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
Brent touching down to the 200dma. Brent crude traded down for a fifth day yesterday with a decline of 0.4% to USD 70/b. This morning it has traded as low as USD 78.6/b and touched down and tested the 200dma at USD 78.6/b before jumping back up and is currently trading up 0.2% on the day at USD 79.1/b.
The Dubai 1-3mth time-spread is holding up close to recent highs. The 1-3mth time spreads for WTI and Brent crude have eased significantly. The Dubai 1-3mth spread is however holding up close to latest high. Indian refiner Bharat is reported to struggle to get Russian crude for March delivery (Blbrg). The Biden-sanctions are clearly having physical market effects. So, the Dubai 1-3mth time-spread holding on to recent high makes a lot of sense. I.e. it was not just a spike on fears.
US oil inventories may have risen 6 mb last week (API). Actual data later today. The US DOE will release US oil data for last week later today. The US API last night indicated that US crude and product stocks may have risen close to 6 mb last week. This may be weighing on the oil price today.
Brent and WTI 1-3mths time-spreads have fallen back while Dubai is holding up
Brent crude is no longer overbought. Down touching the 200dma before bouncing back up a lilttle.
Analys
Crude oil comment: Deferred contracts still at very favorable levels as latest rally concentrated at front-end
Bouncing up again after hitting the 200dma. Bitter cold winter storm in Texas adding to it. Brent crude continued its pullback yesterday with a decline of 1.1% to USD 79.29/b trading as low as USD 78.45/b during the day dipping below the 200dma line while closing above. This morning it has been testing the downside but is now a little higher at USD 79.6/b. A bitter cold winter storm is hitting Texas to Floriday. It is going to disrupt US nat gas exports and possibly also US oil production and exports. This may be part of the drive higher for oil today. But maybe also just a bounce up after it tested the 200dma yesterday.
Some of the oomph from the Biden-sanctions on Russia has started to defuse with arguments running that these sanctions will only delay exports of Russian crude and products rather than disrupt them. The effects of sanctions historically tend to dissipate over time as the affected party finds ways around them.
Donald criticizing Putin. Biden-sanctions may not be removed so easily. In a surprising comment, Donald Trump has criticized Putin saying that he is ”destroying Russia” and that ”this is no way to run a country”. Thus, Donald Trump coming Putin to the rescue, removing the recent Biden-sanctions and handing him a favorable peace deal with Ukraine, no longer seems so obvious.
Deeper and wider oil sanctions from Trump may lift deferred contracts. Trump may see that he has the stronger position while Putin is caught in a quagmire of a war in Ukraine. Putin in response seems to seek closer relationship with Iran. That may not be the smart move as the US administration is working on a new set of sanctions towards Iranian oil industry. We expect Donald Trump to initiate new sanctions towards Iran and Venezuela in order to make room for higher US oil production and exports. That however will also require a higher oil price to be realized. On the back of the latest comments from Donald Trump one might wonder whether also Russia will end up with harder sanctions from the US and lower Russian exports as a result and not just Iran and Venezuela. Such sanctions could lift deferred prices.
Deferred crude oil prices are close to the 70-line and are still good buys for oil consumers as uplift in prices have mostly taken place at the front-end of the curves. Same for oil products including middle distillates like ICE Gas oil. But deeper and lasting sanctions towards Iran, Venezuela and potentially also Russia could lift deferred prices higher.
The recent rally in the Dubai 1-3 mth time-spread has pulled back a little. But it has not collapsed and is still very, very strong in response to previous buyers of Russian crude turning to the Middle East.
The backwardation in crude is very sharp and front-loaded. The deferred contracts can still be bought at close to the 70-line for Brent crude. The rolling Brent 24mth contract didn’t get all that much lower over the past years except for some brief dips just below USD 70/b
ICE Gasoil rolling forward 12mths and 24mths came as low as USD 640/ton in 2024. Current price is not much higher at USD 662/ton and the year 2027 can be bought at USD 658/ton. Even after the latest rally in the front end of crude and mid-dist curves. Deeper sanctions towards Iran, Russia and Venezuela could potentially lift these higher.
