The Petroleum Truth Report

My goal is to offer clear and direct explanations of energy reality. These posts are data-driven interpretations of oil and gas topics that often challenge conventional thinking.

Shale Gas Magical Thinking And The Reality of Low Gas Prices

Enthusiasts believe that shale gas is simultaneously cheap, abundant and profitable thus defying all rules of business and economics. That is magical thinking.

The recently released EIA Annual Energy Outlook 2016 sparkles with pixie dust as it forecasts almost unlimited gas supply at low prices out to 2040 and beyond. Exuberant press reports herald a new era of LNG exports that will change the geopolitical balance of the world and make America great again.

But U.S. shale gas production is declining because of low prices and shale gas companies are in deep financial trouble because in the real world, price and cost matter.

That is not magical.

First Quarter 2016 Financial Performance

The financial performance of shale gas-weighted E&P companies in the first quarter of 2016 was a disaster.

Chesapeake Energy, the biggest shale gas producer in the world, had negative cash from operations. That means that oil and gas sales didn’t even cover operating costs much less capital expenditures like drilling and completion.

Other shale gas-weighted companies including Anadarko, Comstock and Petroquest also had negative cash from operations. Goodrich and Sandridge are in bankruptcy and Exco and Halcon will soon follow. Ultra, Forest, Quicksilver, Swift and Talisman were lost in action last year.

On average, surviving companies out-spent cash flow by two-to-one both in 2015 and 2016 but many normally strong companies greatly increased negative cash flow this year (Figure 1).

Q4 2015 Sampled E&Ps Shale Gas CE-CF

Figure 1. First quarter 2016 and full-year 2015 shale gas E&P company capex-to-cash flow ratios. Source: Google Finance and Labyrinth Consulting Services, Inc.

Devon Energy has been cash-flow neutral through much of the shale gas revolution but disturbingly increased capex-to-cash flow 5-fold in the first quarter of 2016. Similarly, Southwestern Energy has had an excellent record of near-cash flow neutrality but doubled its negative cash flow in 2016.

The debt side of first quarter earnings is far more disturbing. The average debt-to-cash flow ratio for shale gas companies increased almost 4-fold to more than 7, up from less than 2 in 2015 (Figure 2).

Q4 2015 Sampled E&Ps D-CF

Figure 2. First quarter 2016 and full-year 2015 shale gas E&P company debt-to-cash flow ratios. Source: Google Finance and Labyrinth Consulting Services, Inc.

Devon’s debt-to-cash flow was more than 21 and Southwestern’s, more than 17. Gas prices below $3 cannot be sustained without damaging the balance sheets and income statements of even well-managed companies.

Debt-to-cash flow is a critical determinant of risk from a bank’s perspective because it measures how many years it would take to pay off debt if 100% of cash from operations were used for this purpose. This means that it would take these companies an average of 7 years to pay down their total debt using all cash from operating activities.

The energy industry average from 1992-2012 was 1.53 and 2.0 was a standard threshold for banks to call loans based on debt-covenant agreements. That threshold increased in recent years to about 4 but 7 years to pay off debt is clearly beyond reasonable bank exposure risk.

Low Gas Prices and Declining Production

Shale gas is the principal support for all U.S. gas production since conventional gas is in terminal decline. U.S. dry gas production has declined almost 1 Bcf per day since September 2015 largely because of low gas prices (Figure 3).

Dry Gas Prod & HH Price

Figure 3. U.S. dry gas production and Henry Hub price. Source: EIA May 2016 STEO and Labyrinth Consulting Services, Inc.

Henry Hub gas prices have fallen for the last 2 years from more than $6/mmBtu in January 2014 to $2 today and prices have been below $3/mmBtu since early 2015. A similar gas-price decline occurred from June 2011 to April 2012 (Figure 3). Then, dry gas production fell when prices dropped below $3/mmBtu.

$3 is well below the break-even gas price for any operator in any play. Even in the Marcellus–the most commercially attractive shale gas play–break-even prices are more than $3 (Table 1).

Marcellus Operator-EUR Comparison 20 March 2016

Table 1. Marcellus break-even gas prices. COG: Cabot, CHK: Chesapeake. Source: Drilling Info and Labyrinth Consulting Services, Inc.

Shale gas production has fallen 0.83 Bcf/d since February 2016 (Figure 4).

Shale Gas_MASTER Prod

Figure 4. Shale gas production. Source: EIA Natural Gas Weekly and Labyrinth Consulting Services, Inc.

All plays have declined from their respective peaks except the Utica Shale. Marcellus production accounts for more than a third (-0.36 Bcf/d) of shale gas decline in 2016. There is certainly no shortage of supply in that play but low prices and related delays in pipeline commitments have taken their toll on production.

There are no longer any horizontal rigs drilling in the Barnett or Fayetteville, plays that were supposed to help provide the U.S. with 100 years of gas supply . That is the intersection of magical thinking and low gas prices.

Higher Gas Prices Are Likely

Lower gas production along with increased consumption and exports spell higher gas prices later in 2016 and in 2017. Latest data from EIA corroborate the impending late 2016 supply deficit that I wrote about last month (Figure 5).

