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US shale oil rigs keeps rolling in (oil price not yet low enough to reverse the inflow)

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Crude oil price action – A marginal rebound this morning before selling down further

SEB - Prognoser på råvaror - CommodityBrent crude traded down 2.5% w/w to Friday with a close of $46.71/b. From a high close of $49.68/b last Monday it was downhill all week with a selloff from Monday close to Friday close of a full 6%. Not even the report of a large inventory draw in US (Crude: -6.3 mb, Gasoline: -3.7 mb and Distillates: -1.9 mb) on Thursday was able to counter the bearish sell-off. This morning Brent crude rebounded 0.5% to $47.18/b before the selling continued. The invitation of Nigeria and Libya to OPEC & Co’s meeting in St. Petersburg, Russia on July 24th is put forward as the explanation for the rebound. Of course OPEC & Co would like to see a production cap on both Nigeria and Libya. It would of course be no problem for Libya to offer a production cap which would be 5% below its 1.6 mb/d capacity while it now is producing just above 1 mb/d and thus still a long way off from a potential cap of 1.5 mb/d (minus 5% versus capacity of 1.6 mb/d).

Further, what has now become entirely clear is that cutting production makes little sense as long as US drillers keeps adding +30 rigs each month.

Crude oil comment – US shale oil rigs keeps rolling in (oil price not yet low enough to reverse the inflow)

The number of US oil rigs rose by 7 last week and also by 7 for implied shale oil rigs. That is above the 10 week average of 5.8 rigs/week. The weekly average since start of June 2016 is 6.7 rigs/wk. There is typically a 6 week lag from price action to rig count change reaction. Six weeks ago the 18mth forward WTI price stood at around $49 – 50/b and thus above the $45-47/b empirical inflection point from one year ago (the price level where oil rigs neither increase nor decrease). Thus naturally rigs keep flowing into market. I.e. the oil price and the forward WTI crude curve were still too high six weeks ago.

The WTI 18 mth on Friday closed at $47.3/b and thus just touching down to the inflection point (empirical value from one year ago)
US oil rig inflow has not yet stopped and continues to flow into the market at a solid, steady rate as of yet.
The oil price needs to move lower in order to stem the inflow.

Over the past six weeks 35 shale oil rigs were added into active operation. So what is the productive impact of these extra 35 rigs? Our estimate is that today each active rig will lead to about 1200 b/d/mth of new production in a combination of [wells/rig/month] and [barrels/well/day/mth1]. That is 42,000 b/d/mth of new production for the 35 rigs. Today we assume a lag from rig activation to first oil of some 8 months due to pad drilling practice. The 35 rigs added over the past 6 weeks will thus be hitting the market with production in January/February 2018. From then onwards well will be stacked on well month after month. The staggering calculation is that by the end of 2018 these 35 rigs will add some 300 kb/d of production when the production of all these wells is stacked on top of each other (assuming 60% well production decline after 12mths).

Tomorrow the US EIA will release its monthly Short Term Energy Outlook (STEO) with a forecast stretching to end of 2019. The EIA has been lagging and under estimating US crude production consistently over the past year. As such they have revised US production forecast up, up, up every month with respect to 2017 and 2018 forecasts. Today their 2017 forecast is probably mostly correct. Their forecasts for 2018 and 2019 are however in our view hugely under estimated. As such we expect them to continue to revise their US crude production forecasts higher and that this will also be part of their message tomorrow at 1800 CET.

Table 1: US oil rig count up by 7 last week

US oil rig count up by 7 last week

Ch1: US shale oil rig count change versus oil prices 6 weeks ago

US shale oil rig count change versus oil prices 6 weeks ago

Ch2: As oil prices have a lagging impact we expect oil rigs to continue flowing into the market until late August

As oil prices have a lagging impact we expect oil rigs to continue flowing into the market until late August

Ch3: Productive effect of the 35 shale oil rigs added last six weeks: +300 kb/d in December 2018
Assuming 1200 b/d/rig/mth1 and a well production decline of 60% after 12 mths

Productive effect of the 35 shale oil rigs added last six weeks: +300 kb/d in December 2018

Ch4: The official US drilling productivity probably under estimates real productivity by some 40% to 60%
This is what we find when we combine wells/rig/mth with barrels/day/well/mth1
When the US EIA adjust for this in their models it should have a dramatic effect on their US oil production forecast.

The official US drilling productivity probably under estimates real productivity by some 40% to 60%

Table2: Solid draw in inventories in last week’s data

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 Solid draw in inventories in last week’s data

Ch5: Inventories in weekly data back on track for decline – more to come in H2-17
At the moment the market doesn’t care.
The effect should be a tightening of the time spreads at the front end of the crude curve 1 to 3 mths and 1 to 18 months.

