- October 11, 2017
- Posted by: Art Berman
- Category: The Petroleum Truth Report
Oil prices will be lower for longer—that is the conventional wisdom. Data suggests, however, that oil supplies are tightening and that higher prices are likely in the relatively near-future.
Refined Product Demand and Crude Oil Exports
U.S. crude oil plus products comparative inventories have fallen 120 mmb (million barrels) in 26 of the last 32 weeks (Figure 1). Strong domestic demand for refined products and increased crude oil exports are the main reasons. That translates into lower net imports of both crude oil and petroleum products to the United States. The year-to-date average of U.S. product net imports is down 0.5 mmb/day from 2016. That’s 3.5 mmb/week which is about the average weekly storage withdrawal since mid-February.
U.S. crude oil exports have increased reaching a record 1.9 mmb/d during the week ending September 29 (Figure 2).
Increased exports have been part of how producers cope with limited U.S. refining capacity for the ultra-light oil from tight oil plays. Recent increases in exports levels, however, are because of higher international oil prices compared with domestic prices.
Brent has traded at a premium to WTI since U.S. tight oil became a factor in global supply in late 2010. That was largely because of limited take-away and refining capacity for the new U.S. supply in the early days of tight oil production. The Brent-WTI “spread” reached $28 per barrel in September 2011 but decreased when infrastructure caught up with supply. It averaged about $1.68 in the first half of 2017.
In June, the spread began increasing and is currently almost $7 per barrel (Figure 3). Some of this is a “fear premium” because of tensions in the Middle East—the GCC boycott of Qatar and the Iraqi Kurdish independence referendum. Some of it is also a buildup of inventories at the Cushing, Oklahoma storage facility and WTI pricing point.
Inventory increases at Cushing may be partly explained by refinery and pipeline outages following recent hurricanes but the build ups actually began in July a month before Hurricane Harvey. The causes are not entirely clear but rising inventories at Cushing especially when its storage exceeds 80% is generally a negative factor for WTI prices.
In addition to crude oil, exports of distillate, liquefied petroleum gases, and liquefied refinery gases have also increased in 2017.
Comparative Inventories and The Yield Curve
Falling U.S. comparative inventories (C.I.) in 2017 is a trend and not an anomaly. Figure 4 shows the 120 mmb decrease in C.I. since mid-February and the associated “yield curve” (Bodell, 2009) that correlates inventory with WTI price.
The magnitude of the inventory drawdown cannot be over-stated. The fact that it is driven by increasing demand suggests that that U.S. supply is moving steadily toward balance.
OECD comparative inventory (less the U.S.) has fallen 99 mmb since July 2016 (Figure 5). Although the data frequency is lower (monthly vs. weekly) and less systematic than U.S. inventory data, the reduction in C.I. is the main point.
The relative lack of price increase with falling C.I. for both the U.S. and OECD is because the yield curve was flat for much of the reduction because of the the magnitude of storage volume. Now, enough inventory has been drawn down that the curvature of the trend is increasing. Greater price response with incremental reduction in C.I. is likely as volumes approach the 5-year average.
Misplaced Concern About Shale Supply
Fears about burgeoning U.S. supply from shale reservoirs has been a consistent drag on market sentiment about price for at least a year. This has been based more on rig count than real evidence. Continental Resources chairman Harold Hamm has loudly blamed overly optimistic EIA supply forecasts for low U.S. oil prices. This is misplaced and typical of the hyperbole regularly heard from shale company executives.
The fact is that U.S. output has been flat since early 2017 and the EIA has adjusted its forecasts as data replaces sampling algorithms in their accounting (Figure 6).
The reason is that despite increased drilling, frack crews and equipment are not sufficient to meet demand for well completions. Pressure pumping equipment was not maintained and parts were cannibalized after the oil price collapse, and crews were laid off. It may take another year of strong demand to rebuild this capacity.
The result is that far more tight oil wells are being drilled than completed and I expect that this pattern will continue (Figure 7).
Fears that DUCs (drilled uncompleted wells) will flood the market with supply are unrealistic. When these wells are completed, it will be gradual and the natural ~30% annual decline in legacy shale production will be difficult to overcome. Moreover, production from the Eagle Ford and Bakken plays is declining. Only Permian production is increasing and on balance, it is unlikely that net shale production will increase much unless production trends outside the Permian basin somehow reverse.
The Tyranny of Preconception and Conventional Wisdom
In a recent interview about the documentary film The Vietnam War, co-director Ken Burns discussed the “tyranny of preconception and conventional wisdom” on public perception. Similarly, the lower-for-longer mentality has distorted perceptions of global oil markets.