STEO_JAN 2016 Natural Gas Supply Balance

Figure 5. U.S. dry gas supply balance and forecast. Source: EIA May 2016 STEO and Labyrinth Consulting Services, Inc.

A supply deficit does not mean that there won’t be enough gas but will require more extensive withdrawals from inventory and that will move prices higher. During the last supply deficit in 2013 and through much of 2014, Henry Hub spot prices increased from $2 at the peak of the previous surplus to more than $6 per mmBtu and averaged $4.05.

Comparative inventory (C.I.) is determined by comparing current stocks with a moving average of stocks over the past 5 years. There is a strong negative correlation between C.I. and natural gas price (Figure 6).

Natural Gas Comparative Inventory vs. Henry Hub Spot Price

Figure 6. Natural gas comparative inventory vs. Henry Hub price. Source: EIA and Labyrinth Consulting Services, Inc.

The same June 2011-April 2012 price decline shown in Figure 5 correlates with a strong increase in C.I. in Figure 6. In February 2012, C.I. turned around abruptly and prices responded quickly.

Similarly, the February 2014-March 2016 price decline in Figure 5 correlates with a C.I. increase in Figure 6. That build has slowed in recent weeks and C.I. will probably begin falling as production continues to flatten and decline.

During the period of C.I. surplus from October 2011-March 2013, gas prices averaged less than $3 just as they have during the present period of C.I. surplus since February 2015. I expect prices to move above $3 as the winter heating season begins. A possible temporary price drop in September would be consistent with previous periods when ample winter storage levels are reached after the U.S. Labor Day (J.M.Bodell, personal communication).

Shale Gas Magical Thinking: Price and Cost Matter

Shale gas made sense in the first decade of this century when real gas prices averaged almost $7/mmBtu (Figure 7). That was because there was a supply deficit as conventional production declined before shale gas supply increased to replace it.

CPI-Adjusted U.S. Natural Gas Price 1976-2016

Figure 7. CPI-adjusted U.S. natural gas prices, 1976-2016 (April 2016 U.S. dollars. Source: EIA, U.S. Department of Labor Statistics and Labyrinth Consulting Services, Inc.

Since 2009, however, prices have averaged only $3.81 and that is less than the break-even price for core areas of any play except the Marcellus (Table 2).

Marcellus-Utica-Woodford Break-Even Prices May 2016

Table 2. Shale gas break-even gas price summary. Source: Drilling Info and Labyrinth Consulting Services, Inc.

Shale gas enthusiasts have embraced point-forward economics that ignore many important non-capital costs of doing business. That is the difference between the break-even prices in Table 2 and lower estimates found in many analyst reports.

The EIA magically forecasts that shale gas production will increase from almost 40 Bcfd in 2016 to almost 70 Bcfd by 2030 at $5 (2015 dollars) gas prices; it will increase to almost 80 Bcfd by 2040 at prices below $5 per mmBtu.

The prices in Table 2 are for the core areas of the plays–much higher prices will be necessary to produce the marginal areas needed to support supply after core areas are fully developed. Although I respect EIA’s work and do not hold them to a very high standard on long-term forecasts, this view of the future of shale gas is not helpful.

Falling gas prices have exposed the delusion of shale gas magical thinking. Production growth was funded by debt. Capital in search of yield continued to flow and over-production pushed prices below $2 by the end of 2015.

The wreckage is clear from disastrous first quarter financial data and falling production. The Barnett and Fayetteville plays that were supposed to last 100 years are dead at current prices. The Haynesville will probably follow soon enough.

Capital may continue to flow to shale gas companies but most of it will be used to repair balance sheets. Prices will gradually increase and financially stronger companies with core positions in the Marcellus and Utica plays will survive. Many companies will not.

The U.S. has perhaps a decade of gas supply at about $6 and considerably more at higher prices. By the time prices reach those levels, the folly of export will be apparent.


Figure 8. Magical thinking. Source:


Returning To Market Balance: How High Must Prices Be To Save The Oil Industry?

The global oil market is returning to balance based on the latest data from the EIA. That should mean higher oil prices but how high must prices be to save the industry?

Data suggests that oil producers need prices in the $70-80 range to survive. That is unlikely in the next year or so. Without more timely price relief, the future looks grim for an industry on life support.

EIA Revises Consumption Upward

Major EIA revisions to world oil consumption* data provide a new perspective on oil-market balance.

The world was over-supplied by only 570 kbpd of liquids in April compared to EIA’s earlier estimate for March of 1,450 kbpd; that March estimate has now been revised downward to 970 kbpd (Figure 1). February’s over-supply has been revised downward from 1,180 to 240 kbpd.

These revisions indicate that oil markets are much closer to balance than previously thought.

World Market Balance MAY STEO

Figure 1. EIA world liquids market balance (supply minus consumption). Source: EIA and Labyrinth Consulting Services, Inc.

EIA adjusted world consumption growth for 2016 upward to 1.4 mmbpd. Its estimate for 2017 is now a very strong 1.54 mmbpd (Figure 2).


Figure 2. EIA annual consumption growth and forecast. Source: EIA and Labyrinth Consulting Services, Inc.

