Preparing for an oil slump away from US pumps

The Oilholic is delighted to be back in lovely San Francisco, California, some 5350 miles west of London town. And what a 'crude' contrast it has been between two visits - when yours truly was last here little less than two years ago, the oil price was in three figures and our American cousins were (again!) bemoaning oil prices at the pump, not all that unaware about even higher prices we pay in Europe.

Not so anymore – for we’re back to under $3 per gallon (that’s 3.785 litres to Europeans). Back in January, CNBC even reported some pumps selling at rock bottom prices of as little as 46 cents per gallon in eastern US; though its doubtful you’ll find that price anywhere in California. 

Nonetheless, the Bay Area’s drivers are smiling a lot more and driving a lot more, though not necessarily honking a lot less in downtown San Francisco. By and large, you might say its happy days all around; that’s unless you run into an oil and gas industry contact. Most traders here are pretty prepared for first annual decline in global oil production since 2009, underpinned by lower US oil production this year.

Ratings agency Moody’s predicts a peak-to-trough decline in US production of at least 1.3 million barrels per day (bpd) that is about to unfold. On a related note, Genscape expects North American inventories to remain at historically high levels for 2016, and production to fall by -581,000 bpd in 2016, and -317,000 bpd in 2017, as surging blended Canadian production is expected to grow at +84,000 bpd year-over-year in 2016.

Most reckon the biggest US shale declines will occur in the Bakken followed by the Eagle Ford, with Permian showing some resilience. Genscape adds that heavy upgrader turnarounds in Spring 2016 will impact near-term US imports from Canada.

All things being even, and despite doubts about China’s take-up of black gold, most Bay Area contacts agree with the Oilholic that we are likely to end 2016 somewhere in the region of $50 per barrel or just under.

As for wider domino effects, job losses within the industry are matter of public record, as are final investment decision delays, capital and operating expenditure cuts that the Oilholic has been written about on more than one occasion in recent times. Here in the Bay Area, it seems technology firms conjuring up back office to E&P software solutions for the oil and gas business are also feeling the pinch.

Chris Wimmer, Vice President and Senior Credit Officer at Moody's, also reckons the effects of persistently low crude oil prices and slowing demand in the commodities sectors are rippling through industrial end markets, weakening growth expectations for the North American manufacturing sector.

Industry conditions are unfavourable for almost half of the 15 manufacturing segments that Moody's rates, with companies exposed to the energy and natural resource sectors at the greatest risk for weakening credit metrics.

As a result, Moody's has lowered its expectations for median industry earnings growth to a decline of 2%-4% in 2016, from its previous forecast for flat to 1% growth this year. "This prolonged period of low oil prices initially affected companies in the oil & gas and mining sectors, but is spreading to peripheral end markets," Wimmer said.

"Slackening demand and cancelled or deferred orders in the commodities sectors will constrain growth for a growing number of end markets as the fallout from commodities weakness and lackluster economic growth expands."

Everyone from Caterpillar to Dover Corp has already warned of lower profits owing to weak equipment sales to customers in the agriculture, mining, and oil and gas end markets. The likelihood of deteriorating performance will continue to increase until the supply and demand of crude oil balance and macroeconomic weakness subsides, Wimmer concluded.

Finally, as the Oilholic prepares to head home, not a single US analyst one has interacted with seems surprised by a Bloomberg report out today confirming the inevitable – that China will surpass the US as the top crude oil importer this year. As domestic shale production sees the US import less, China’s oil imports are seen rising from an average of 6.7 million bpd in 2015 to 7.5 million bpd this year.

And just before one takes your leave, Brent might well be sliding below $40 again but all the talk here of a $20 per barrel oil price seems to have subsided. Well it’s the end of circling the planet over an amazing 20 days! Next stop London Heathrow and back to the grind. That's all from San Francisco folks. Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2016. Photo I: Vintage Tram in Downtown San Francisco. Photo II: Gas prices in Fremont. Photo III: Golden Gate Bridge, San Francisco, California, USA © Gaurav Sharma, March 2016.

Oil storage, Chinese imports & Afren’s CEO

When the oil price is rocky, it seems storage in anticipation of better days is all the rage. Afterall, it does take two to play contango, as the Oilholic recently opined in a Forbes column. But leaving those wanting to play the markets by the side for a moment, wider industry attention is indeed turning to storage like never before.

