
Comparative inventories have fallen dramatically since mid-February yet oil prices languish in the mid-to-upper $40 range. But what will it take for oil prices to break out of the $45 to $55 range?
WTI prices increased from below $45 to almost $55 per barrel based on expectation that OPEC cuts would quickly balance international oil markets and result in near-term higher oil prices. While that expectation lasted, prices remained near $55 from late November 2016 until early March 2017 (Figure 1).
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Figure 1. WTI Prices Have Been Largely Range-Bounded Between $45 and $55/Barrel Since The OPEC-NOPEC Production Cuts. Source: EIA, Bloomberg and Labyrinth Consulting Services, Inc.
Prices adjusted downward four times between March and August as it became clear that output cuts were not enough to produce a meaningful price recovery. Since mid-August, markets have rallied back to the ~$49 per barrel price average since November.
Tight Oil Rig Counts
Rising rig counts in U.S. tight oil plays have been the most important factor constraining oil prices. Investors fear that resulting increased output will prevent the market from reaching balance.
Rig counts in the Permian basin, Bakken and Eagle Ford plays began increasing after WTI fell below $30 per barrel in early 2016. Since OPEC first suggested the possibility for a production cut in August 2016, tight oil rig counts have more than doubled (Figure 2).
Figure 2. Tight OIl Rig Counts Have Doubled Since Mid-August 2016. Eagle Ford horizontal rig count has fallen the most of the tight oil plays. Source: Baker Hughes and Labyrinth Consulting Services, Inc.
While the increase in the number rigs is impressive, the most revealing aspect of Figure 2 is the decline of the Eagle Ford, and the flattening of Permian basin and Bakken rig counts since June. This suggests that the appetite for tight oil plays among equity investors may be moderating.
Despite claims of sub-$40 per barrel break-even prices by Permian basin producers, rig count data indicates that overall play economics require higher prices. The weekly change in Permian rig count suggests that break-even WTI prices may be closer to $55 or $60 per barrel (Figure 3). Break-even prices for some producers are certainly lower but higher prices are required for the average company.
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Figure 3. Rig Count Weekly Change Suggests Permian Break-Even Price Is $55-$60/Barrel. Rig Count Rises and Falls on Expectation of $55 to $60 Prices. Source: Baker Hughes, EIA and Labyrinth Consulting Services, Inc.
Above all, rig count reflects capital flows and the availability of other peoples’ money to fund the tight oil plays—this is critical to production maintenance and growth. Figure 3 shows that capital availability is dependent on expectation of $55 to $60 oil prices. Capital flows have apparently faded with those expectations or else producers are using available capital for other purposes in addition to drilling. Related: In A Bold Move, Saudis Raise Crude Prices For Asia
Comparative inventory (C.I.) fell 117 million barrels (mmb) from mid-February through the end of August (Figure 4).* This is the most significant oil market development since oil prices collapsed in 2014 but it has had little impact on oil prices so far.
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Figure 4. ~4.2 mmb/week (600 kb/d) Decrease in Net Petroleum Product Imports Account For Most Inventory Reductions in 2017. Note: Net imports of petroleum products increased 1.7 mmb for the week ending September 1 because of Hurricane Harvey. Latest data is not included in Figure 4 because it skews net imports based on a weather-related anomaly. Source: EIA and Labyrinth Consulting Services, Inc.
Lower net imports of petroleum products is the main reason for this reduction in C.I. Refinery intakes are at record levels as refiners produce and sell refined products in the U.S. and abroad. As I pointed out last month, this trend is only sustainable if demand for U.S. refined products persists.
While exporting products helps reduce U.S. stocks, it aggravates the global over-supply of liquids. Higher net imports in recent months suggest that this trend may be weakening or ending.
Figure 5 shows the magnitude of inventory reductions from mid-February to late August as a “yield curve” of WTI price vs. C.I.
I estimated a range of probable year-end C.I. values to be between 55 and 75 mmb using EIA August STEO inventory forecasts and 2017 inventory decline trends. This range of C.I. translates to December WTI prices between $48 and $51 per barrel. Related: Can Russia Develop Its Shale Reserves?
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Figure 5. Most-Likely December 2017 C.I. Range 55-75 mmb and $48-$51/barrel WTI prices. Source: EIA and Labyrinth Consulting Services, Inc.
Large reductions in C.I. so far have not resulted in meaningful increases in oil prices because the yield curve is fairly flat. That is typical of outsized storage levels.
Oil prices collapsed in 2014 because of excess supply from over-production. Low prices and the contango term structure of forward curves encouraged putting large volumes of crude oil and refined products into storage.
By Art Berman for Oilprice.com
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