IEA’s demand growth estimate for 2015 is 1.8 mmbpd but the agency maintains its 1.2 mmbpd estimate for 2016 based on concerns about global economic growth.

It is easy to be skeptical about these new revelations but reports by both groups have been pointing toward improving market balance for some time.

Oil Prices and Market Balance

Oil markets are never in balance. Producers always misjudge demand and either over-shoot or under-shoot with supply. Balance is simply a zero-crossing from one state of disequilibrium to the next, from surplus to deficit and back again.

Since 2003, the oil market has only been within 0.25 mmbpd of balance 16% of the time. The average price (2016 dollars) for that near-market balance rate was $82 per barrel (Figure 3).

Market Balance Price

Figure 3. World liquids market balance (supply minus consumption), 2003-2016. Source: EIA and Labyrinth Consulting Services, Inc.

But that was essentially the average oil price of $78 per barrel for the entire period (Figure 4).

CPI-Adjusted WTI Prices, 2000-2016

Figure 4. CPI-adjusted WTI prices, 2003-2016. Source: EIA and Labyrinth Consulting Services, Inc.

In fact, market balance occurred in every monthly average oil-price bin in Figure 5 except $130 per barrel.  Although prices above $90 per barrel represent 37% of near-market balance prices from 2003 to 2016, oil prices also averaged more than $90 per barrel 36% of the time during that 15-year period.

Market Balance Histogram

Figure 5. Brent oil price histogram at plus-or-minus 0.25 million barrels per day of world liquids production. Source: EIA & Labyrinth Consulting Services, Inc.

In other words, market balance merely reflects whatever price the market deems necessary to maintain supply at the time. There is no clear causal relationship between market balance and specific higher or lower oil prices. Balance merely represents the midpoint between prices on either side of the disequilibrium states that it demarcates.

Our recent memory is of $90-100 per barrel prices so we think that was normal. When those prices prevailed in 2007-2008 and in 2010-2014, the disequilibrium state of the market was largely deficit. Moving toward market balance and being on the deficit side of market balance are hardly the same thing.

The Price Producers Need

Lower-cost oil producers of the world (Kuwait through Deepwater in Figure 6) need $50-80 per barrel and an average price of $65 per barrel to break even. Probably $70-80 is a minimum price range for near-term survival of more efficient producers allowing that some will still lose money at those prices.

IMF OPEC and Unconventional Break-Even Prices

Figure 6. Projected 2016 break-even oil prices for OPEC and unconventional plays. Source: IMF, Rystad Energy, Suncor, Cenovus, COS & Labyrinth Consulting Services, Inc.

Existing Canadian oil sands projects, and Bakken and Eagle Ford Shale core areas are among the very lowest-cost major plays in the world. For all of the OPEC rhetoric about the high cost of unconventional oil, few OPEC countries are competitive with unconventional plays when OPEC fiscal budgetary costs are included.

Tight Oil Companies On Life Support

Despite this relatively favorable rating, most unconventional producers are on life support at current oil prices.

All of the tight oil-weighted companies that I follow had negative cash flow in the first quarter of 2016 except EP Energy and Occidental Petroleum (Figure 7). Nine companies increased their capex-to-cash flow ratios compared with full-year 2015 results and six increased that ratio by more than 2.5 times.

Q1 Tight Oil CE-CF

Figure 7. First quarter 2016 and full-year 2015 tight oil E&P company capital expenditure-to-cash flow ratios. Source: Google Finance and Labyrinth Consulting Services, Inc.

On average in 2016, companies spent $1.90 more in capex than they earned while in 2015, they spent $0.60 more than they earned. The percent of negative cash flow has increased more than three-fold so far in 2016 compared with 2015.

The good news is that about half of the companies (Apache, EOG, Laredo, Continental, Statoil, and Diamondback) only increased negative cash flow slightly despite falling revenues. The bad news is that the rest (Marathon, Whiting, Pioneer, Murphy, ConocoPhillips and Newfield) did not.

The debt side of first quarter earnings is far more disturbing. The average debt-to-cash flow ratio for tight oil companies increased more than 3-fold to 10, up from 3 in 2015 (Figure 8).

Q1 Tight Oil D-CF

Figure 8. First quarter 2016 and full-year 2015 tight oil company debt-to-cash flow ratios. Cash flow was annualized based on first quarter data. Source: Google Finance and Labyrinth Consulting Services, Inc.

Debt-to-cash flow is a critical determinant of risk from a bank’s perspective because it measures how many years it would take to pay off debt if 100% of cash from operations were used for this purpose. This means that it would take these companies an average of 10 years to pay down their total debt using all cash from operating activities.

The energy industry average from 1992-2012 was 1.53 and 2.0 was a standard threshold for banks to call loans based on debt-covenant agreements. That threshold increased in recent years to about 4 but 10 years to pay off debt is clearly beyond reasonable bank exposure risk.


How High Might Oil Prices Go?

Current prices around $46 per barrel are a big improvement from earlier this year when prices were below $30. Nevertheless, all producers–companies and exporting countries alike–are failing and probably need sustained prices in the $70-80 per barrel range to survive.