We are told the US hub of Cushing, Oklahoma has never had it so good were we to rely on Genscape’s solid research on what’s afoot. In trying times, the industry turns to the most economical onshore storage option on the table. For some, actually make that many, Cushing is such a port of call.

As of February-end, Genscape says 63% of Cushing’s storage capacity has already been utilised. Capacity has never exceeded 80%, since Genscape began monitoring storage at Cushing in 2009. So were heading for interesting times indeed!

Meanwhile, the country now firmly established as the world’s top importer of crude oil – i.e. China – might well be forced to import less owing to shortage of storage capacity! Well established contacts in Shanghai have indicated to this blogger that in an era of low prices, Chinese policymakers were strategically stocking up on crude oil.

With Chinese economic data being less than impressive in recent months, it probably explains where a good portion of the 7.1 million barrels per day (bpd) imported by the country in January and February went. However, now that available storage is nearly full, anecdotal evidence suggests Chinese oil imports are going to drop off.

Import volumes for April are not likely to be nearly as strong. As for the rest of the year, the Oilholic expects Chinese imports to stay flat. Furthermore, Barclays analysts believe putting faith in China’s economic growth to support oil prices would be “premature” at best, with the country undergoing structural changes.

On a related note, lower oil prices will also slow the revenue growth of Chinese oilfield services (OFS) companies as their upstream counterparts continue to cut capex. Putting it bluntly, Chenyi Lu, Senior Analyst at Moody’s noted: "In addition to the impact on revenues, Chinese OFS companies will also see their margins weaken over the next two years as their exploration and production customers negotiate lower rates."

Finally, before yours truly takes your leave, it seems the beleaguered London-listed independent upstart Afren has finally named a new CEO following its boardroom debacle. Industry veteran Alan Linn will take-up his post as soon as the company’s “imminent” $300 million bailout is in place. We wish him all the luck, given his task at hand. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Oil pipeline, Fairfax, Virginia, USA © O. Louis Mazzatenta / National Geographic

Viewing US oil output through Drillinginfo’s lens

Perceptions about massive a decline in US oil production currently being put forward with such fervour and the ground reality of an actual one taking place are miles apart; or should we say barrels apart. 

Assuming that a decline in production stateside would start eroding the oil supply glut thereby lending slow but sure support to the oil price is fine. But declarations on the airwaves by some commentators that a North American decline is already here, imminent or not that far off, sound too simplistic at best and daft at worst.

The Oilholic agrees that Baker Hughes rig count, which this blog and countless global commentators rely upon as a harbinger of activity in the sector, has shown a continual decline in operational rigs over recent weeks and months. However, that does not paint a complete picture.

Empirical and anecdotal data from Canada demonstrates that Western Canadians are aiming to do more with less. According to research conducted by the Canadian Association of Petroleum Producers (CAPP), fewer wells would be dug this year but production will actually rise on an annualised basis over 2015. That’s despite the fact that the Western Canadian Select fell to US$31 per barrel at one point.

There’s a similar story to be told in the US of A, and digital disruptors at Drillinginfo are doing a mighty fine job of narrating it. The Austin, Texas headquartered energy data analytics and SaaS-based decision support technology provider opines that much of the current conversation obsessively intertwines the oil price dip with a decline in activity, bypassing efficiencies of scale and operations achieved by US shale explorers.

“Our conjecture is that an evident investment decline does not imply that production is nose-diving in tandem. Quite the contrary, our research suggests exploration and production firms are 25% more efficient than they were three years ago,” says Tom Morgan, Analyst and Corporate Counsel at Drillinginfo.

It’s not that Drillinginfo is not recording dip in rig counts and new drilling projects coming onstream via its own DI Index. Towards the end of February, its US rig count stood at 1433, while new US oil production dipped 9% on the month before to 525 million barrels per day (bpd). However, if what’s quoted here sounds better than what you’ve heard elsewhere then it most probably is for one simple reason.

“What we put forward is in real-time. Two years ago, we started handing out GPS trackers to operators to latch on to their rigs. It was not easy convincing an old fashioned industry to immediately warm up to what we were attempting to do. It was a long drawn out process but we converted many people around to our viewpoint.

