The Party is Over For Tight Oil but Raymond James Says, “Party On, Dude!”

Posted in The Petroleum Truth Report on September 12, 2015

The party is over for tight oil.

Despite brash statements by U.S. producers and misleading analysis by Raymond James, low oil prices are killing tight oil companies.

Reports this week from IEA and EIA paint a bleak picture for oil prices as the world production surplus continues.

EIA said that U.S. production will fall by 1 million barrels per day over the next year and that,

“expected crude oil production declines from May 2015 through mid-2016 are largely attributable to unattractive economic returns.”

IEA made the point more strongly.

“..the latest price rout could stop US growth in its tracks.”

In other words, outside of the very best areas of the Eagle Ford, Bakken and Permian, the tight oil party is over because companies will lose money at forecasted oil prices for the next year.

Global Supply and Demand Fundamentals Continue to Worsen

IEA data shows that the current second-quarter 2015 production surplus of 2.6 million barrels per day is the greatest since the oil-price collapse began in 2014 (Figure 1).

Chart_Prod Surp-Def Sept 2015
Figure 1. World liquids production surplus or deficit by quarter. Source: IEA and Labyrinth Consulting Services, Inc.
(click image to enlarge)

EIA monthly data for August also indicates a 2.6 million barrel per day production surplus, an increase of 270,000 barrels per day compared to July (Figure 2).

World Liquids Production, Consumption & Relative Surplus or Deficit_August 2015
Figure 2. World liquids production, consumption and relative surplus or deficit by month.
Source: EIA and Labyrinth Consulting Services, Inc.
(click image to enlarge)

It further suggests that the August production surplus is because of both a production (supply) increase of 85,000 barrels per day and a consumption (demand) decrease of 182,000 barrels per day compared to July.

The world oil demand growth picture is discouraging despite an increase in U.S. gasoline consumption (Figure 3).

Chart1_Demand Growth_Sept 2015
Figure 3. World liquids demand growth. Source: EIA and Labyrinth Consulting Services, Inc.
(click image to enlarge)

World liquids year-over-year demand growth has fallen by almost half from 2.3% in September 2014 to 1.2% in August 2015. This is part of overall weak demand in a global economy that has been severely weakened by debt.

The news from both IEA and EIA is, of course, terrible for those hoping for an increase in oil prices.

U.S. production has fallen 510,000 barrels of crude oil per day since April 2015 while OPEC production has increased 1.2 million barrels per day since the beginning of the year (Figure 4). U.S. production increases in the first quarter of 2015 were partly because of an oil-price rally that ended badly this summer, and because of new projects coming on-line in the Gulf of Mexico.

Chart_OPEC-US Oil Prod_August 2015
Figure 4. OPEC and U.S. crude oil production. Source: EIA and Labyrinth Consulting Services, Inc.
(click image to enlarge)

It appears that OPEC is winning the contest with U.S. tight oil producers to see which can continue to over-produce oil at low prices. IEA ended its September Oil Monthly Report saying,

“On the face of it, the Saudi-led OPEC strategy to defend market share regardless of price appears to be having the intended effect of driving out costly, “inefficient” production.”

In other words, tight oil and oil sands production.

With Iran poised in early 2016 to add almost as much oil as the amount of the U.S. production decline to date, the outlook for tight oil producers could not be worse. And yet, the sell-side analysts and investment bank research groups continue to chant the refrain of logic-defying hope for tight oil producers in the face of crushingly low oil prices.

Party On, Dude!

This week, Raymond James joined the chorus with its bewildering “Energy Stat: U.S. Operators’ Response to Low Oil Prices? Get More Efficient!” 

The message is all about rig productivity and drilling efficiencies. I showed in my post last week that these measures are nothing but red herrings to distract from the unavoidable truth that all tight oil companies are losing money at current oil prices.

I would like to say that Raymond James is simply repeating the shop-worn and illogical cliché that “We’re losing money but making it up on volume” but it’s much worse than that.

There is no mention of money in the report. There is not a single dollar sign ($) in the text or figures nor are there are there any costs, prices or cash flows mentioned. That seems odd since Raymond James is, after all, a financial advisory company.

Raymond James presents 30-day IP (initial production rate) data to show that everything is fine and getting better in the tight oil patch.

Really guys? Is that why oil companies are laying off staff, cutting budgets and selling assets?

