Analys
Shale oil denial once again?
Price action – Dollar headwinds driving speculators to take money off the table
Equities across the board rebounded 0.7% ydy following the recent North Korea driven sell-off. The USD Index however gained 0.4% on the day which helped to drive all commodity indices lower with the overall Blbrg commodity index down 0.7% with energy losing the most. Brent crude sold down 2.6% closing at $50.73/b while the longer dated Brent Dec 2020 contract only lost 1% closing at $52.62/b.
Since a Brent crude oil price low of $44.35/b in June 21st net long speculative WTI positions have moved in only one direction – up. Since then the number of net long speculative WTI contracts have increased by 156,000 contracts (+42%) or 156 mb. As of Tuesday last week the number of net long speculative WTI contracts stood at 532,000 contracts which was the 7th highest speculative position over the past 52 weeks. Except for the release of the US EIA’s monthly Drilling Productivity report there was little in the news that warranted the 2.6% sell-off in Brent crude oil prices other than speculators taking money off the table following 7 consecutive weeks of rising long bets.
Crude oil comment – Shale oil denial once again?
What puzzles us a lot is graph 2 below. It shows the US EIA’s projection of US crude oil production coming out of Lower 48 states (i.e. ex Gulf of Mexico and Alaska). Thus it basically constitutes US shale oil production even though it includes a million or two of US crude production which is not shale oil as well.
What the the US EIA STEO August report projects is that from January to September the marginal, annualized Lower 48 crude oil production growth has averaged 1.25 mb/d. That we buy into. Then however, from October 2017 onwards their projected growth rate then suddenly collapse to a marginal annualized growth rate of only +0.2 mb/d all to the end of 2018 (on average).
When the US shale oil production was booming from 2011 to 2015 the story was always that yes, production is growing strongly now, but next year it will taper off. The tapering off never happened before the oil price collapsed and all breaks were on. During 2012, 2013 and 2014 the US shale oil production grew relentlessly at an annual pace of 1 mb/d.
Thus even if the market is fully aware of US shale oil these days. Fully aware that rigs are rising and productivity is rising. The story still looks a bit the same in terms of what the US EIA currently is projecting in its August STEO report. Yes, shale oil is growing at a strong marginal, annual pace now, but from October onwards it is all going to slow sharply. Thus shale oil awareness is definitely there but is it again too pesimistic in terms of volumes delivered down the road just as was the case consistently from 2012 to 2014/15. Still some kind of shale oil denial in a way in terms of production down the road.
Yesterday the US EIA released its drilling productivity report (DPR) and its DUC’s report (Drilled wells and uncompleted wells). First out the reports stated a projection that US shale oil production will increase by 117 kb/d mth/mth to September. That equals a marginal, annualized pace of 1.4 mb/d per year. The puzzle is that the EIA projects that this strong growth rate is going to suddenly fall back in October onwards.
What was further revealed was that the number of completed wells per month continued to rise by 25 wells mth/mth to 859 wells in July. Completions were however still trailing way behind the number of wells drilled by more than 200 wells. Wells drilled reached 1075 wells in July which also was an increase mth/mth by 28 wells. Thus completions are rising but are still solidly trailing behind drilling of wells.
For US shale oil production to slow down we first need to see a halt in the number of drilling rigs being added into operation. Only 2 implied shale oil rigs were added last week, but the number is still rising marginally rather than falling. But yes, that part is slowing down. The next step then is to see that completions manage to catch up with drilling. I.e. completions needs to move from a July level of 859 wells completed to at least 1075 wells drilled. Then the last step is that completions start to draw down the now very high DUC inventory which has seen an increase of 1595 wells since November 2016 now standing at 6154 wells.
So during the unavoidable (some time in the future) draw down period of DUCs we need to see that completions move above drilled wells per month in order to draw down the DUC inventory. I.e. the number of wells completed should move above 1075 wells per month unless of course the number of drilling rigs declines. A lower oil price or reduced access to capital is typically the driving forces which would lead to a reduction in drilling rigs. Captial spending and profitability is definitely at the top end of the agenda these days in the shale oil space.
In terms of the DUC inventory build up. In perspective the 1595 wells added since November last year equates to some 5-600 million barrels of additional producible oil within a three year time frame. That is if we assume 350,000 barrels of oil from each well during the first three years of production on average for all wells.
