We are beginning to see the first real signs of the global oil markets moving rapidly back into balance. OPEC, which produces approximately 40 percent of the world’s oil supply, cannot meet future oil demand on their own.
• On May 11th the U.S. Energy Information Administration (EIA) reported that U.S. crude oil production declined by 206,000 barrels per day over the six weeks ending May 5, 2016.
• In the same weekly report:
o U.S. crude oil inventories unexpectedly fell by 3.41 million barrels during the week ending May 6, 2016
o Gasoline inventories declined by 1.231 million barrels
o Distillate stockpiles fell by 1.647 million barrels
• The International Energy Agency (IEA) say the annual summer spike in demand for transportation fuels has begun.
When the oil markets are oversupplied, the speculators which control the oil futures markets tend to ignore supply outages that they consider short-term. For example, the forest fires in Alberta that shut-in more than a million barrels per day of Canadian heavy oil products in early May did not seem to have much impact on the price of oil. As supply and demand move back into balance, an outage of that size will send the NYMEX strip prices sharply higher. The oil sands projects shut in by the fires are now coming back on-line, but it will take months before production is fully restored.Related: Oil Climbs Higher As Goldman Sachs Sees Glut Shift To Deficit
Nigeria has much bigger problems
On Friday, May 13 an explosion closed a second Chevron facility in Nigeria, Africa’s biggest oil producer. The explosion was the result of an attack by militants who are upset with their government. 70 percent of Nigerians live on less than $1/day. They see the “Top 1 Percenters”living like kings, while they have trouble finding enough food to eat. Apparently, they have money enough for guns and explosives.
Exxon Mobil also reported on May 13 that a drilling rig damaged a pipeline, shutting off more production of crude. Nigeria’s oil production was already down 600,000 barrels per day before these two incidents, primarily the result of militant attacks. Shell is now evacuating workers from its offshore Bonga oilfield following a militant threat. Shell’s Forcados export terminal has been shut down since a February bombing. To say Nigeria is a mess is an understatement.
Adding to the country’s problems is the fact that they are over a year behind in paying invoices for oilfield services. Schlumberger Ltd. (SLB) has pulled personnel and equipment out of Nigeria, apparently tired of running up the bad debts.
Venezuela: Another OPEC nation on steep decline
Latin American oil production is now down close to 500,000 bpd from year ago levels.
On May 6, Bloomberg reported that Halliburton (HAL) has joined rival Schlumberger in curbing activity in Venezuela due to lack of payment during the oil industry’s worst financial crisis.
“During the first quarter of 2016, we made the decision to begin curtailing activity in Venezuela,” Halliburton, the world’s second-largest oil services provider, said May 6th in a filing with the U.S. Securities and Exchange Commission. “We have experienced delays in collecting payment on our receivables from our primary customer in Venezuela. These receivables are not disputed, and we have not historically had material write-offs relating to this customer,” the company said.
Halliburton’s receivables in Venezuela rose 7.4 percent in the first quarter to $756 million compared to the end of 2015, representing more than 10 percent of its total receivables, the Houston-based company said. If you own Halliburton stock, prepare yourself for a big bad debt expense later this year.Related: Saudi Arabia Loses Top Credit Rating from Moody’s
On the demand side of the equation, May is the beginning of an annual spike in demand for hydrocarbon based liquid fuels. In their monthly Oil Market Report dated May 12, 2016 theInternational Energy Agency (IEA) forecasts that demand will increase by 1.66 million barrels per day from the first quarter of this year to the third quarter.
If history repeats itself, the demand spike will be even larger. In 2010, the final year of the last major oil price cycle, the IEA began the year forecasting a 1.0 million barrel per day increase that year. Actual demand growth was 3.3 million barrels per day. The forecast error made in 2010 was that IEA’s formula for calculating demand, did not consider the impact of lower fuel prices on demand. I believe they’ve made the same mistake this time around.
Key points from the IEA report:
• Global oil demand growth for 1Q16 was revised upwards to 1.4 mb/d, led higher by strong gains in India, China and, more surprisingly, Russia. Russia had a cold winter and they still use a lot of oil for space heating.
• Oil inventory builds are beginning to slow in the OECD; in 1Q16 they grew at their slowest rate since 4Q14 and in February they drew for the first time in a year.
• “Changes to the data in this month’s Oil Market Report confirm the direction of travel of the oil market towards balance. The net result of our changes to demand and supply data is that we expect to see global oil stocks increase by 1.3 mb/d in 1H16 followed by a dramatic reduction in 2H16 to 0.2 mb/d.”
• “We have left unchanged our outlook for global oil demand growth in 2016 at a solid 1.2 mb/d. However, for 1Q16 revised data shows demand growing faster at 1.4 mb/d, in spite of the northern hemisphere winter being milder than usual. This strong 1Q16 performance might raise expectations that demand will remain at this stronger level causing us to raise our average figure for 2016.” As you can see by this statement, IEA is already seeing the error in their forecasting model. Like most government agencies, they will never come out and say they screwed up.
During the first quarter, oil prices were under pressure from predictions that China’s demand for oil would soften this year. Chinese demand growth has slowed down from the rapid pace of the prior ten years, but it is still going up. This is thanks in part to sales of SUVs that are still climbing in China. Apparently the Chinese people are becoming more status driven (like Americans), owning an SUV in China indicates your family has joined the Upper Middle Class.
Per the IEA report, India is rapidly becoming the leader in global demand growth. Oil demand in India increased by 400,000 barrels per day year-over-year in the first quarter.Related: Does Tesla Care About Its Stock Price?
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Conclusion: History Repeats Itself
I have worked in the upstream energy sector for 38 years. During my career the industry has survived six major and a few minor oil price cycles. It will survive this one because the products made from crude oil, natural gas and natural gas liquids (NGLs) are critical to the world economy. Our high standard of living depends on a steady supply of oil.
Oil price cycles do not end well. The big ones, and this is one of the biggest ever, overshoot the mark and result in a supply shortage. With OPEC now producing flat out, there is very little excess production capacity in the world. After the end of 2016, when oil supply and demand are back in balance, all significant supply outages (i.e. Canadian fire, Nigerian militants, ISIS attacks in the Middle East, etc.) will send crude oil prices skyrocketing. The Wall Street analysts that are saying we will never see oil over $100/bbl again will be eating those words.
Oil prices do not go up or down in a smooth line, as you can see in the chart above. Investors that can look past the short-term noise and invest in the best companies will harvest market beating gains as this cycle moves back to the long-term trend.
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