That is a stretch from the mid-$40’s resistance level of the past 10 months or so (Figure 9).

NYMEX Futures & OVX Sept 2014-2016

Figure 9. NYMEX WTI futures prices and OVX oil-price volatility index, September 2014-2016. Sourc: EIA, CBOE & Labyrinth Consulting Services, Inc.

In fact, EIA’s forecast data suggest that improving market balance may result in a minor supply deficit by the second half of 2017 (Figure 10). Its forecast for Brent price, however, is to remain below $60 per barrel.

EIA Market Balance-Brent-Forecast

Figure 10. EIA market balance, Brent price and forecast. Source: EIA & Labyrinth Consulting Services, Inc.

Through A Glass Darkly

The price rally that began in late January-early February 2016 seems to have substance even though there are outsized inventories that concern serious observers. Anticipation of future supply deficits are moving prices higher in defiance of present-moment fundamentals to the contrary. Recent consumption data from EIA support improving oil prices going forward.

At the same time, I expect to see high price volatility and price cycling similar to what has characterized oil markets since prices collapsed in late 2014. The current cycle appears to have found resistance at about $46-48 per barrel and will probably move downward in an uneven way over the next few months before beginning the next upward cycle.

Recent outages in Kuwait, Nigeria, Venezuela and Canada have underscored the fragility of supply despite the prevailing production surplus. Under-investment during 2015 and 2016 will undoubtedly lead to much higher oil prices in just a few years especially with strong demand growth.

Prices must eventually reach the $70 to $80 per barrel range to restore balance sheets enough that investment may resume. It is, however, difficult to see that happening in 2016 or 2017 without serious supply disruptions or an OPEC production cut. Otherwise, prices should gradually and irregularly improve over the course of several 4- to 5-month cycles.

The weak global economy will be an important check on price recovery. Demand has improved during the period of lowest real oil prices since the 1990s but I expect demand destruction at prices higher than about $60 per barrel.

The last two years have severely damaged the oil industry and some producers and plays will not survive even with higher prices.

A return to market balance does not necessarily mean that prices will return to the $70-80 range. That is the level necessary to keep enough producers in business to maintain an adequate supply of the world’s primary energy source at a somewhat affordable price.

If a weakened world economy cannot support those prices, we may see supply dwindle in a few years to levels that cause price spikes that cannot be absorbed. That may bring a traumatic end to the Age of Oil. People will have to learn to get by with less in a future based on lower energy-density fuels and lower economic growth potential than oil has provided.

Primary Energy Pie October 2015

*Consumption a measure of oil use. It is often used as a proxy for demand but does not address the supply stream including stocks. It does not measure requirement for oil that may differ from use. 

Gasoline Demand Is A Red Herring For The Oil Market


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Gasoline demand is a red herring.

A red herring is something that ​takes ​attention away from a more ​important ​subject. Gasoline demand distracts from the more important subject that there is no fundamental reason for the current oil-price rally.

U.S. Gasoline Consumption Has Fallen 2 Million Barrels Per Day Since 2005

Those who believe that gasoline demand is the fire behind oil’s recent rally confuse production with consumption. They also don’t understand that Americans increased their driving when oil prices were $100 per barrel and continued to travel more miles throughout and despite oil-price highs and lows.

A recent Bloomberg article stated, “American gasoline consumption rose to 9.25 million barrels a day in March, an all-time high for the month.”

9.25 million barrels per day is product supplied, the measure of how much gasoline is produced in U.S. refineries. Total wholesale and retail sales is the measure of U.S. consumption and that amount is only 7.76 million barrels per day.

Consumption of gasoline in the U.S. has increased 802 thousand barrels per day (kbpd) since January 2014 but is 1,973 kbpd less than peak consumption in June 2005.

U.S. production of gasoline is 908 kbpd more than the post-Financial Collapse low in January 2012 but is 542 kbpd less than the peak in July 2007 (Figure 1).

Gasoline Product Supplied, Total Sales & Exports

Figure 1. Gasoline product supplied, total sales and net exports (12-month moving averages). Source: EIA and Labyrinth Consulting Services, Inc.

Meanwhile, net gasoline exports are at record high levels. Exports have increased 1,443 kbpd since June 2005.

So, consumption has increased but remains far below pre-2012 levels. Production is again approaching earlier peak levels but most of the increased volume is being exported. The belief that U.S. consumption is approaching record highs is simply not true.

Americans Are Driving More But Using A Lot Less Gasoline

Americans are driving more than ever before. Vehicle miles traveled (VMT) reached an all-time high of 3.15 trillion miles in February 2016 (Figure 2).

VMT have increased 97 billion miles per month (3%) since the beginning of 2015 and gasoline sales have increased 187 kbpd (2%). The rates of increase are not proportional.

Total U.S. Gasoline Sales & Vehicle Miles Traveled

Figure 2. Total U.S. gasoline (wholesale and retail) sales (12-month moving average) and vehicle miles traveled. Source: EIA, U.S. Federal Reserve Bank and Labyrinth Consulting Services, Inc.