In this perspective it is difficult to understand the US EIA’s projection that US L48 crude oil production growth is going to slow sharply from October onwards. Drilling rigs are still rising (although slowly) and completions still has a lot of catching up to do just to get up to speed with drilling and then some to draw down the DUC inventory.
Not surprisingly we are bullish for US crude oil production for 2018 where we expect US crude oil production to increase y/y by 1.5 mb/d rather than the US EIA’s y/y projecting that US crude oil will only increase 0.6 mb/d y/y to 2018.
OPEC will have a lont on its hands in 2018 and will likely need to manage supply all through to the end of 2018 rather than to end of Q1-17.
(Data for drilling and completions etc in this report were for the regions Anadarko, Bakken, Eagle Ford, Niobrara and Permian and are from the US EIA.)
Ch1 – Net long specs in WTI reached the 7th highest in a year last Tuesday
A strong, long rise in net long spec since the price low in late June
Sideways price action during most of August with no success to the upside when Brent hit $53.64/b.
Then dollar headwinds and North Korea risk aversion. Both pushing specs to take money off the table
Oil prices in graph are averaged over weeks ending Tuesday. Same as specs reporting
Ch2 – US EIA STEO August report projects a sharp slowdown in marginal growth in US L48 crude oil production from October onwards
How is that possible when drilling rig count is still rising and completions are still working hard catching up rising as well.
Ch3 – Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)
Today’s level looks unimpressive versus 2014 levels. But they need to be adjusted with productivity improvements
Ch3 – Productivity adjusted – Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)
If we productivity adjust the historical data of number of wells drilled and completed with productivity then:
a) Number of drilled wells today per month is 40% higher then the previous peak in September 2014
b) Number of completed wells is 11% higher than the previous peak in October 2014
If completions catches up to current drilling then completions will run 40% higher than the previous peak in October 2014 in productivity adjusted terms.
Ch 4 – Strong rise in DUC (uncompleted wells) inventory since November last year
Equating it to oil it has increased close to 600 mb since Nov last year in terms of oil from first three years of production each well
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
Selling down on a ”deal”. Brent crude fell 6.2% last week with accelerated weakness towards the end of the week. Close of the week at $87.33/b and low of the week (and on Friday) of $85.8/b. Brent is falling another 4% this morning to $83.7/b on confirmation by Iran that a MoU text has been reached and that it will be signed on Friday this week.
So what is this ”deal” worth? Talk on the desk here this morning is that it is much like ”putting lipstick on a pig” where Trump has to sell this at home as a victory where ”the SoH has reopened”, the nuclear issue will be ironed out over the coming 60 days (or maybe 600 days?) and US consumers are getting a lower gasoline price and maybe US republicans survives the midterm elections.
The importance for Iran is that it emerges as the defacto winner of this war in the eyes of the non-US public world. That Iran now onwards is the ”ruler of the SoH” (combo of geography and new weapons systems like drones) or more softer: ”the guarantor of safe passage through the SoH”.
Iran doesn’t need nuclear weapons any more. Nuclear deterrence doesn’t work any more. Ukraine has made many attacks deep into Russia without being nuked in return. Plenty of Iranian ballistic rockets blasts over Israel but Iran wasn’t nuked in return.
There is no trust between the US and Iran. We don’t know all the details yet of the MoU. But what we do know is that there is no trust between the US and Iran what so ever. This is probably more like a descriptive text on how they can cooperate in a way where both sides keeps tactical leverage. Neither side makes irreversible concessions. Violations can be punished quickly. Cooperation produces immediate benefits.
This is a fragile structure. It can easily break down. There may be details which cannot be overcome. To be seen on Friday. The US has to show that it is willing put enough force behind managing and restraining Israel versus Hezbollah in Lebanon. We have seen that Netanyahu hasn’t listened all that much to Trump’s directives and wishes. This could be a major obstacle.
A gradual reopening is tactically preferable for Iran. A tactical leverage for Iran right now is that global oil stocks have been drawn down towards painful and increasingly dangerous levels with increasing risks for oil price spikes in mid-July to August. This together with US midterm elections on 3 November gives tactical leverage to Iran. Iran probably doesn’t want to fully give up on that leverage. A rapid, full reopening where global stocks are able to refill over the coming 60 days will significantly erode that leverage. If Iran reinstates a closure of the SoH after 60 days (if talks break down again), then the effect won’t be that impactful in terms of prices and the US midterm elections.