Besides, everyone knows that IPs are a practically meaningless predictor of EUR or profitability, and something that producers often manipulate to create press releases in order to satisfy investors.

Nonetheless, they forecast “2015 to be a banner year for both oil/gas well productivity gains.” Interesting but irrelevant since it’s going to be an atrocious year for profits.

Here is my table from last week’s post for the best of the tight oil companies in the best parts of the plays.

PXD-EOG-CLR H1 2015 COST PER BOE SUMMARY
Table 1. First half (H1) 2015 cost per barrel of oil equivalent summary for Pioneer, EOG and Continental.
Source: Company SEC filings and Labyrinth Consulting Services, Inc.
(Click image to enlarge)

EOG, Pioneer and Continental lost between $10 and $24 per barrel in the first half of 2015 but Raymond James says, “Never mind and party on, Dude!”

This report by Raymond James is both misleading and clearly out-of-touch with the price and investment environment that the International Energy Agency and the Energy Information Administration  describe.

Conclusions

ExxonMobil CEO Rex Tillerson summarized the situation this week in an interview with Energy Intelligence:

“It [tight oil] will compete. Will all of it compete at all pricing? No.”

For the next year or so, tight oil wells will not be commercial except in the best parts of the best plays. Tight oil companies will lose money. For the most part, the efficiency gains are behind us.

Until market fundamentals of supply and demand come into balance, prices will remain low. Goldman Sachs predicted yesterday that U.S. oil prices through the first quarter of 2016 will be “low enough to discourage investment in new oil production and shrink the global glut of crude.”

Clearly for now, the party is over for tight oil.


36 comments on this entry


  1. I have noticed that the most of the people drilling any oil wells around here own drilling rigs. Obviously, There are leases that are close to expiring, but there are other reasons people are drilling. We are paying $11/ft for the rig I am on now, which is low, so it is a good time to drill. Other wells, like the one next week, will kick off a big project (30 miles 3D shoot) so we are too excited to wait to drill that. I have worked on 2 development wells recently, which I thought was odd, so I asked. The old man said “I’m 76 years old and I don’t have time to wait this (low price) out, I usually don’t even buy green bananas, and if my investors don’t like it, they can go non-consent.” Another guy I work for says he drills oil wells, that is what he does, so that is what he is continuing to do.
    Another interesting issue is production rates. The company I am working for today will produce every drop of oil as soon as possible. They (40 yr old “CEO”) say they are oil harvesters, not speculators. They say if they wait to sell it the price might go down, so they sell what they can when they can. The guy across the lease line (61 yr old president) has wells in the same formation pumping a fraction of their potential. He is “in no hurry to give it away at these prices.”
    One other company has drastically increased production this year, but hasn’t drilled a well. They had been going so fast drilling, that completions were far behind and they constantly had problems keeping stuff running. The interesting consensus is that all these companies will increase production this year, but they predict everyone else’s production to fall.


  2. Sean,

    Thanks for your comments although I’m not sure that I understand your point or its relevance to my post.

    If you are saying that prices for rigs and seismic, etc. have fallen, I agree and addressed that in my post last week. We are in a period of deflation. Most of the so-called “efficiency gains” are really just lower prices.

    The issue isn’t whether you are an oil “harvester” or something else. The issue is, Can you make any money producing at current oil prices? If your overhead and costs are low, and your project economics work at $40 oil prices, then, by all means, you should drill the prospects.

    That is not the case for tight oil because wells are expensive even at lower costs, and other expenses like debt service, G&A, plus operating expenses use up most of the margin for a barrel of oil before money is spent to drill a well!

    If a company owns drilling rigs then, there is a consideration of the cost not to drill while paying for the rig. That may be a matter of choosing how to lose less, rather than more, money and not a question of profit. Chesapeake is the only public company that I know of that owns its drilling rigs (and that may have changed since I last checked).

    All the best,

    Art


  3. Heaven is on earth according Carson Energy,they can make a profit at $15.
    No doubt they will find people to invest,beyond shame.


  4. William,

    I expect that Carson is talking about their lifting costs only so their sin is deception not outright lying.