For example, VMT was fairly flat from mid-2011 until oil prices collapsed in September 2014 yet gasoline sales fell more than 1 million barrels per day during the same period. Americans traveled the same number of miles but used a lot less gasoline. Even with the VMT increase since 2015, sales are still 539 kbpd less than in January 2009.

Vehicle Miles Traveled Independent of Gasoline Prices

Gasoline prices fell along with oil prices in late 2014 and consumption increased (Figure 3) but the relationship between prices and consumption is not straight-forward.

Gasoline Price and Sales

Figure 3. Gasoline retail prices and sales. Source: EIA and Labyrinth Consulting Services, Inc.

Prices reached a low in January 2015 and then increased to a peak in July 2015. Gasoline sales increased right along with prices, not exactly the relationship we would expect. Although gasoline usage is strongly seasonal, consumption is not simply a function of price.

Figure 4 shows that vehicle miles traveled increased from March 2013 through September 2014 when oil prices averaged almost $100 per barrel. It is unclear why Americans began driving more but it was not because gasoline prices were cheap.


Figure 4. Vehicle miles traveled and WTI crude oil prices. Source: EIA, U.S. Federal Reserve Bank & Labyrinth Consulting Services, Inc.

When oil prices fell to less than $43 per barrel by January 2015, there was no change in VMT growth. Furthermore, VMT continued to increase despite cycles of high and low prices in 2015 that first rose to $60 and then fell to less than $30 per barrel.

The factors that underlie driving behavior are complex. Gasoline price is among those factors but there is no clear correlation between price and consumption.

To put gasoline consumption in context, the 187 kbpd increase in gasoline sales since January 2015 is 1.2% of monthly U.S. oil consumption. The increase in product supplied is 1.7% of monthly consumption.

Crude Oil Imports Increased As U.S. Production Declined

As U.S. crude oil production began to decline in 2015, more oil was needed to produce gasoline and other refined products so imports increased.

From April 2015 to March 2016, oil production decreased 660 kbpd (-7%) but net crude oil imports increased 800 kbpd (+10%) (Figure 5).

Crude Oil Production and Net Imports

Figure 5. Crude oil production and net imports. Source: EIA April 2016 STEO and Labyrinth Consulting Services, Inc.

When analysts mistake gasoline production for consumption, they include gasoline made from imported oil in their celebration of increased U.S. “demand!”

Moreover, increased imports are also included in U.S. inventory volumes. If the whole situation seems complicated, that’s because it is and the lesson is to be careful about your sources of information.

Gasoline Demand Is A Red Herring

Americans are driving more than ever but using less gasoline than a decade ago. A lot of this is undoubtedly because of greater fuel efficiency. It seems unlikely that gasoline consumption will ever again reach levels before the Financial Collapse in 2008-2009.

The correlation between gasoline price and vehicle miles traveled is not very good. Americans started driving more when prices were very high and kept driving more despite large fluctuations in price. I cannot explain this except to observe that aspects of gasoline consumption must be somewhat inelastic. Price matters but not as much or in the same way that I imagined.

What is clear is that gasoline consumption is not a significant factor in the recent oil-price rally. The collective consciousness that drives the oil market is fed up with low oil prices. It looks for and sometimes invents excuses to raise prices and ignores compelling reasons to lower them.

Gasoline demand is the most recent invention and it is a genuine red herring.


No-Brainer Production Freeze Ends Mindlessly

The production freeze meeting in Doha was a no-brainer but it ended mindlessly with no action taken.

OPEC plus Russia and Mexico met yesterday to agree to do almost nothing by freezing production. Instead, they agreed to do absolutely nothing leaving everyone wondering why they even held the meeting.

All that they had to do was agree not to increase oil production above levels in January. They could have modified that to current levels. Probably, that would have ensured that oil prices remain near currently inflated levels that were created mostly by expectation of a production-freeze agreement to begin with.

It should have been a no-brainer because the Doha group’s production is already 130,000 barrels per day less than it was in January (Figure 1). Kuwait, Qatar, Russia, Mexico, Ecuador and Indonesia are all producing slightly more than they were in January but were prepared to go back to those levels.

Doha Chart_Difference Mar-Jan 17 April 2016

Figure 1. Doha participants March vs. January 2016 crude oil production. Source: EIA and Labyrinth Consulting Services, Inc.

Iran is producing about 350,000 bpd more than in January and has stated its intent to raise output much higher. Everyone else is producing less or the same as in January.

But this has been clear for months. Iran called the idea of a production freeze “ridiculous”  in February and did not even send a representative to the meeting in Doha.

So, what was the point of the meeting?



An Oil-Price Recovery? We’re Not There Yet

Oil prices have increased 60% since late January. Is this an oil-price recovery?

Two previous price rallies ended badly because they had little basis in market-balance fundamentals. The current rally will probably fail for the same reason.

The Oil Glut Worsens But Prices Reach 2016 Highs

Although oil prices reached the highest levels so far in 2016 during the past few days, the global over-supply of oil worsened in March.

EIA data released this week shows that the net surplus (supply minus consumption) increased to 1.45 million barrels per day (Figure 1). Compared to February, the surplus increased 270,000 barrels per day. That’s a bad sign for the durable price recovery that some believe is already underway.