So a gradual and partial reopening where global markets gets the oil they need while they are unable to rebuild stocks could be a practical middle way for both parties. Trump can sell it as ”the SoH has reopened” and get affordable gasoline for US consumers. Iran can sell it as ”the SoH has fully reopened, but there is some friction” so flow is only 60-80% of normal.
Not much real demand destruction below $100/b. What we do know is that there is not much real price pain demand destruction for oil globally at an oil price below $100/b. A lot of demand-shock destruction. Fear. But demand should now come roaring back towards normal with fear for exceptionally high prices now is rapidly receding.
Sudden China demand destruction due to EVs? Bullocks. EV share of total Chinese carpool now around 13%. Share of new sales of EVs has reached 50%. This is a very gradual process. It doesn’t make oil demand fall like a rock over night. When EV new sales share reaches 100%, then the gasoline car pool will contract by some 5-10% per year. But that is only gasoline. Sudden reduction in Chinese oil demand is more about shock and risk.
Chinese crude oil imports will come roaring back. At what price? Today’s ”neutral” oil price is $70/b. That is the five year price which has steadily traded around the $70/b mark over the past 3-4 years. With still a risky picture one would think that China and the rest of the world will be big buyers of oil in the range of $70-85/b.
Global demand will likely snap back towards normal, forecasted demand and growth at such prices.
Physical reopening is a gradual process. The physical and practical reopening of the SoH will likely be gradual rather than sudden. And that probably suites Iran tactically as well.
Brent M1 price versus the Brent 5-yr (today’s ”normal” price)
Market is starting to take US/Iran headlines with a pinch of salt. Brent crude rose $2.8/b yesterday to an official close of $112.1/b. But after that it traded as low as $108.05/b before ending late night at around $109.7/b. Through the day it traded in a range of $106.87 – 112.72/b amid a flurry of news or rumors from Iran and the US. ”US temporary sanctions during negotiations” (falls alarm). ”We will bomb Iran” (not anyhow),… etc. While the market is still fluctuating to this kind of news flow, it is starting to take such headlines with a pinch of salt.
We’ll see. Maybe, maybe not. The Brent M1 contract is trading at $110.2/b this morning which very close to the average ticks through yesterday of $110.4/b.
Trump with bearish, verbal intervention whenever Brent trades above $110/b it seems. What seems to be a pattern is that Trump states something like ”very good negotiations going on with Iran”, ”New leaders in Iran are great,..”, ”Great progress in negotiations,…”, ”Deal in sight,..” etc whenever the Brent M1 contract trades above $110/b. An effort to cool the market. These hot air verbal interventions from Trump used to have a heavy bearish impact on prices, but they now seems to have less and less effect unless they are backed by reality.
As far as we can see there has been no real progress in the negotiations between the US and Iran with both sides still standing by their previous demands.
Iran is getting stronger while the cease fire lasts making a return to war for Trump yet harder. Iran is naturally in constant preparation for a return to war given Trump’s steady threats of bombing Iran again. Iran is naturally doing what ever is possible to prepare for a return to war. And every day the cease fire lasts it is better prepared. This naturally makes it more and more difficult and dangerous for the US to return to warring activity versus Iran as the consequences for energy infrastructure in the Persian Gulf will be more and more severe the longer the cease fire lasts. Israel seems to see it this way as well. That the war is not won and that current frozen state of a cease fire gives Iran opportunity to rebuild military and politically.
Global inventories are drawing down day by day. How much? In the meantime the Strait of Hormuz stays closed. There is varying measures and estimates of how much global inventories are drawing down. Our rough estimate, back of the envelope, is that global inventories are drawing down by at least some 10 mb/d or about 300 mb/d in a balance between loss of supply versus demand destruction. Other estimates we see are a monthly draw of 250-270 mb/d. The IEA only ’measured’ a draw in global observable stocks of 117 mb in April with oil on water rising 53 mb while on shore stocks fell 170 mb. But global stocks are hard to measure with large invisible, unmeasured stocks. As such a back of the envelope approach may be better.