    Thanks for your comment,

    Art


  5. Thanks for another excellent post, Art.

    Personally I think we’re on the precipice of a new wave of “reality check” hitting the industry. Right now, we’re still stuck in the mental trap of “waiting for U.S. production to decline”, because that’s what so many analysts have been hanging their hats on… The idea that the crash in rig count over the last 6-12 months will cause a steep U.S. production decline that will magically propel oil prices back up to $80, a level at which they could indeed make a buck.

    For those of us who actually pay attention, it’s already resoundingly clear that KSA alone has already increased its production almost enough to offset the U.S. decline. If you also factor in Iran coming back online over the next year, it’s clear that the U.S. production decline story, while true, is just another irrelevant red herring.

    Almost nobody seems to be focused on what really matters: What’s it going to take to cause KSA to reverse course and cut production to support prices? They clearly can’t afford to keep this game going indefinitely. I’ve speculated in my newsletter that they will wait out October (because it’s U.S. credit review season) and then perhaps try to cut a deal with Russia to join them in a quota-based price support agenda. But that’s just my guess, and I could be wrong.

    But what I’m quite certain of is that KSA is holding the purse strings here. They can keep punishing U.S. tight oil operators with low prices, and they can go considerably lower from here if they want to. Some day they will intentionally reverse course. The people who either anticipate what catalyst will force a course change or are astute enough to perceive the reversal immediately (likely in the face of disinformational public policy announcements) will be the big winners among oil traders.

    Erik Townsend


  6. Erik,

    Thanks for your comments.

    Although you are right that the U.S. production decline of 510,000 barrels per day doesn’t make much difference in the global scheme of over-supply, it is important to the Saudis because this is the price discovery that they are seeking.

    The Saudi stratagem is not to not punish the U.S. tight oil producers but, rather, to dislodge the enablers, i.e. the investment bankers and capital providers. The reality check that you mention is what this is about.

    I think that Saudi Arabia and their Gulf partners can keep this up a long time, certainly long enough to accomplish what I have described because the time line is probably less than another year. Other OPEC members will balk but I don’t know how much they matter. As you say, Saudi Arabia is at the con.

    All the best,

    Art


  7. If “tight oil” is constricted and not feasible at current prices what other formations and sands would work with the current prices predicted? Buda, Glenrose, Travis Peak, Bossier? What looks good other the the “shale plays”?


  8. Walter,

    It is not a question of reservoir but economics.

    For a reasonably big company, there must be sufficient reserves to matter. That probably rules out Travis Peak, Bossier, etc. A year ago, I would have thought this included Buda and Glen Rose, but EOG is spending a lot of money on infrastructure for these reservoirs in Madison and Houston counties, Texas.

    Thanks for your questions,

    Art


  9. This analysis, at least as it pertains to the immediate future, which, of course, is your main interest, strikes me as thoroughly convincing. However, you also state, “For the most part, the efficiency gains are behind us.” This statement seems to have implications for the longer term. As you know, views on the prospects for future productivity gains in tight oil E&P are mixed. Although one might argue that such matters are inherently uncertain, I wonder if you could expand on your reasons for believing that future progress is likely to be limited.


  10. Lee,

    Thanks for your question.

    The core issue on drilling efficiency and rig productivity: are they real and how are they measured? We simply do not know the cost component of these “efficiencies.”

    The oil and gas industry has been hyping efficiencies since the beginning of time and for shale plays in particular since at least 2006 but I have yet to see these efficiencies expressed in a cash flow or income statement.

    I have no doubt that wells are drilled in fewer days than before but I don’t know how that translates into the marginal cost of producing a barrel of oil or a cubic foot of natural gas. The same applies to horizontal bore holes and multi-stage hydraulic fracturing. I do not question that these techniques improve rates but I am less clear about how they affect reserves which include a price component.

    As I stated in my post “Rig Productivity is a Red Herring,” I believe that most of the claimed efficiencies are the lower cost of drilling rigs and other services in a lower oil-price environment. Because oil-field service companies are now offering services at essentially cost, there is little room to achieve further savings.

    The message is that technology may improve rates but this generally comes at a higher cost.

    Art


  11. Thank you.

    Lee


  12. Art, It is amazing if you look at the comments from the readers of the major news articles regarding US shale oil production. All of the comments I just read from the following article were positive regarding how well the US shale oil industry is doing. “OPEC: The US shale boom is over”, Business Insider By Akin Oyedele, 5 hours ago.