EIA Market Balance April 2016

Figure 1. EIA world liquids market balance (supply minus consumption). Source: EIA STEO April 2016 Labyrinth Consulting Services, Inc.

The production freeze that OPEC plus Russia will discuss this weekend has already arrived. Supply increased only 20,000 barrels per day in March. Consumption, however, decreased by 250,000 barrels per day. That’s not good news for the world economy although first quarter consumption is commonly lower than levels during the second half of the year.

Meanwhile on Wednesday, April 12, Brent futures closed at almost $45 and WTI futures at more than $42 per barrel, the highest oil prices since early December 2015.

The April IEA Oil Market Report was also released this week and it largely corroborates EIA data. First quarter 2016 liquids supply surplus was 1.53 million barrels per day compared to EIA’s 1.71 million barrels per day for the quarter (Figure 2).

Chart_Market Balance-MAR 2016

Figure 2. IEA world liquids market balance (supply minus demand). Source: IEA April 2016 OMR & Labyrinth Consulting Services, Inc.

The first quarter 2016 surplus fell 220,000 barrels per day from the fourth quarter 2015. Overall supply declined 660,000 barrels per day but demand fell by 880,000 barrels per day.

IEA’s demand growth forecast for 2016 remains 1.2 million barrels per day. 2015 demand growth was a very high 1.8 million barrels per day because of low oil prices. 1.2 million barrels per day is, however, consistent with average growth from 2011 through 2014.

Price Cycles

Oil prices have increased from $26 to $45 per barrel during the current January – April price rally (Figure 3). This is based partly on hope for an OPEC-plus-Russia production freeze that almost everyone agrees will do nothing to balance global oil markets.

NYMEX Futures 2015-16 Rallies & Decline OVX

Figure 3. NYMEX WTI futures prices & OVX oil-price volatility index, 2015-2016. Source: EIA, CBOE, Bloomberg and Labyrinth Consulting Services, Inc.

There were two major price cycles in 2015. During the first cycle, WTI prices increased from about $44 in mid-March to more than $60 by early May over a period of about 50 days. This was based on plunging U.S. rig counts and withdrawals from storage. Prices remained around $60 per barrel for 25 days and then fell to about $38 by mid- to late August over a period of 72 days. The total trough-to-trough period of the cycle was 157 days.

During the second cycle, prices increased from $38 to more than $49 per barrel in only 7 days in late August 2015 based on good economic news about China and U.S. storage withdrawals. Prices fluctuated between $39 and $49 with an average price of almost $45 per barrel for 93 days. After falling below $40 per barrel in early December, prices dropped to $26.55 on January 20, 2016, a period of 46 days.The total trough-to-trough period of the cycle was 146 days.

At the beginning of the present cycle, prices increased from $26.55 to $33.62 in late January and then dropped to $26.21 on February 11. This “double-bottom” pattern probably tested the low-price threshold for the greater oil-price collapse that began in June 2014.

That does not mean that a price recovery is in progress. It suggests that because $26 per barrel is so far below the marginal cost of production that prices are more likely to increase going forward than to discover a lower bottom.

Following the double-bottom, prices increased to $41.45 on March 22 over a period of 40 days. Prices fell to $35.70  over the next 12 days before increasing to $42.17 on April 13. Yesterday, prices fell to $41.52. The total duration of this cycle is 63 days so far.


Aside from the global production surplus, the huge amount of oil in storage is the other key factor working against a price recovery right now.

Last week, a larger-than-anticipated 4.94 million barrel withdrawal from U.S. storage re-ignited the price rally that had stalled during the previous week. A 6.6 million barrel addition this week was largely ignored by the market as futures prices fell only $0.44 yesterday.

U.S. stocks are near record high levels of 78 million barrels more than at this time in 2015 and 138 million barrels more than the 5-year average (Figure 4).

Crude Oil Stocks_5-Year Comparison

Figure 4. U.S. crude oil inventory comparison. Source: EIA and Labyrinth Consulting Services, Inc.

OECD stocks are also at record levels of 3.13 billion barrels of liquids (Figure 5). That is 359 million barrels more than the 5-year average but 54% of those volumes are U.S. stocks.

OECD Comparative Inventory April 2016

Figure 5. OECD liquids inventories. Source: EIA and Labyrinth Consulting Services, Inc.

Comparative inventory patterns have been mixed and unclear for the past few weeks. Cushing stocks have been decreasing but Cushing-plus-Gulf Coast and overal U.S. crude oil inventories have been alternating between decrease and increase. It is, therefore, too early to tell whether comparative inventory data supports a price increase or not.

U.S. Crude Oil Production

U.S. crude oil production continues to fall although not enough to significantly reduce the world supply surplus. March production fell to 9.04 million barrels per day, 90,000 barrels per day less than in February and 660,000 barrels per day less than peak production in April 2015 (Figure 6).


Figure 6. U.S. crude oil production. Source: EIA STEO April 2016 & Labyrinth Consulting Services, Inc.

EIA forecasts that production will drop another 920,000 barrels per day by September 2016 for a total decline of 1.58 million barrels per day compared to April 2015.