Inventories in weekly data back on track for decline – more to come in H2-17

Ch6: WTI net long speculative positions slightly higher last week
Net long position still to the high side of neutral

WTI net long speculative positions slightly higher last week

Ch7: Crude forward curves close on Friday and one week ago

 Crude forward curves close on Friday and one week ago

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

More weakness and lower price levels ahead, but the world won’t drown in oil in 2026

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Some rebound but not much. Brent crude rebounded 1.5% yesterday to $65.47/b. This morning it is inching 0.2% up to $65.6/b. The lowest close last week was on Thursday at $64.11/b.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The curve structure is almost as week as it was before the weekend. The rebound we now have gotten post the message from OPEC+ over the weekend is to a large degree a rebound along the curve rather than much strengthening at the front-end of the curve. That part of the curve structure is almost as weak as it was last Thursday.

We are still on a weakening path. The message from OPEC+ over the weekend was we are still on a weakening path with rising supply from the group. It is just not as rapidly weakening as was feared ahead of the weekend when a quota hike of 500 kb/d/mth for November was discussed.

The Brent curve is on its way to full contango with Brent dipping into the $50ies/b. Thus the ongoing weakening we have had in the crude curve since the start of the year, and especially since early June, will continue until the Brent crude oil forward curve is in full contango along with visibly rising US and OECD oil inventories. The front-month Brent contract will then flip down towards the $60/b-line and below into the $50ies/b.

At what point will OPEC+ turn to cuts? The big question then becomes: When will OPEC+ turn around to make some cuts? At what (price) point will they choose to stabilize the market? Because for sure they will. Higher oil inventories, some more shedding of drilling rigs in US shale and Brent into the 50ies somewhere is probably where the group will step in.

There is nothing we have seen from the group so far which indicates that they will close their eyes, let the world drown in oil and the oil price crash to $40/b or below.

The message from OPEC+ is also about balance and stability. The world won’t drown in oil in 2026. The message from the group as far as we manage to interpret it is twofold: 1) Taking back market share which requires a lower price for non-OPEC+ to back off a bit, and 2) Oil market stability and balance. It is not just about 1. Thus fretting about how we are all going to drown in oil in 2026 is totally off the mark by just focusing on point 1.

When to buy cal 2026? Before Christmas when Brent hits $55/b and before OPEC+ holds its last meeting of the year which is likely to be in early December.

Brent crude oil prices have rebounded a bit along the forward curve. Not much strengthening in the structure of the curve. The front-end backwardation is not much stronger today than on its weakest level so far this year which was on Thursday last week.

Brent crude oil prices have rebounded a bit along the forward curve.
Source: Bloomberg

The front-end backwardation fell to its weakest level so far this year on Thursday last week. A slight pickup yesterday and today, but still very close to the weakest year to date. More oil from OPEC+ in the coming months and softer demand and rising inventories. We are heading for yet softer levels.

The front-end backwardation fell to its weakest level so far this year on Thursday last week.
Source: SEB calculations and graph. Bloomberg data
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Analys

A sharp weakening at the core of the oil market: The Dubai curve

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Down to the lowest since early May. Brent crude has fallen sharply the latest four days. It closed at USD 64.11/b yesterday which is the lowest since early May. It is staging a 1.3% rebound this morning along with gains in both equities and industrial metals with an added touch of support from a softer USD on top.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

What stands out the most to us this week is the collapse in the Dubai one to three months time-spread.

Dubai is medium sour crude. OPEC+ is in general medium sour crude production. Asian refineries are predominantly designed to process medium sour crude. So Dubai is the real measure of the balance between OPEC+ holding back or not versus Asian oil demand for consumption and stock building.

A sharp weakening of the front-end of the Dubai curve. The front-end of the Dubai crude curve has been holding out very solidly throughout this summer while the front-end of the Brent and WTI curves have been steadily softening. But the strength in the Dubai curve in our view was carrying the crude oil market in general. A source of strength in the crude oil market. The core of the strength.

The now finally sharp decline of the front-end of the Dubai crude curve is thus a strong shift. Weakness in the Dubai crude marker is weakness in the core of the oil market. The core which has helped to hold the oil market elevated.

Facts supports the weakening. Add in facts of Iraq lifting production from Kurdistan through Turkey. Saudi Arabia lifting production to 10 mb/d in September (normal production level) and lifting exports as well as domestic demand for oil for power for air con is fading along with summer heat. Add also in counter seasonal rise in US crude and product stocks last week. US oil stocks usually decline by 1.3 mb/week this time of year. Last week they instead rose 6.4 mb/week (+7.2 mb if including SPR). Total US commercial oil stocks are now only 2.1 mb below the 2015-19 seasonal average. US oil stocks normally decline from now to Christmas. If they instead continue to rise, then it will be strongly counter seasonal rise and will create a very strong bearish pressure on oil prices.

