Tuesday, March 21, 2017

No Recovery In Sight For Oil Markets

By Andy Lipow
March 21, 2017

On November 30, 2016, OPEC and non-OPEC oil producers agreed to production cuts of 1.8 million barrels per day, hoping that this action would bring the market back in balance and prices would rise. And rise they did, from around $49.44 per barrel on the announcement date to nearly $54.50 on February 23, 2017. It seemed that OPEC was on the right track and that train was headed for $60 in the near future.

Market participants began betting on higher prices, buying futures contracts and higher prices became a reality very quickly. Both the CME Group and Intercontinental exchange noncommercial net long positions grew to record levels. However over the last 10 days, a long liquidation has begun, net length positions have declined and the market has fallen below the pre-production cut levels. What happened and where do we go from here?

Ahead of the January 1, 2017 implementation date, in December, producers sold and shipped as much crude oil as they could, and those shipments showed up at their customers doorsteps over the next two months. This occurred at the same time that refiners, especially in the U.S., began reducing their crude processing rates as the spring maintenance season got underway.

According to the Energy Information Administration, refining utilization dropped from about 91 percent in December 2016 to just over 85 percent in the week ending March 10. This represented a decline in oil demand of 1 million barrels per day. Not only that, the Strategic Petroleum Reserve has recently conducted two sales, totaling 16 million barrels of oil, which began hitting the market at the end of February and into early March.

"Fast forward to today, where the crude curve is rather flat. Translation: We figured out the technology to get our costs down and we can get more oil out of the ground at today's price level."

The result, crude oil stocks in the U.S. hit an all-time record high last week. (For the purist, if one adds back in the 32 million barrels of lease crude oil stocks, one can see that today's inventory levels are higher than those reported in October 1929).

Higher prices also helped reduce the incentive to store oil on tankers. While floating storage in the North Sea has all but disappeared, the December production rush pushed oil sales into Asia where tankers are currently backed up awaiting discharge orders in places like Singapore.

OPEC and non OPEC producers probably did not count on the resiliency of shale oil producers and other around the world to cut costs and improve efficiency. In its March 7, 2017 Short Term Energy Outlook, the EIA is now forecasting all time record crude oil production in the U.S. of 9.7 million barrels per day in 2018, up 800,000 barrels per day from 2016 levels.

While most of the talk has been about the Permian Basin, other producers have also cut costs. Last August, Statoil announced that its Johan Sverdrup North Sea oil discovery is profitable at $25 per barrel. Late last year, Canadian oil producers announced expansion projects: Cenovus at Christina Lake and CNRL at Kirby North.

Add to the mix the return of Libyan oil supplies and the oil market is simply not drawing inventories as fast as OPEC and non OPEC producers would like.

Twelve years ago, when crude oil first hit $60 per barrel, the market saw its deepest contango ever. Translation: If crude oil supplies are tight now, imagine what it will be in the future and we need much higher prices to get it out of the ground.

Fast forward to today, where the crude curve is rather flat. Translation: We figured out the technology to get our costs down and we can get more oil out of the ground at today's price level.

As oil remains under pressure in the near term awaiting signs of declining inventories, the long liquidation is likely to drag prices down to $45 per barrel. In response OPEC and no-OPEC producers will be forced to issue a series of pronouncements indicating their seriousness at reducing the oversupply, most likely culminating in an agreement in May to extend production cuts until the end of 2017.

They can only sit by and hope that the International Energy Agency is correct in forecasting a 1.4 million barrel per day demand increase in 2017 to soak up the surplus.

In the meantime, could oil prices rise to $60 on the back of some geopolitical event? It is not hard to imagine. But looking ahead, I expect WTI prices to be at $55 come January 2018.

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