The price of oil has bounced 20% since January 29 when the benchmark West Texas Intermediate had dipped below $44 a barrel, but according to Edward Morse, Citigroup’s global head of commodity research, that dizzying bounce is a “head-fake.”
Because the fundamentals are still terrible. Oil production in the US is still rising, despite drillers shutting down drilling activities at a record pace. Drilling fewer new wells is hurting oil field services companies, and the pain is fanning out across the oil patch and beyond. It hit private equity firms, it sank energy junk bonds, it triggered layoffs, but it isn’t curtailing oil production. Not yet.
So the US remains by far the largest contributor to “global oil supply growth,” the US Energy Information Administration just pointed out, with production in 2014 jumping by 1.59 million barrels a day. By comparison: in Iraq, the second largest contributor to global oil supply growth, production edged up by 0.33 million barrels a day.
“Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia,” explained the Citi report, cited by Bloomberg. “The market is oversupplied, and storage tanks are topping out.”
Production will continue to rise, despite plunging drilling activity, and won’t slow down until the third quarter this year. As the oil glut is growing, it wreaks havoc on the price of oil, potentially pushing it, according to the report, into the neighborhood of $20 a barrel – “for a while.”
Analysts, faced with the oil glut that resulted from the US shale oil revolution, are scrambling to bring their erstwhile sky-high expectations into line with reality. They have slashed their projections for the energy sector; and according to FactSet, revenues are expected to plunge 36% in the first quarter. The plunge is so steep that it will drag revenue “growth” for all S&P 500 companies combined into the negative, -2.3% in Q1 and -2.6% in Q2.
And the US shale oil revolution has defanged OPEC. It can no longer control oil prices at will to maximize profits for oil-producing countries, including the US. A sort of an unpleasant free market has suddenly re-broken out. “It looks exceedingly unlikely for OPEC to return to its old way of doing business,” Citi’s report said. “While many analysts have seen in past market crises ‘the end of OPEC,’ this time around might well be different.”
But Citi is an integral part of Wall Street, and Wall Street dreams of a V-shaped recovery of everything because that’s where the quick and big bucks are to be made. Prices even in the current range are unsustainable for the industry, the report pointed out, and will entail a wave of “disinvestment from oil,” of the type we’re already seeing. But then, after oil plunges into the $20-range, presumably by no later than the third quarter, mirabile dictu, the price will soar, according to the report, and I mean SOAR, with Brent hitting $75 a barrel by the end of this year – more than tripling in a little over a quarter.
From $52 a barrel to $20 and then to $75 in just one year? That’s the kind of V-shaped recovery that dreams are made of. Every trader lusts for this. Wall Street lusts for it. Hedge funds can hardly contain themselves at the mere thought of it. So whose book is Citi talking up?
If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets. And beyond that, investment banks stand to lose a lot: in 2014, Citi earned $492 million in energy-related investment-banking revenues – more than any other bank! More even than JP Morgan.
So Wall Street must have a V-shaped recovery in place by 2016, or else.
We have watched the price of natural gas drop to ludicrously low levels – and stay there. Natural gas producers have been bleeding for years. Those that could, switched production to shale plays that were rich in oil, condensate, and natural-gas liquids that brought much higher prices and allowed some of these gas wells to be profitable. But now, their prices have plunged as well, and that solution has gone up in vapors. Yet, production continues to soar from record to record! There has been no V-shaped recovery in the price of natural gas. And if or when there is a price spike, it won’t be the right side of a “V,” but a spike after years of terrible bleeding.
OK, oil is different. It’s a global commodity, which landlocked US natural gas is not. And there was a V-shaped recovery after the financial crisis as the central-bank money-printing binge around the world inflated nearly all assets. This time around, there isn’t a financial crisis, and no sudden collapse in global demand. Instead we have lackluster demand, rising production, and increasingly a glut. And the Fed, the biggest perpetrator at the time, is sitting on its hands. So that breath-taking, stunning V-shaped recovery back to paradise might remain what dreams are made of.
Meanwhile, far from Wall Street, and out in the oil patch, the cutbacks in the exploration-and-production sector are hitting oil-field services companies hard. They too are cutting back. The impact is rippling out further. And the bloodletting will go on.
By. Wolf Richter of Wolf Street