That’s all good news except that U.S. liquids production increased 130,000 bpd in March and the world market balance is measured in liquids (Figure 7). Moreover, production is 1.85 mmbpd more than in January 2014 when the global supply surplus began, just a bit more than the present supply imbalance.

US Liquids PROD STEO_APR 2016

Figure 7. U.S. crude oil production. Source: EIA STEO April 2016 and Labyrinth Consulting Services, Inc.

A Path To Oil-Price Recovery?

A year-and-a-half into the oil-price collapse, this market looks for any excuse to raise prices. A meaningless OPEC-plus-Russia production freeze has entranced market observers since the beginning of 2016.

EIA and IEA data indicate that world supply is flat-to-declining already without any help from those major exporters. The problem is that consumption has also been declining and that the net production surplus remains around 1.5 million barrels per day.

No lasting price recovery is possible until the market moves convincingly toward balance.

Inventories exceed all historical levels. Comparative inventories may be declining and that is hopeful. Still, inventories fell at the beginnings of the two price cycles in 2015 only to increase again with oil prices falling to lower levels than at the beginnings of those price rallies.

No lasting price recovery is possible until inventory levels move convincingly toward 5-year average levels.

I hesitate to say that this time may be different. Yet, growing concern about long-term supply because of deferred investment may differentiate this cycle from the previous two. The late January – mid-February 2016 “double-bottom” event also suggests that this cycle may be somewhat different from those in 2015 insofar as it may not end with prices lower than at its start.

I suspect that the present price rally is the first in a series of upward-increasing cycles. It will probably end with lower prices in a few months but I doubt those will be below $30 per barrel and may settle in the low-to-middle $30 range. Bad news about the world economy has the potential to move the lows lower. Political instability particularly in the Middle East has the potential to move prices higher despite fundamentals.

Results of the upcoming Doha meeting are already included in current pricing. Unless the outcome is unexpectedly negative, there may be a brief price bump but only a production cut will move prices higher over the longer term.

We are on a path toward price recovery but it will be a slow and a long one with many bumps along the way. I doubt that means a return to the $90-plus price levels of 2011-2014 nor do I think that the global economy is strong enough to support anything approaching those levels.

Markets don’t always move according to the fundamental elements of supply, demand and inventories. A meaningful, longer-term price recovery, however, must be based on those fundamentals. We’re moving in that direction but we’re not there yet.



Natural Gas Prices Should Double

Natural gas prices should double over the next year.

Over-supply plus a warm 2015-2016 winter have resulted in low gas prices. That is about to change because supply is decreasing (Figure 1).

Supply Balance_STEO_JAN 2016 Natural Gas 24 Jan 2016

Figure 1. EIA U.S. natural gas supply balance and forecast. Production, consumption and supply balance values are 12-month moving averages. Source: EIA and Labyrinth Consulting Services, Inc.

Total supply–dry gas production plus net imports–has been declining since October 2015* because gas production is flat, imports are decreasing and exports are increasing. Shale gas production has stopped growing and conventional gas has been declining for the past 15 years. As a result, the supply surplus that has existed since December 2014 is disappearing and will move into deficit by November 2016 according to data in the EIA March STEO (Short Term Energy Outlook) .

During the last supply deficit from December 2012 to November 2014, Henry Hub spot prices averaged $4.05 per mmBtu. Prices averaged $1.99 per mmBtu in the first quarter of 2016 so it is reasonable that prices may double during the next period of deficit.

EIA forecasts that gas prices will increase to $3.31 by the end of 2017 but that is overly conservative because it assumes an immediate and improbable return to production growth once the supply deficit and higher prices are established (Figure 1).

Production companies are in financial distress and are unlikely to return to gas drilling at the $2.75 price that EIA forecasts for November 2016. The oil-field service industry is in disarray and is probably unable to reassemble drilling and fracking crews and equipment in less than 6 to 12 months after demand resumes.

There are currently on 92 rigs drilling for gas. That is 150 rigs less than the previous record-low set in 1992 (Figure 2). Production cannot be maintained at this level despite unrealistic faith in drilling efficiency and spare capacity from uncompleted wells.

Gas Directed Rig Count

Figure 2. U.S. gas-directed rig count, 1987-2016. Source: Baker Hughes and Labyrinth Consulting Services, Inc.

A Tale of Two Price Cycles  

Storage and production patterns for 2015 – 2016 appear quite similar to patterns observed in 2011 – 2012. Both periods are characterized by exceptionally high storage and comparative inventory levels, and record-low spot gas prices.

The storage and comparative inventory surplus of October 2011 – March 2012 disappeared as gas supply fell in response to low prices (Figure 3). By April 2013, gas prices were near $4.20 because the surplus had become a deficit. A cold winter sent prices above $6.00 in February 2014.

A similar pattern may be occurring in 2016.

The monthly average Henry Hub price for gas in March 2016 was $1.71 per mmBtu. That is the lowest CPI-adjusted monthly price (February 2016 dollars) in 40 years (Figure 3 shows 1999-present).  The previous record low price was $2.01 in April 2012. The 2012 low coincided with a comparative inventory peak followed by an inventory deficit and gas prices that exceeded $4.00 by December 2013. The current 2016 price low must be near the latest comparative inventory peak.