“At present, over 80% of rigs in continental US are reported on daily via Drillinginfo installed GPS units. In return, the participants get free access to our collated data. At this moment in time, not only can I point out each of these rigs via a heat signature (see image from January above left, click to enlarge), but also pinpoint the coordinates for you to locate one, drive there and verify yourself. I’d say our data is 99% accurate based on back testing and reconciling trends with our archives,” Morgan adds.

Drillinginfo also examines the actual spud of a well that's been drilled but not yet completed, as well as permit applications. “The thought process in case of the latter is that if you have applied for a permit to drill, then you are more than likely [if not a 100%] sure of going ahead with it.”

Drillinginfo saw a 24% decline in US permit application between January and February. This shows that investment is slowing down, yet at the same time operational wells are generally on song. With the end of first quarter of this year in sight, the US is still the world’s leading producer in barrels of oil equivalent terms.

Oil production continues to rise, albeit not in incremental volumes noted over the first and second quarters of last year prior to the slump. US producers, or shall we say those producers who can, are strategically lowering operations in less bankable or logistically less connected shale plays, while perking up production elsewhere.

For instance, while the collated production level at Bakken shale plays in North Dakota is declining, production at Eagle Ford shale in Texas has risen to 159,000 bpd; a good 26,000 bpd above levels seen towards the end of last year.  In terms of the type of wells, Drillinginfo sees older vertical wells bear the brunt of the slump, while production at onstream horizontal wells is either holding firm or actually rising a notch or two.

“No one is pretending that market volatility and the oil price slump isn’t worrying. What we are encountering is that shale players are trying to achieve profitability at a price level we could not imagine ten, five or even three years ago because technology has advanced and efficiencies have improved like never before,” Morgan adds.

While pretty reliable, feed-through of information via the Baker Hughes rig count is not real-time but looking backwards based on a telephone and electronic submission format. By that argument, the Oilholic finds what Drillinginfo has to say to be an eye-opener in the current climate, particularly in an American context. 

However, company man Morgan, who has known Drillinginfo's co-founder and CEO Allen Gilmer since both their freshmen years at Rice University back in the 1980s, has a more polished description.

“Today we talk of heat map of rigs, real-time data, rig movement monitoring, type and location of rigs going offline, and much more. I’d say we’re bringing agility via a digital medium to participants in a very traditional business.”

That agility and sense of perspective is something the industry does indeed crave, especially in the current climate. The Oilholic would say what Genscape is bringing to storage monitoring; Drillinginfo is bringing to upstream data analytics. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graphic: Map of new US wells drilled in January 2015, and those drilled within the last six months © Drillinginfo, 2015

Oil markets & producers on a tricky skating rink

So we had a crude oil price plunge early January, followed by a spike that promptly "un-spiked", only to rise from the ashes and subsequently go down the path of decline again. Expect further slippage, more so as the last week of profit taking takes place before the March futures contracts close, which in ICE Brent’s case would be February 13.

Amid the ups and downs of the last six weeks, headline writers were left tearing their hair on a daily basis switching from "Brent extends rally" to "Oil slides despite OPEC talk of a floor" to "Falling Premiums" to "Crude oil getting hammered" and back to "Oil jumps". All the while commentators queued up with some predicting a return to a US$100 per barrel Brent price "soon", alongside those sounding warnings about a drop to $10.

The actual market reality is both here and nowhere, as we enter a period of constant slides and spikes between $40 and $60. There are those who say the current oil price level cannot be sustained and supply-side analysts, including the Oilholic, who say the current oil production levels cannot be sustained. Both parties are correct – a price spike and a supply correction will happen in tandem, but not overnight.

It will take at least until the summer for sentiments about lower production levels to feed through, if not longer. More so, as many are gearing up to produce more with less, for example in Western Canada where fewer wells would be dug this year, but the production tally would be higher than the previous year. Taking a macro viewpoint, all the chatter of bull runs, bear attacks and subsequent rallies is just that – chatter. Market fundamentals have not materially altered.