Will OPEC+ lift its voluntary quotas by zero, 137 kb/d, 500 kb/d or 1.5 mb/d? On Sunday of course OPEC+ will decide on how much to unwind of the remaining 1.5 mb/d of voluntary quotas for November. Will it be 137 kb/d yet again as for October? Will it be 500 kb/d as was talked about earlier this week? Or will it be a full unwind in one go of 1.5 mb/d? We think most likely now it will be at least 500 kb/d and possibly a full unwind. We discussed this in a not earlier this week: ”500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d”

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily. That core strength helped to keep flat crude oil prices elevated close to the 70-line. Now also the Dubai curve has given in.

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily.
Source: SEB calculations and graph, Bloomberg data

Brent crude oil forward curves

Brent crude oil forward curves
Source: Bloomberg

Total US commercial stocks now close to normal. Counter seasonal rise last week. Rest of year?

Total US commercial stocks now close to normal.
Source: SEB calculations and graph, Bloomberg data

Total US crude and product stocks on a steady trend higher.

Total US crude and product stocks on a steady trend higher.
Source: SEB calculations and graph, Bloomberg data
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Analys

OPEC+ will likely unwind 500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d in one go could be in the cards

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Down to mid-60ies as Iraq lifts production while Saudi may be tired of voluntary cut frugality. The Brent December contract dropped 1.6% yesterday to USD 66.03/b. This morning it is down another 0.3% to USD 65.8/b. The drop in the price came on the back of the combined news that Iraq has resumed 190 kb/d of production in Kurdistan with exports through Turkey while OPEC+ delegates send signals that the group will unwind the remaining 1.65 mb/d (less the 137 kb/d in October) of voluntary cuts at a pace of 500 kb/d per month pace.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Signals of accelerated unwind and Iraqi increase may be connected. Russia, Kazakhstan and Iraq were main offenders versus the voluntary quotas they had agreed to follow. Russia had a production ’debt’ (cumulative overproduction versus quota) of close to 90 mb in March this year while Kazakhstan had a ’debt’ of about 60 mb and the same for Iraq. This apparently made Saudi Arabia angry this spring. Why should Saudi Arabia hold back if the other voluntary cutters were just freeriding? Thus the sudden rapid unwinding of voluntary cuts. That is at least one angle of explanations for the accelerated unwinding.

If the offenders with production debts then refrained from lifting production as the voluntary cuts were rapidly unwinded, then they could ’pay back’ their ’debts’ as they would under-produce versus the new and steadily higher quotas.

Forget about Kazakhstan. Its production was just too far above the quotas with no hope that the country would hold back production due to cross-ownership of oil assets by international oil companies. But Russia and Iraq should be able to do it.

Iraqi cumulative overproduction versus quotas could reach 85-90 mb in October. Iraq has however steadily continued to overproduce by 3-5 mb per month. In July its new and gradually higher quota came close to equal with a cumulative overproduction of only 0.6 mb that month. In August again however its production had an overshoot of 100 kb/d or 3.1 mb for the month. Its cumulative production debt had then risen to close to 80 mb. We don’t know for September yet. But looking at October we now know that its production will likely average close to 4.5 mb/d due to the revival of 190 kb/d of production in Kurdistan. Its quota however will only be 4.24 mb/d. Its overproduction in October will thus likely be around 250 kb/d above its quota  with its production debt rising another 7-8 mb to a total of close to 90 mb.

Again, why should Saudi Arabia be frugal while Iraq is freeriding. Better to get rid of the voluntary quotas as quickly as possible and then start all over with clean sheets.

Unwinding the remaining 1.513 mb/d in one go in October? If OPEC+ unwinds the remaining 1.513 mb/d of voluntary cuts in one big go in October, then Iraq’s quota will be around 4.4 mb/d for October versus its likely production of close to 4.5 mb/d for the coming month..

OPEC+ should thus unwind the remaining 1.513 mb/d (1.65 – 0.137 mb/d) in one go for October in order for the quota of Iraq to be able to keep track with Iraq’s actual production increase.

October 5 will show how it plays out. But a quota unwind of at least 500 kb/d for Oct seems likely. An overall increase of at least 500 kb/d in the voluntary quota for October looks likely. But it could be the whole 1.513 mb/d in one go. If the increase in the quota is ’only’ 500 kb/d then Iraqi cumulative production will still rise by 5.7 mb to a total of 85 mb in October.

Iraqi production debt versus quotas will likely rise by 5.7 mb in October if OPEC+ only lifts the overall quota by 500 kb/d in October. Here assuming historical production debt did not rise in September. That Iraq lifts its production by 190 kb/d in October to 4.47 mb/d (August level + 190 kb/d) and that OPEC+ unwinds 500 kb/d of the remining quotas in October when they decide on this on 5 October.

Iraqi production debt versus quotas
Source: SEB calculations, assumptions and graph, Bloomberg actual production data to August
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