- September 8, 2017
- Posted by: Art Berman
- Category: The Petroleum Truth Report
The most likely case is that WTI will remain stuck in the upper $40 to lower or mid- $50 range through December 2017.
Comparative inventories have fallen dramatically since mid-February yet oil prices languish in the mid-to-upper $40 range. What will it take for oil prices to break out of the $45 to $55 range boundaries since OPEC production cuts were announced in late 2016?
WTI prices increased from below $45 to almost $55 per barrel based on expectation that OPEC cuts would quickly balance international oil markets and result in near-term higher oil prices. While that expectation lasted, prices remained near $55 from late November 2016 until early March 2017 (Figure 1).
Prices adjusted downward four times between March and August as it became clear that output cuts were not enough to produce a meaningful price recovery. Since mid-August, markets have rallied back to the ~$49 per barrel price average since November.
Tight Oil Rig Counts
Rising rig counts in U.S. tight oil plays have been the most important factor constraining oil prices. Investors fear that resulting increased output will prevent the market from reaching balance.
Rig counts in the Permian basin, Bakken and Eagle Ford plays began increasing after WTI fell below $30 per barrel in early 2016. Since OPEC first suggested the possibility for a production cut in August 2016, tight oil rig counts have more than doubled (Figure 2).
While the increase in the number rigs is impressive, the most revealing aspect of Figure 2 is the decline of the Eagle Ford, and the flattening of Permian basin and Bakken rig counts since June. This suggests that the appetite for tight oil plays among equity investors may be moderating.
Despite claims of sub-$40 per barrel break-even prices by Permian basin producers, rig count data indicates that overall play economics require higher prices. The weekly change in Permian rig count suggests that break-even WTI prices may be closer to $55 or $60 per barrel (Figure 3). Break-even prices for some producers are certainly lower but higher prices are required for the average company.
Above all, rig count reflects capital flows and the availability of other peoples’ money to fund the tight oil plays—this is critical to production maintenance and growth. Figure 3 shows that capital availability is dependent on expectation of $55 to $60 oil prices. Capital flows have apparently faded with those expectations or else producers are using available capital for other purposes in addition to drilling.
Comparative Inventory
Comparative inventory (C.I.) fell 117 million barrels (mmb) from mid-February through the end of August (Figure 4).* This is the most significant oil market development since oil prices collapsed in 2014 but it has had little affect on oil prices so far.
Lower net imports of petroleum products is the main reason for this reduction in C.I. Refinery intakes are at record levels as refiners produce and sell refined products in the U.S. and abroad. As I pointed out last month, this trend is only sustainable if demand for U.S. refined products persists.
While exporting products helps reduce U.S. stocks, it aggravates the global over-supply of liquids. Higher net imports in recent months suggest that this trend may be weakening or ending.
Figure 5 shows the magnitude of inventory reductions from mid-February to late August as a “yield curve” of WTI price vs. C.I.
I estimated a range of probable year-end C.I. values to be between 40 and 75 mmb using EIA August STEO inventory forecasts and 2017 inventory decline trends. This range of C.I. translates to December WTI prices between $50 and $56 per barrel.
Continued demand for refined products is the key. I stated in a previous post that I doubted that ongoing U.S. inventory reductions were sustainable because of over-supply in international refined product markets. That would result in lower reductions in C.I. and most-likely December prices in the upper $40 to lower $50 range.
On the other hand, if refined product demand remains strong and inventory reductions follow a trend similar to that of the last several months, it is more likely that year-end WTI prices will be in the $50 to $56 per barrel range.
Large reductions in C.I. so far have not resulted in meaningful increases in oil prices because the yield curve is fairly flat. That is typical of outsized storage levels.
Oil prices collapsed in 2014 because of excess supply from over-production. Low prices and the contango term structure of forward curves encouraged putting large volumes of crude oil and refined products into storage.
Record U.S. inventory levels were reached in February 2017. Inventory reductions since then leave comparative inventories down only somewhat from record levels (Figure 6).
Progressively higher absolute inventory levels push the 5-year average continually higher. Since C.I. is the difference between inventories and the 5-year average, falling C.I. relative to climbing 5-year averages results in a fairly flat yield curve (Figure 5).
A greater rate of curvature will result in higher oil prices from incremental C.I. reductions as the yield curve approaches the y-axis and mid-cycle price. That, however, is not likely to happen in 2017.
Barring unforeseen supply outages and ongoing rates of C.I. reduction, December 2017 WTI prices should be only slightly higher than current prices namely, in the lower or mid-$50 range at best.
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* C.I. increased 5 mmb for the week ending September 1 and net imports of petroleum products increased 1.7 mmb because of Hurricane Harvey. Latest data is included in Figure 5 but not Figure 4 because it skews net imports based on a weather-related anomaly.
Thank you ART,
I think my Math shows this to be a drop of Approx. 20 Million barrels per month from ( Storage Inventory ) which will ( I think by Dec) begin to have a BIG impact on prices ( going Up ) .This factor combined with PERMIAN needing approx. $55 dollars to break even means Selling prices realistically must be over $55 dollars per barrel soon ( I am guessing this will occur no later than December and thereafter increase to over $65 dollars a Barrel .
Thank you again Art, best, jerry, Mundiregina Resources Canada
Jerry,
It is risky to use inventory withdrawal rates for the summer de-stocking period and apply them to the Fall-Winter re-stocking period.
It is less likely going forward that withdrawals will be as robust as they have been.
Your comments about the Permian break-even prices are valid but it’s really a question of what the capital providers/enablers do and not what it takes to make a profit.
All the best,
Art
HI Art,
I totally agree with your idea of an increase of net import of petroleum product in the next future but don’t you think this process could be dalayed until when the spread between WTI and Brent will come back to 2$?