    I wish the commenters were correct in their assertion that the US shale oil business is beating OPEC. But your numbers from the best companies in the best shale oil plays demonstrate they are losing $10 to $24/bbl. The general public is both mis-lead by efficiency articles, and/or just ‘wanting’ it to be true that the US tight oil plays are beating OPEC down. Amazing.


  13. Daniel,

    Those comments are coming from the same reservoir of anger and resentment over a perceived loss of American greatness that Donald Trump accesses in his campaign–“Make America Great Again!”

    The commenters are oblivious to the facts in Oyedele’s article.

    It’s all about American exceptionalism and macho in the face of often unseen forces in the world (and in the U.S.) that threaten the beloved delusion. It is classic cognitive dissonance or, as I prefer, cognitive distortion.

    All the best,

    Art


  14. A sub-comment for Lee:

    New technology itself does not necessarily entail economic improvements, particularly if we step out of the virtual world into the real one. Electronics and IT tech development have indeed generated spectacular improvements in handling and processing data, for business, government and personal purposes. However once we leave the data only territory and go into the real world of moving, processing and transforming physical matter, the dependency is not so clear cut.

    A good example is introduction of directional drilling or trenchless technologies in general into pipeline construction. The trend started in the 70s, blossomed in the 90s, and now is a standard thing. Many casual observers of this industry mistakenly believe that HDD has made building pipelines cheaper. Not really, in open spaces where you can trench it did not. It is very hard for a half a million to a million dollar directional drilling rig which needs deployment, positioning, mud pumps and recycling systems to beat a 40,000 dollar excavator which can just come and trench the thing – or indeed a bunch of immigrant workers with shovels on 20 dollars a day.

    What HDD did was to enable the industry to build where it could not before or to build without interrupting traffic, etc. BUT NOT CHEAPER. I am sure the same applies to tech improvements in tight oil. I vividly recall reading about a “magical” “jewel” stainless steel drill pipe which allegedly works miracles in the drilling process. I am sure it may have substantially improved guidance, tensile properties, data acquisition or whatever but getting stainless steel downhole did not make the process cheaper.

    The improvements are almost certainly a deflationary phenomenon, and there we some people who are involved in the US production who confirmed this point of view on one of Art’s previous comment chains.


  15. Andrew,

    Thanks for your comments and help in answering Lee’s question.

    The other tight oil and shale gas canard is the volume of production that must mean success.

    Here is a great article: “How China used more cement in 3 years than the U.S. did in the entire 20th Century.”

    It was all done on credit from the People’s Bank of China on both sides–free money to produce the cement and free money to buy it.

    All the best,

    Art


  16. I noticed that you diminshed the capex cost. 20 % is assumed to be for maintenance cost (for 2014 for EOG the result is approx 7520 (investments)/220 (production)*80 % = 27,34).
    I still cannot agree with the way you calculate the CAPEX per barrel. Some of the capex is for future production, not cogs in the year 2014.
    I retain a kind of replacement cost by dividing total capex by the barrels discovered in that year which gives 7520/519=14,50. The total cost for EOG for the year 2014 comes at $ 34 which (coincidentally) is about the same as the future cash inflows needed to cover the future development and production costs as presented on page F-42 of the 10K.
    Investments that increase the net proved reserves are not to be considered costs but assets.


  17. GV,

    Thanks for your comments and explanation of how you handle capex as a function of reserve additions.

    I chose to deal with it more simply for the following reasons. First, how will you reduce the 2014 reserves since all reserves are at a price and the SEC price for 2015 will be much lower than the ~$94/barrel that was used to book 2014 reserves. So the rather strict approach you take to reserve adds must be balanced with reserve subtractions. Second, what proportion of the 2015 reserves are proven producing vs proven undeveloped? There is considerable uncertainty that PUD reserves will, in fact, be developed especially at lower prices.

    Because of those complex variables, I have taken a simpler approach that you are right to question but I have to question a more rigorous approach because of what I have described.