Despite the latest Baker Hughes data showing fewer operational rigs compared to this point last year, the glut persists and there is some way to go before it alters. Roughly around 5% of current global oil production is taking place at a loss. Yet producers are biting the bullet wary of losing market share. It'll take a lot longer than a few weeks of negative rig data in the new year, before someone eventually blinks and makes a substantial impact on production levels. The Oilholic reckons it will be around June.

Until then, expect the market to continue skating in the $40 to $60 rink. In fact, there is some justification in OPEC Secretary General Abdalla Salem El-Badri’s claim that oil prices have bottomed out. While we could have a momentary dip below $40, something which the Western Canadian Select has already faced. However, by and large benchmark prices have indeed found resistance above $40. 

Having said so, the careful thing to do between now and (at least) June would be to not get carried away by useless chatter. When Brent shed 11.44% in the first five trading days of January, only to more than recover the lost ground by the end of the month (see chart on the right, click to enlarge), some called it a mini-bull run.

Percentages are always relative and often misleading in the volatile times we see at the moment, as one noted in a recent Tip TV broadcast. So mini-bull run claims were laughable. As for the eventual supply correction, capex reduction is already afoot. BP, Shell, BG Group and several other large and small companies have announced spending cuts. A recent Genscape study of 95 US exploration and production (E&P) companies noted a cumulative capex decline of 27%, from $44.5 billion last year to a projected $32.5 billion this year.

Meanwhile, Igor Sechin, the boss of Russia’s Rosneft has denied the country would be the first to blink and lower production in a high stakes game. Quite the contrary, Sechin compared the US shale boom to the dotcom bubble and rambled about the American position not being backed up by crude reserves.

He also accused OPEC along familiar lines of conspiring with Western nations, especially the US, to hurt Russia. Moving away from silly conspiracy theories, Sechin does have a point – the impact of a lower oil price on shale is hard to predict and is currently being put to test. We’ll know more over the next two to three quarters.

However, comparing the shale bonanza to the dotcom bubble suggests wilful ignorance of a few basic facts. Unlike the dotcom bubble, where a plethora of so-called technology firms put forward their highly leveraged, unproven, profit lacking ventures pitched to investors by Wall Street as the next big thing, independent shale oil upstarts have a ready, proven product to sell in barrels.

Of course, operational constraints and high levels of leveraging remain burdensome in a bearish oil market. While that might cause difficulties for fringe shale players, established ones will carry on regardless and find ways to mitigate exposure to volatility.

In case of the dotcom bubble, where some had nothing of proven tangible value to sell, independents tipped over like dominos when the bubble burst, apart from those who had a plan. For instance, the likes of Amazon or eBay have survived and thrived to see their stock price recover well above the dotcom boom levels.

Finally, in case of US shale players, ingenuity of the wildcatters catapulted them to where they are with a readily marketable product to sell. There is anecdotal evidence of that same ingenuity kicking in tandem with extraction process advancements thereby making E&P activity viable even at a $40 Brent price for many if not all.

So it's not quite like Pets.com if you know what the Oilholic means. Sechin’s point might be valid but its elucidation is daft. Furthermore, US shale players might have troubling days ahead, but trouble is something the Russian oil producers can see quite clearly on their horizon too. Additionally, shale plays have technological cooperation aimed at lowering costs on their side. Sanctions mean sharing of international technology to sustain or boost production as well as lower costs is off limits for the moment for Russia.

On a closing note, its being hotly disputed these days whether and by how much lower oil prices boost global economic activity, as one noted in a recent World Finance journal video broadcast. Entering the debate this week, Moody’s said lower oil prices might well give the US economy a boost in the next two years, but will fail to lift global growth significantly as headwinds from the Eurozone, China, Brazil and Japan would dent economic activity.

Despite lower oil prices, the agency has maintained its GDP growth forecast for the G20 countries at just under 3% in both 2015 and 2016, broadly unchanged from 2014. Moody's outlook is based on the assumption that Brent will average $55 in 2015, rising to $65 on average in 2016. 

It assumes that oil prices will stay near current levels in 2015 because demand and supply conditions are "unlikely to change markedly" in the near future, as The Oilholic has been banging on many a blog post including this one. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Danger of slipping sign. Graph: Oil Benchmark Prices, January 2015 © Gaurav Sharma