Marco,
You may be right but there are other considerations such as the heavier crude needed to blend ultra-light tight oil in order to refine the stuff. Recently, Saudi Arabia has been shipping less oil to the U.S. Refiners have been increasingly relying on Columbia, Brazil and Venezuela heavy oil to fill the gap.
The increase in net imports is happening now based on empirical data. Whether or not it makes financial sense is another story.
All the best,
Art
When I see the phrase “break-even price” being talked about it makes me wonder if there is not some apples to oranges comparisons being made. I know when I see “break-even price” to me it means will I ever get my money back at this price while considering net present value to some degree but I do wonder if that is what everyone else means when they use that phrase.
Is that or something similar what you mean when you write “break-even price”?
Frankie,
When I say break-even price, I mean the wellhead price needed to make an 8% NPV including all capital and variable open costs except land. So yes, it is the price needed to get your money back including the cost-of-capital/time value of money.
All the best,
Art
Why exclude cost of land when calculating break even price? Even if the company sells the land after oil/gas depletion, the company will be selling the land at a loss. Not one tight oil company has made money when you consider all costs. Question remains…When will Wall Street take stop financing these unprofitable companies?
Oil Watcher,
I gave up on the cost of land a long time ago because producers wrote those cost off long ago. They are forever gone from the balance sheets. It doesn’t make it right to exclude them but it is necessary for people to be able to compare my economics with break-even price claims by the producers.
Thanks for your question.
Art
Art,
related to financial side don’ t you think the wti/brent spread
Is so wide and in the next future could narrow?
Marco,
Most of the increased premium of Brent to WTI is because of the Qatari diplomatic crisis. Brent was trading at a $0.40 premium to WTI in April before Qatar paid a huge ransom to Shi’ite militants in Iraq for the return of Qatari hostages. After Qatar normalized diplomatic relations with Iran in late July, the premium has increased another $3.89/barrel.
I do not know how this crisis will resolve itself but the Brent premium to WTI seems to depend on the outcome.
All the best,
Art
Great article, two questions:
1. Am I correct that those last 40 barrels of comparative inventory draw will make the difference for price
2. Shouldn’t you take the inventory average of 10 years or so because c.i. is falling now also because of the rising 5 yr average?
Thanks!
Timo,
You make some excellent points. Yes, the increased curvature of the yield curve makes a big difference for incremental price vs C.I.
On the subject of using a 10-year vs a 5-year average, I did not develop the concept or mechanics of comparative inventory. I have had recent and extensive discussions with J.M. Bodell who did and defer to his belief that a 5-year average is the best way to go.
All the best,
Art
Dear Sir, greeting from Ireland
Had I discovered your articles beforehand I would not now be invested in oil stocks
Your analysis relating to Comparative inventories is out standing, included in this, is your Aug 7th article US inventory reductions probably not sustainable, unaccountable oil
Figure 6. 137 Million Barrels of Unaccounted-For Oil in Storage (28% of total). Source: EIA and Labyrinth Consulting Services, Inc.
In view of your articles would it be possible for you to superimpose EIA monthly figures against EIA weekly estimates’ I refer here to oil price .com Sept 3rd-Nick Cunningham’s article-How EIA guesstimates keep oil prices subdued
I agree with you completely based upon hard facts, not sentiment that oil prices will decline in the near future due to oversupply and weak demand , leading to increase inventory.
Thank you for your hard work
AJ Craig
Alan,
Thanks for your comments. I have fond memories of several geological field excursions in County Clare during the 1990s and a lovely couple of days in Dublin in late 2014 with Colin Campbell, Jean Laherrere and other peak oil luminaries.
You have identified the critical factor going forward namely, demand. Most forecasts are based on a business-as-usual model for the global economy although I am less optimistic. Things looked weak before the U.S. hurricanes.
We have seen the first glimpse of Hurricane Harvey’s effect on U.S. refinery intakes, net imports and field production–basically a disaster. It may take weeks or months for the infrastructure to recover. Then, there are the broader effects on the economy of Houston, the 4th largest city in the U.S. Things are a mess here and will be for some time.
The effect of Irma on energy will be minimal, I imagine but the combined economic effects of Irma and Harvey will be huge and will strain the federal budget, bankrupt a few insurance companies and result in tremendous losses in productivity.
If everything snaps right back to normal, WTI prices may reach $55 by year end but it’s hard to see how that will happen. I think the most-likely case will be for little movement in net prices in the U.S. with perhaps equal P25 cases for $55 and $45 December pricing.
All the best,
Art
Have you been watching the Haynesville? After the big drop from 2011 to 2013, it has held steady at about 4 BCF/d. Lately it is actually growing production. This is with $3 gas, too.
The strip shows DEC delivery contract at $50.50. As of time of this comment. This does not mean it will happen just like odds at a horse race don’t guarantee the winner, but it is the literal betting guess. If someone knows better, they can bet against the market.
EIA publishes a CI for future prices (it is not an EIA forecast, but just the markets valuation of different dollar level puts and calls).
https://www.eia.gov/outlooks/steo/report/prices.cfm (first chart, scroll over the graph and a window will pop up with numbers for the data points; excel chart also available)
That graph shows a 90% CI from ~$39 to $63. IOW, 5% chance that price is less than $39, 90% chance it is from $39 to $63, 5% chance more than $63.
This was released when strip was a couple bucks lower, so you move that CI up to about $41 to $65. WE are also almost a month closer in timing, so you could adjust it to a tighter window. Maybe $43 to $61. (This is not saying price will never wander out of that range during the month, but is odds for the settlement date price. Approximately, it is the odds for the month average.)