There are two things you’re not supposed to do in business journalism. One is to admit mistakes before somebody calls you on them. The other is to write in the first person; “I,” “me” and so on.
So I’ll get it over with. I was wrong. On January 17, 2015 I wrote an article titled, “Oil Prices To Recover by Q3,” followed by, “…oil won’t increase to $100 anytime soon. But it will certainly rise much closer to the global replacement cost of about $80 in about six months or the end of summer 2015.”
In fact, it went the other direction. On January 16, the last trading day before my prediction, benchmark U.S. crude pricing West Texas Intermediate (WTI) closed at US$48.48. Eight months later, when it was supposed to be way up, it was more than $4 a barrel lower. WTI closed on September 18, 2015 at US$44.68.
Summer ends today. Oops. But there are still nine days to the end of Q3 (September 30) for an oil price miracle to vault WTI to US$65 or higher, a price at which I would be vindicated, perhaps even be considered some sort of seer.
But, barring a military altercation in the Strait of Hormuz or the blockade of equally important Middle East oil supply choke point, I will be just plain wrong. Oil markets are clearly subject to different forces than in the past. And when it comes to wrong price predictions, I’m in good company.
The good news is, I never bought any more oil stocks to exploit my cleverly identified recovery. The bad news is I never sold any either.
The International Energy Agency (IEA) is as good a source as any to figure out where global crude markets have been. The simple table below charts the last two quarters of 2014 and the first two quarters of 2015 to explain why prices have fallen as far as they have.
(Click to enlarge)
Source: International Energy Agency
Historically, Q4 is the strongest for demand and Q1 is the weakest. In Q1 of 2013, world oil demand was 90.74 million barrels per day (b/d). Three years later, Q4 2016, IEA estimates global oil demand will have risen to 96.24 million b/d, 5.5 million b/d in actual barrels and 6 percent in terms in ratios. Related: Midweek Sector Update: Iran Holding Up Its End Of The Bargain, So Far
Whatever progress oil haters and alternative energy sources would like to have on world oil demand, the price collapse is working. Demand for oil is supposed to increase by 1.5 million b/d in 2015 and 1.7 million b/d in 2016, up significantly from earlier estimates. This is driven partially by industrialization and partly by lower prices—U.S. gasoline demand is rising, as is the demand for bigger vehicles such as light trucks and SUVs.
The issue has been supply and the production surplus; the spread between supply and demand. Over this one-year period, supply has grown by 2.14 million b/d globally even though the price has been falling. As the surplus has increased, the price has gone in the opposite direction, with the exception of Q2 this year. However, this price-rise anomaly has since repaired itself.
Years of massive investments in new oil supplies clearly don’t shut off overnight, particularly if those projects have already seen companies invest billions of dollars and are on the home stretch of completion. Such is the case for Canada’s oil sands, which will add some 800,000 b/d in new production in the next three years, although greenfield projects have ground to a halt. The Gulf of Mexico and other long-term offshore development still have projects nearing or at the completion stage which will also add to future supply, regardless of current market conditions.
But what can be stopped, because it doesn’t make economic sense, has been cancelled or delayed. Tens of billions of future capital spending is on hold. Many producers are scaling back budgets further as prices remain stubbornly low. Conventional drilling in North America is the most responsive to price in either direction. The major decline in the Canadian and U.S. rig count is well known.
OPEC, which the world’s privately-owned oil industry has counted upon to maintain some stability in world oil markets for over 40 years, remains unpredictable. OPEC, which has an official quota of 30 million b/d, no longer even talks about enforcement as it pumps close to 32 million b/d, with Iran ready to add more. In January, nobody was thinking U.S. President Barrack Obama would be able to not only close a deal with Iran, but overcome stiff opposition in Congress to use presidential authority to remove the global economic sanctions on Iran, thus allowing it add even more oil to a flooded global market. Less affluent OPEC members have been asking for cooperation and even talking to the Russians, but the low-cost Persian Gulf producers are staying the course, at least for now. Related: Can The Saudi Economy Resist ‘Much Lower For Much Longer’?
One of the problems this downturn has illustrated is access to quality information. U.S. shale is the most egregious example. The business community has read for months that shale oil production just keeps rising. Although the oil well drilling rig count is down 60 percent, analysts have reported the rigs are more efficient and the prospects are being high-graded. There have been phenomenal quantities of absolute rubbish written and widely reported about the indestructability of U.S. shale and how it is now the new OPEC in terms of its capacity to be a low cost, swing producer.
Finally, real figures are emerging. Production has been overstated in the U.S. by some 100,000 b/d a month all year. While the momentum from past investments took some time to lose speed, production peaked in April. It is now widely recognized to the end of August that previously impervious U.S. shale production was down over 400,000 b/d from its springtime peak. In a research report dated September 4, First Energy Capitals’s Martin King’s analysis was titled, “U.S. Crude Oil Supply Has Definitely Rolled Over.” King estimated U.S. shale oil output may be down 640,000 b/d from its peak by September 30 and as much as a million b/d by the end of the year.
What makes U.S. tight oil more amazing is how it is financed. A research report titled “shale’s dirty secret” was released by Citi Research September 8 containing information many insiders know. At these prices, many tight oil developers don’t generate positive cash flow and depend entirely on capital inflows to stay in business. Half of the 135 public exploration and production (E&P) companies studied by Citi are outspending cash flow and only survive because of investors who either don’t know better or don’t understand the business and keep pouring in cash.
One news report called U.S. capital markets “the new OPEC.” U.S. oil production would and could remain high so long as investors keep pouring money into high-decline tight oil wells that don’t generate enough full-cycle cash flow to pay for themselves. This is being done despite growing evidence most U.S. tight oil producers lose cash on every barrel they produce. This will end soon and for many overleveraged outfits, end poorly.
The rise in demand and the decline in U.S. shale oil output combining for a million b/d swing in world output was correctly predicted by yours truly in January. What I didn’t know was this would not be enough to swing prices in the right direction.
But all is not lost. Despite all the bad data, faulty projections, incorrect headlines, investment on faith, overlooking supply risk from volatile countries and regions and a new mantra of “lower for longer” (whatever “longer” really means), the global supply and demand curves will cross. In its mid-September report, the IEA published the following graph which finally shows supply and demand curves crossing in Q4 2016, about a year from now. Better late than never.
Source: International Energy Agency Related: Peak Oil Has More To Do With Oil Prices Than You May Think
The only thing you know for sure about this IEA chart is the forward looking numbers are wrong. The IEA is forecasting a lower decline in U.S. tight oil than other sources indicate already has occurred. Iran is said to be adding oil but how much crude is currently being exported from that country through overland back channels is unknown. There is no geopolitical risk priced into oil today despite continued tensions in many producing countries. And the relentless string of bad news and a rising U.S. dollar which have pressured all commodities – not just oil – has to ease up at some point.
If there is anything we should have all learned from the past 10 months since OPEC pulled the plug on supporting world oil markets is: very much of what you read is wrong. Including me.
With oil selling at a fraction of replacement cost; with no sources of accurate production data (such as what we get in Canada, thanks to governments owning the mineral rights and demanding timely production reports); with so much analysis coming from people who really don’t understand how this business works, the turnaround in the market will happen sooner than later.
But the last time I published a date, it didn’t work out so well.
By David Yager of Oilprice.com
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