    All the best,

    Art


  18. Art,
    Again, always appreciate the data driven analysis. I think it’s interesting that the de-leveraging pressure is falling on the service companies. Many are doing cost free, up-front work in exchange for production sharing agreements. Other smaller producers are forcing HY bond holders to take massive haircuts or exchange for long dated paper and/or worthless stock (obviously attempting to stave off the inevitable bankruptcies.) The de-leveraging cycle must play out through the E&P’s as they cannot simply export their deflationary pressures into the financial markets and on the backs of service companies or investors. Surprised to see no consolidation in the shale fields yet but do believe it will still occur. Watching Rex’s move.
    As we continue to see, EIA cannot forecast their way out of a paper bag. Maybe the newly adopted method will help. Otherwise it’s going to be non-stop, lagging revisions from here on out. U.S. production will defiantly contract by 1mm barrels per day within a year but likely much more so than that. Maybe Iran makes up the difference, maybe not. They need significant investment to improve infrastructure to produce at levels they are publically stating.
    It is outside of the US where the big contraction will come from- as other beleaguered economies joined at the hip to commodity investment and production suffer. Canada SAGD is out at current prices, especially when one looks at spread between WTI and WCS. Russia will probably lose 1 mm per day in the next year as well. Venezuela, Brazil, etc. are screwed. All future deep water plans are probably on hold.
    From a financial perspective, sector rotation into the energy sector including select shale names is an attractive investment play (for me). Falling knife maybe but it’s close to hitting the floor. Fundamentals are not driving current oil prices. Traders are playing off a very pronounced technical pattern. If you look at this chart of USO, you will see an island bottom (downward exhaustion gap followed by breakaway gap up) that formed off the 38ish level (which corresponds to 2009 low).

    That is a strong chart pattern and indicates to me that we have probably put in a bottom for prices. Traders will probably test that low again but the weak hands have already folded at that level. Again, this is not an argument for all shale but select players bought near the bottom (or averaged in) could provide high upside returns in the event of future supply squeeze (especially if it coincides with an OPEC cut). I have made my argument here before that shale is more akin to a manufacturing business than an exploration business after the initial build out phase is expensed. No reason to doubt that some of these companies could become cash flow positive in the future. There is a time (not far off IMHO) that shale will be more mid-cost than high-cost and will be the de-facto swing barrel.
    I’m not a financial analyst. I have small position in EOG, CRZO, SM, and HESS. I work for an independent E&P in South Texas and we don’t even dream of touching high cost, high decline projects. We work the shallow oil trends along the gulf coast and, for the most part, the economics are still viable at today’s prices. I have no need to defend shale or shale companies. I agree with most of your work especially because it is not opinion but fact derived from data. But since you seem to focus on the economic outlook for tight oil, I feel the need to point out that personal or retail investing ideas often have a duality to them that pits upside versus risk. Is investment in companies like EOG or PXD risky? Sure. But compared to the broader landscape, I’ll take a value play that is underpinned by the most important commodity on earth- oil.


  19. Ryan,

    You are right about the deflationary effect on oil prices. Energy is simply the bellwether so its value fell first and most thought it was a secular oil supply and demand problem. Well, it was but, as you say, part of a larger process called the economy.

    I would like to agree with your observations that oil has found a bottom but I doubt it. Fundamentals say no and the uncertainties and contraction in the global economy suggest that the deflationary cycle is at a relatively early stage.

    I’m no financial analyst either but I am not buying energy stocks right now. Your logic is correct that energy/oil is the most important commodity in the world and underlies the global economy. I’m just not convinced that a bottom to this vortex has been discovered yet.

    All the best,

    Art


  20. Sorry guess my chart didn’t show up.


  21. Art,

    In my view the biggest disadvantage of shale is economies of scale. It must be a difference if oil is produced in one 100 000 bbl/d in the North Sea or Saudi Arabia or in 1000 wells of 100 bbl/d. The economic advantage may not be 1:1000 yet it should be manyfold as infrastructure and transportation alone must be much more expensive. This has nothing to do with new technology as also conventional wells could use this new technology.


  22. Heinrich,

    You are correct. That is why break-even cost is a silly measurement. The appropriate measure is unit cost per barrel or, better, net energy (energy in vs. energy out but we are a long way from understanding this).

    Art


  23. Art,

    I wonder if you feel inclined to comment on the past several weeks’ DOE inventory reports including this morning’s drawdown. Specifically, with respect to the question of how recent weeks compare to hisorical norms around Fall Maintenance and whether there is still any real risk of a storage crisis.