Forward curves for Brent crude swaps and ICE gasoil swaps.
Nat gas front-month getting costlier than Brent crude and fuel oil. Likely shifting some demand away from nat gas to instead oil substitutes.
Brent crude was already ripe for a correction lower. Brent closed down 0.8% yesterday at USD 80.15/b and traded as low as USD 79.42/b intraday. Brent is trading down another 0.4% this morning to USD 79.9/b. It is hard to track and assign exactly what from Donald Trump’s announcements yesterday which was impacting crude oil prices in different ways. But crude oil was already ripe for a correction lower as it recently went into strongly overbought territory. So, Brent would probably have sold off a bit anyhow, even without any announcements from Trump.
Extending the life of US oil and gas. The Brent 5-year contract rose yesterday. For sure he wants to promote and extend the life of US oil and gas. Longer dated Brent prices (5-yr) rose 0.5% yesterday to USD 68.77/b. Maybe in a reflection of that.
Lifting the freeze on LNG exports will be good for US gas producers and global consumers in five years. Trumps lifting of Bidens freeze on LNG exports will is positive for global nat gas consumers which may get lower prices, but negative for US consumers which likely will get higher prices. Best of all is it for US nat gas producers which will get an outlet for their nat gas into the international market. They will produce more and get higher prices both domestically and internationally. But it takes time to build LNG export terminals. So immediate effect on markets and prices. But one thing that is clear is that Donald Trump by this takes the side of rich US nat gas producers and not the average man in the street in the US which will have to pay higher nat gas prices down the road.
Removing restrictions on federal land and see will likely not boost US production. But maybe extend it. Donald Trump will likely remove restrictions on leasing of federal land and waters for the purpose of oil and gas exploration and production. But this process will likely take time and then yet more time before new production appears. It will likely extend the life of the US fossil industry rather than to boost production to higher levels. If that is, if the president coming after Trump doesn’t reverse it again.
Donald to fill US Strategic Reserves to the brim. But they are already filled at maximum rate. Donald Trump wants to refill the US Strategic Petroleum Reserves (SPR) to the brim. Currently standing at 394 mb. With a capacity of around 700 mb it means that another 300 mb can be stored there. But Donald Trump’s order will likely not change anything. Biden was already refilling US SPR at its maximum rate of 3 mb per month. The discharge rate from SPR is probably around 1 mb/d, but the refilling capacity rate is much, much lower. One probably never imagined that refilling quickly would be important. The solution would be to rework the pumping stations going to the SPR facilities.
New sanctions towards Iran and Venezuela in the cards but will likely be part of a total strategic puzzle involving Russia/Ukraine war, Biden-sanctions on Russia and new sanctions on Iran and Venezuela. All balanced to end the Russia/Ukraine war, improve the relationship between Putin and Trump, keep the oil price from rallying while making room for more oil exports of US crude oil into the global market. Though Donald Trump looks set to also want to stay close to Muhammed Bin Salman of Saudi Arabia. So, allowing more oil to flow from both Russia, Saudi Arabia and the US while also keeping the oil price above USD 80/b should make everyone happy including the US oil and gas sector. Though Iran and Venezuela may not be so happy. Trumps key advisers are looking at a big sanctions package to hit Iran’s oil industry which could possibly curb Iranian oil exports by up to 1 mb/d. Donald Trump is also out saying that the US probably will stop buying oil from Venezuela. Though US refineries really do want that type of oil to run their refineries.
Big money and USD 80/b or higher. Donald Trump holding hands with US oil industry, Putin and Muhammed Bin Salman. They all want to produce more if possible. But more importantly they all want an oil price of USD 80/b or higher. Big money and politics will probably talk louder than the average man in the street who want a lower oil price. And when it comes to it, a price of USD 80/b isn’t much to complain about given that the 20-year average nominal Brent crude oil price is USD 77/b, and the inflation adjusted price is USD 102/b.
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