Oil products is what the world is consuming. Oil product prices likely to rise while product stocks fall. Strategic Petroleum Reserves (SPR) are predominantly crude oil. Discharging oil from OECD SPR stocks, a sharp reduction in Chinese crude imports and a reduction in global refinery throughput of 6-7 mb/d has helped to keep crude oil markets satisfactorily supplied. But global inventories are drawing down none the less. And oil products is really what the world is consuming. So if global refinery throughput stays subdued, then demand will eventually have to match the supply of oil products. The likely path forward this summer is a steady draw down in jet fuel, diesel and gasoline. Higher prices for these. Then, if possible, higher refinery throughput and higher usage of crude in response to very profitable refinery margins. And lastly sharper draw in crude stocks and higher prices for these. But some 6 mb/d of oil products used to be exported through the Strait of Hormuz. And it may not be so easy to ramp up refinery activity across the world to compensate. Especially as Ukraine continues to damage Russian refineries as well as Russian crude production and export facilities.
Watch oil product stocks and prices as well as Brent calendar 2027. What to watch for this summer is thus oil product inventories falling and oil product premiums to crude rising. Another measure to watch is the Brent crude 2027 contract as it rises steadily day by day as the Strait of Hormuz stays closed and global oil inventories decline. The latter is close to the highest level since the start of the war and keeps rising.
The Brent M1 contract and the Brent 2027 prices and current price of jet fuel in Europe (ARA). All in USD/b
Our back of the envelope calculation of the global shortage created by the closure of the Strait of Hormuz. Note that 3.5 mb/d of discharge from SPR is also a draw. Note also that ’Forced demand loss’ of 2.5 mb/d is probably temporary and will fall back towards zero as logistics are sorted out leaving ’Price demand loss’ to do the job of balancing the market. Thus a shortfall of at least 9 mb/d created by the closure. More if SPR discharge is included and more if Forced demand loss recedes.
Brent is climbing higher. Front-month is at USD 106.3/bl this morning, close to a weekly high and a USD 9/bl jump from Mondays open. This is the move we flagged as a risk earlier in the week: the market shifting from ”a deal is around the corner” to ”this is going to take longer than we thought”.
Analyst Commodities, SEB
During April, rest-of-year Brent remained remarkably stable around USD 90/bl. A stability which rested on one single assumption: the SoH reopens around 1 May. That assumption is now slowly falling apart.
As we highlighted yesterday: every week of delay beyond 1 May adds (theoretically) ish USD 5/bl to the rest-of-year average, as global inventories draw 100 million barrels per week. i.e., a mid-May reopening implies rest-of-year Brent closer to USD 100/bl, and anything pushing into June or July takes us meaningfully higher.
What’s changed in the last 48 hours:
#1: The US military has formally warned that clearing suspected sea mines from SoH could take up to six months. That is a completely different timescale from what the financial market is pricing. Even a political deal tomorrow does not immediately reopen the strait.
#2: Trump has shifted his tone from urgency to ”strategic patience”. In yesterday’s press conference: ”Don’t rush me… I want a great deal.” The market is reading this as a president no longer feeling pressured by timelines, with the naval blockade running in the background.
#3: So far, the military activity is escalating, not de-escalating. Axios reports Iran is laying more mines in SoH. The US 3rd carrier strike group (USS George H.W. Bush) is arriving with two countermine vessels. Trump yesterday ordered the US Navy to destroy any Iranian boats caught laying mines. While CNN reports that the Pentagon is actively drawing up plans to strike Iranian SoH capabilities and individual Iranian military leaders if the ceasefire collapses. i.e., NOT a attitude consistent with an imminent deal!
Spot crude and product prices eased off the early-April highs on a combination of system rerouting and deal optimism. Both now weakening. Goldman estimates April Gulf output is reduced by 14.5 mbl/d, or 57% of pre-war supply, a number that keeps getting worse the longer this drags on.
Demand-side adaptation is ongoing: S. Korea has cut its Middle East crude dependence from 69% to 56% by pulling more from the Americas and Africa, and Japan is kicking off a second round of SPR releases from 1 May. But SPRs are finite.
Ref. to the negotiations, we should not bet on speed. The current Iranian leadership is dominated by genuine hardliners willing to absorb economic pain and run the clock to extract concessions. That is not a setup for a rapid resolution. US/Israeli media briefings keep framing the delay as ”internal Iranian divisions”, the reality is more complicated and points toward weeks and months, not days.
Our point is that the complexity is large, and higher prices have only just started (given a scenario where the negotiations drag out in time). The market spent April leaning on the USD 90/bl rest-of-year assumption; that case is diminishing by the hour. If ”early May reopening” is replaced by ”June, July or later” over the next week or two, both crude and products have meaningful room to reprice higher from here. There is a high risk being short energy and betting on any immediate political resolution(!).
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