    My own position for weeks has been “this thing ain’t over yet, and the bottom probably isn’t in yet for oil prices”. Like Art, I speculate that Saudi Arabia won’t declare “mission accomplished” until the *source of funding* for the shale industry is defeated. It’s not about punishing the shale operators. It’s about teaching Well Street not to lend them any more money. My hypothesis has been that the shale industry’s big vulnerabilities are fall maintenance (risk of out of control inventory builds if supply glut persists during reduced consumption) and October revolving credit review season, when the money could get cut off. I figured Sept. and Oct would be the day of reckoning for the crude oil market, when prices would likely bottom in front-month terms.

    But my whole thesis was based on my prediction that summer driving season would end, fall maintenance would be upon us, and *inventory builds would resume in Earnest, in size comparable to what we saw in spring.*

    Ironically my forcast “came true” early, with front month prices falling to $37.75 briefly in late August, well before I’d predicted a string of inventory builds to occur. I’ve been saying “this isn’t over yet and the bottom probably isn’t in yet” primarily because I see these two key downside risks (inventory builds and non-renewal of credit lines). But so far, the inventory builds have yet to materialize. Today’s drawdown really got my attention.

    Could it be that declining domestic supply is catching up with the oversupply and the risk of a storage crisis has been averted? Or is this just the calm before the storm?

    I still think the credit review cycle is where KSA should logically be expected to apply the most downward pressure on oil prices. Whether they have sufficiently precise control over the effects of their actions to even target a specific month is questionable. If you are the type who believes that another down-leg in crude oil prices could be intentionally engineered by KSA, it’s safe to say that the motive is there.

    But the inventory trend really has me re-thinking my whole thesis. Could it really be that the U.S. production decline has finally caught up with the oversupply curve, and the low really was put in back on Aug. 23rd? I doubt it – it almost feels to me like the last leg down is being saved for credit review time. But the inventory numbers are telling a very different story so far. Another significant drawdown next week would force me to seriously re-think my “bottom’s not in yet” view.

    Art, I welcome your comments and those of others here. I know you don’t like to comment on speculations about people’s motives, etc. But I’m sure you are better qualified than me to know what the inventory numbers are telling us. Is it just too early in the month to expect inventory builds associated with fall maintenance, or should we be feeling those effects by now?

    Erik


  24. Erik and Ryan,

    Reliance on inventory is a meaningless exercise in 2015. The year-over-year volumes are so much greater than the 5-year average, max and min (or anything since records have been kept) that all we are measuring is weekly change in relative over-supply. There is no way in WordPress to insert a chart or I would show you–perhaps in another post.

    We are in a new and unexplored land and are trying to find our way by using a map from someplace else.

    To that end, I am in complete agreement that the U.S. over-supply problem is nowhere near over and that price must move painfully lower to shut it down.

    All the best,

    Art


  25. For Erik,

    Agree with thesis on credit re-determination. Although, I believe it will affect individual oil stocks/companies more so than front month pricing. I will stick by my guns that current pricing is more financialized than fundamental. Another leg down is likely to come from a technical move more so than any fundamental pressure KSA can exert. Much the same way the recent rally was a technical move that happened despite any positive or substantial fundamental happenings.
    Important to consider how difficult inventory estimates are. While oil in storage may be accounted for, US has expanded field and pipeline storage capacity immensely over past few years. How can EIA possibly predict that?
    I think today’s drawdown is an anomaly. Three weeks ago while the down trend was intact (prices sliding by $2 per week) for over a month, the doom and gloom really flattened out the forward curve. Once we reached the 38 level, the curve slid back into deep contango. This finally incentivized producers to stop pumping and get payed to store. This was exemplified in announcements by EOG and HESS at the time. Refiners are enjoying tremendous crack spreads not seen in nearly a decade. At the same time producers where looking to put pressure on storage, Refiners where hedging out crack spreads as far as possible. So despite fall maintenance, Refiners are truly incentivized to operate at high capacity. Did you notice how quickly they got the BP refinery back online?
    My take away is that inventories should continue to build but that may not necessarily be a bad thing for prices. Unless the schizophrenic market continues to over react to every piece of news.


  26. Erik,

    I wanted to comment on your post because it is almost verbatim what I have been thinking.

    I, too, was thinking the inventory build that started occurring in August would be exacerbated when refineries went on fall maintenance and I still believe that will be the case. After seeing the amount of traffic on the roads and the number of people on the Texas coast (the most I have seen on Mustang Island in a long time), I expected a draw — except a much larger draw. I was actually surprised to see such a small number this week and the build in products.