CPI-HH & CI 1999-2016

Figure 3. U.S. natural gas storage and CPI-adjusted Henry Hub spot price in February 2016 dollars per mmBtu. Source: EIA, U.S. Bureau of Labor Statistics and Labyrinth Consulting Services, Inc.

Comparative inventory is a measure of gas storage volume compared to a moving average of inventory values for the same time period over the 5 previous years. Comparative inventory (CI) provides an excellent negative correlation with natural gas spot prices.

Absolute storage levels were nearly the same for the last week of March 2016 (2,468 Bcf) and the last week of March 2012 (2,472 Bcf), and 2016 appears to be trending lower relative to 2012 (Figure 4).

Comparison of Gas Storage Levels 2012-2016 HH-CI-FUTURES 19 MARCH 2016

Figure 4. Comparison of U.S. natural gas storage levels, 2012-2016. Source EIA and Labyrinth Consulting Services, Inc.

Gas production was flat from February 2012 through December 2013 in response to the price collapse that culminated in April 2012 (Figure 5). The price minimum coincided with a supply surplus maximum that disappeared and became a supply deficit by February 2013.

Chart_PROD-SUP BAL-HH 2008-16

Figure 5. Dry gas production, Henry Hub prices and total supply surplus or deficit. Supply surplus and deficit values represent 12-month moving averages as in Figure 1. Source: EIA and Labyrinth Consulting Services, Inc.

Gas production has been flat since September 2015 (Figure 5).  Total dry gas production in March 2016 was 0.7 bcfd less than in September 2015 and the latest EIA data indicates that production for April is 1.2% (-0.83 bcfd) less than a year ago. EIA’s supply forecast (Figure 1) suggests that the present surplus will become a deficit later in 2016.

Why Natural Gas Prices Will Double

I used the EIA March 2016 STEO inventory forecast to calculate comparative inventory for the rest of 2016 and 2017.  This data indicates a fall in comparative inventory beginning in April or May 2016 (Figure 6).

EIA & Berman Gas CI and Price Forecast

Figure 6. U.S. natural gas comparative inventory, Henry Hub price and forecast. Source: EIA and Labyrinth Consulting Services, Inc.

That should result in a return to higher gas prices. The price estimate based on comparative inventory (shown in red) is more bullish than EIA’s price forecast (shown in orange) but both indicate a substantial percentage increase in prices.

EIA forecasts $3.10 gas prices in January and February 2017, and $3.31 in December 2017. My forecast based on comparative inventories is about 15% higher overall than EIA’s but peak prices are 20-30% higher.  It calls for winter prices in the $4-range for 2016 and 2017.

Putting Prices In Perspective

A doubling of gas prices to $4.00 per mmBtu may seem overly optimistic based on current price levels that have averaged about $2.00 since the beginning of 2016. Yet average prices since 1976 are $4.61 in 2016 dollars and the modal value for that period is $3.50 (Figure 7).

CPI WTI & HH 22 March 2016

Figure 7. CPI-adjusted Henry Hub price and forecast (February 2016 dollars per mmBtu. Source: EIA, U.S. Bureau of Labor Statistics and Labyrinth Consulting Services, Inc.

Moreover, the average price since January 2009 is $3.80 (2016 dollars) and the long-term trend-line is above $5.00 per mmBtu. All the data presented in this analysis suggests that present prices represent the low point in a price cycle similar to 2012-2014 in which $2 gas was the low point in an overall cycle whose average price was $3.65. That price is consistent with average prices since 2009 and the long-term modal price. The average of 2012-2014 peak prices (November 2013-December 2014 period negative comparative inventory–Figure 6) was $4.34 per mmBtu.

My forecast for gas prices to average $3.65 in 2017 (Figure 6) is quite conservative. It is based on the dubious EIA assumption that producers will quickly respond to a an increase in gas prices to about $2.35 per mmBtu (their forecast price) and that production will increase strongly throughout the rest of 2016 and 2017.

That is what happened in early 2014 (Figure 5) but then, gas prices were more than $6 and external capital was readily available before the oil-price collapse that began later that year. Although capital is still available, companies are more likely use it to pay down debt than to resume drilling especially for gas at least for the rest of 2016 and possibly longer.

The days of pure gas players are pretty much over and liquids are a more attractive drilling target at any price than natural gas. Having said that, the best operators (Cabot, EQT and Chesapeake) in the Marcellus Shale play need $3.50 to $4.00 gas prices to break even and most need $4.25 to $5.50. In the Utica and Woodford plays, most operators need at least $5.00 to $6.00 prices to break even.

February gas production has declined 0.7 bcfd from its peak in September 2015. EIA’s production forecast calls for a 1 bcfd increase by December 2016 and an almost 3 bcfd increase by December 2017. It is difficult to imagine that either price forecast shown in Figure 6 would result in the drilling resurgence necessary to realize those higher rates.

That is why it is probably conservative to suggest that gas prices will double in the next year or so.