    One thing I wanted to point out is that the stocks of Total Petroleum Products has been increasing at an extremely fast rate since last September when domestic production hit around 8.5 – 8.6 Mbbl/day; today we sit around 9.1 Mbbl/day. The best case scenario I see is low prices force producers to cutback production leading to a transition from a supply glut to a product glut which should begin to abate by the middle of next year as driving season approaches, demand increases, and supply decreases below 8.5 Mbbl/day. This assumes prices based on fundamentals and not speculation.

    However, the scenario I foresee playing out is artificially high prices based on speculation, like we saw in May-June, leading E&P’s to “feel” like the bottom has been reached and prices will continue to rise. This may lead to more projects coming on line and more domestic production. Not only would this put us back at risk of a Crude Storage glut, we would have a Petroleum Product glut. The end result would be a much harder crash in prices lasting much longer.

    I think had prices fallen lower earlier this year, demand would have picked up through the summer driving season and some of the inventory would have been drawn off. I don’t think the market realized this until halfway through summer when it was too late. I think the rebound in price lately is purely more speculation (rate hike, crude storage, rig counts, EIA forecasts, IEA forecasts, possible OPEC meeting, Tarot Cards and crystal balls) and not fundamentals.

    All of this leaves out credit determinations, world wide factors, etc. I’m just giving my opinion looking at the fundamentals in the U.S. I know Mr. Berman will have a much better take than myself; I just wanted to offer my thoughts as you and I had the same thoughts.


  27. A potential silver-lining in relation to US shale producers, may very well be that it is not the world’s only marginal form of oil production.

    As far as I realize, Canadian tar sands production is even more expensive than US shale production and will be seeing major contractions in output if the price remains at the current very low levels.

    To some extent, something similar applies to African offshore production, Latin American offshore production and the North Sea as well. I am sure there are other oil producing regions on the planet that are quite marginal.

    If production declines occur elsewhere as well, then the oil price may very well recover without US output having to give up all of its recent gains.

    Is this a possible scenario?


  28. Stavros,

    You make a good point but I believe that OPEC’s objective is to stop the capital providers and enablers from funding further mal-investment in expensive oil projects. Their target is not the U.S. producers in particular and probably the same capital enablers are behind many expensive oil investments.

    Thanks for your comment,

    Art


  29. Art,

    Thanks so much for commenting!

    I notice that your view seems to have changed considerably. When you penned ‘When will Oil Prices Turn Around’, I was surprised to note (at the time) that you thought it was pretty much “over” in the low $40s, while I was still expecting considerable downside.

    May I ask what changed your mind? Or am I misinterpreting the story by concluding that you changed your mind?

    Thanks,
    Erik


  30. Erik,

    I apologize if I mistakenly gave the impression that I thought that ~$40 would be the absolute floor for prices.

    When I wrote “When will Oil Prices Turn Around” and “World Oil Supply Decreased, Demand Increased in July: EIA,” my expectation was that the fall in oil prices would slow or stop, at least temporarily. That is what occurred and prices have since recovered to the $47-50 range.

    This expectation was based on positive supply and demand data from May through July that suggested the market was moving in the right direction toward balance albeit with a very long way to go.

    August data moves the production surplus back in the wrong direction. There is evidence that U.S. production has begun to fall and will fall further but global supply remains strong.

    Even domestic U.S. production must fall a lot more to work through crude stocks that are almost 100 million barrels more than levels a year ago. The negligible drop in Bakken production of only 26,000 bopd since December 2014 underscores the problem.

    All the best,

    Art


  31. Hi there Arthur. Consumption is not the same as Demand and Production not the same as Supply. Consumption and Production refer to the market equilibrium point at which Supply and Demand meet. Supply and Demand are curves (functions) while Consumption and Production are points. Stocks balance the gap between Production and Consumption (what you depict in Figure 1).

    We have already a good deal of mystification and confusion thrown around by the mainstream media. At alternative venues like this we should aim at a clarifying discourse, imho.

    Apart from that this is a very good post. I appreciate your quasi-regular writings, a sober voice is a rare thing in the energy world.


  32. Luís,

    Thanks for your comments.

    Are EIA’s barrels of production different from IEA’s barrels of supply? Are EIA’s barrels of consumption different from IEA’s barrels of demand?

    All the best,

    Art


  33. I just noticed this:

    Art Berman wrote:

    > The year-over-year volumes are so much greater than the 5-year average, max and min (or anything since records have been kept) that all we are measuring is weekly change in relative over-supply. There is no way in WordPress to insert a chart or I would show you–perhaps in another post.

    Art, I’d absolutely love to see that chart – either in a new post as you alluded or via e-mail.

    Thanks in advance,
    Erik


  34. Art,

    I hope you won’t mind me re-opening this discussion at such a late date, but I’m still confused by some of your comments. And API just reported another surprise inventory draw. If it is confirmed by DOE tomorrow morning, I’m really going to have to re-evaluate my market views.

    Art said:

    >To that end, I am in complete agreement that the U.S. over-supply problem is
    >nowhere near over and that price must move painfully lower to shut it down.

    Check. We’re on the same page so far. But earlier in the same post you wrote:

    >Reliance on inventory is a meaningless exercise in 2015. The year-over-year volumes are
    >so much greater than the 5-year average, max and min (or anything since records have
    >been kept) that all we are measuring is weekly change in relative over-supply. There is no >way in WordPress to insert a chart or I would show you–perhaps in another post.

    I feel like I’m missing something here. Yes, what the inventory draws/builds are measuring is relative oversupply, and yes, it’s going to stay an OVER-supply for some time to come. But it seems to me that price pressure is a function of the degree of that oversupply. And more to the point, the “big risk” that could threaten $20 oil prices would be if a storage crisis became imminent.

    So I don’t understand the “Reliance on inventory is irrelevant” sentiment at all. It seems to me that more big inventory builds should be the primary catalyst for another big leg down, and that more big inventory draws should be the catalyst for prices to rally further on “The risk of a storage crisis has now been averted” sentiment. After all, if we keep getting these inventory draws (indicating that the oversupply is getting smaller), doesn’t that eventually lead to the oversupply being eliminated?

    I assume that we all agree that oil prices should be higher than present when viewed from the standpoint of what’s sustainable long-term. My thesis has been that another leg down is still coming before the oversupply can be resolved, and you seem to echo that. But to my thinking, these inventory draws are direct evidence that we’re both wrong. I don’t understand why you seem to be dismissing their significance. Could you elaborate?

    Thanks,
    Erik


  35. Erik,

    I wouldn’t get too excited about changes in inventory. As I earlier stated, I was thinking the same (inventory build = lower price; draw = higher price).

    Then I plotted the following: US Ending Stocks excluding SPR of Crude, US Stock of All Petroleum Products Excluding Crude, US Field Production, US Imports, and Combined US Field and Imports.

    I found something very interesting; from around early 1985 to around late 1998, the price of oil (adj to 2015 dollars) slowly but steadily declined (with the exception of a spike during the Gulf War) from $39 to $20. Then a ‘correction’ happened sending prices back up to the upper 30’s by 2002. During this time, something interesting was happening that, today, would be considered ‘bullish’ for prices: crude stocks were declining, US production was declining, total petroleum products were slowly declining and imports were up. Total crude inputs were increasing while stocks were decreasing; bullish in my view.

    Even more interesting, from 2004 to 2011, something else happened that would be considered ‘bearish’ for oil: crude stocks were increasing, total petroleum products were increasing, US Production was essentially flat and imports were declining — all while prices shot up. Total crude inputs were declining while stocks were increasing; bearish in my view.

    From 2011 to current, imports have fallen but are still fairly high while US production shot up leading to a historic level of crude oil stocks and a level of petroleum products not seen since 1982.

    I’m starting to suspect that the high price which began in 2002 and escalated in late 2003 and lasted until last year may have been driven somewhat by fear and tensions in the Middle East (invasion of Iraq in 03), and to some degree, China. To say that US Shale drove the price down isn’t making sense. Total inputs (import and domestic) are similar today as in 1975-1979. Both led to historic inventory levels for their time.

    As I re-examine, I’m beginning to wonder if fear drove the prices higher in the late 70’s and early 2000’s instead of fundamentals and oil is just returning to a price it ‘should’ be at — a price that it averaged for 19 years: $35 +/- $6 per barrel.

    I know there were so many more factors (global, geopolitical, economic, etc) that factored in during these times, but I think it helps to sometimes take a simplistic view and start from there.


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