That mantra made sense in 2015 and in the first half of 2016 as global inventories soared and supply outstripped demand. But data clearly shows that things have changed. The OPEC-NOPEC production cuts and increased demand for oil and refined products have resulted in a profound reduction of inventories. If those patterns continue, higher oil prices are likely in the first half of 2018.
I agree Art, things are changing, albeit much slower than many more optimistic (than myself) people predicted. I’m also seeing a change in sentiment from oil price pundits, with a lot more negativity towards the ponzishale. I’m wondering if there is going to be a sever about-face on the Permian very soon. Here’s to steady mid-60’s in February.
Jesze,
Even if there is a capital contraction in the Permian basin, there is plenty of momentum with 335 horizontal rigs that will not change overnight. My guess is that the higher prices that I anticipate will bring other people’s money back to the Permian. There just aren’t that many asset classes that can return reasonable margins and they are mostly over-valued. If some of the air is let out of stock prices for Permian players and oil prices increase, money will probably return.
Best,
Art
Weekly US crude exports varied between 600 kb/d and 1 mb/d in 2017. Is that high 1.9 mb/d export you are mentioning (and 1.5 mb/d the week before) a one-off event? Maybe related to refinery shut-downs during and after Harvey? Any re-exports?
Matt,
Thanks for your comments and question. The high crude oil exports for September–average 1.5 mmb/d–are somewhat anomalous but more related to the Brent-WTI spread than to hurricane disruptions in my opinion. The trend, however, is that exports are higher for 2017 than for 2016 and that is unlikely to change unless a weaker global economy affects oil demand (certainly possible).
All the best,
Art
Art,
Love your presentations. Love how you stick to your guns and don’t mistake the leftovers for a feast.
I have a question regarding CI changes over the winter, CI declines stagnated last winter. You are modeling some declines this winter, but with the pace moderating from recent past. Where is the risk to your forecast? For more draws or less draws?
Thank you,
David
David,
CI is not seasonally sensitive because it is a comparison of current storage levels with the 5-year average for the same week. If CI increases, it is because inventories are growing faster than they have in the past.
The chief risk to my forecast is that demand weakens for domestic refined products, and for exported crude oil, distillate and LPG/LRG. Those are the main factors driving inventory reductions. Exported crude oil will probably decline from exceptionally high September levels as Brent and WTI prices re-converge but average 2017 levels are still almost 70% higher than in 2016.
All the best,
Art
ART. the article is very good . As well there are political considerations which at happening in the Middle East/Kurdistan which will cause issues for Higher Oil prices .Thank you Art for the great research
Mundi,
As there always will be!
Best,
Art
Art, thank you for the information and insight. I was looking on the web for information about the impact of Harvey, but this whole article helps put that small piece in perspective. The import export information is good, but it has a larger meaning when you combine the other information regarding what is going on in the middle East. Sprinkle in the DUC and it bakes up pretty nicely. Thanks for the hard work.
Love your presentations!
I have a question regarding the C.I. vs oil price relationship (yield curve). As you mentioned before, Cushing inventory seems having a bigger impact on WTI price. Is there a similar yield curve relationship if Cushing comparative inventory or Cushing + Gulf coast comparative inventory is used?
Thanks much!
Gerald
Gerald,
Certainly. I update Cushing & Gulf Coast CI every week. Here is what Cushing looks like.
It is not as diagnostic as the U.S. crude + product yield curve because it is only crude and a relatively small volume compared with total U.S. stocks but it is interesting. I find the CI vs WTI standard graph more useful.
All the best,
Art
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Art-
Great article. Since increasing exports is the major factor in reducing CI in 2017 and US crude oil exports only started up again in early 2016, what effect could these US exports have on the yield curve in the CI plot? It seems the CI analysis becomes a bit more complicated with the lifting of the US export ban and with US crude competing with Brent crude on the global market.
Also what is the likelihood of curbed WTI price increases due to hedging by producers to secure financing for further development?
Jeff,
Increased crude exports and domestic consumption are the major factors in reducing CI in 2017. I don’t see any complication to the CI methodology from increased export volumes: CI will negatively correlate with WTI price regardless of the causes for CI increase or decrease.
I suspect that we may have recently seen the upper limit of U.S. export capacity at ~2 mmb/d. This was because of a weird convergence of factors that included 2 big hurricanes, a large and probably temporary Brent premium to WTI and a temporary reduction in light oil production by Nigeria leaving an opening for U.S.light to fill the void. Ultimately global refining capacity for ultra-light crude is limited and will not change without considerable investment based on a belief in long-term change in the composition of available crude for refining.
Hedging affects the term structure of the future strip by flattening prices for delivery a year or two in the future. Hedging is only effective when the forward curve is in fairly strong contango. Both WTI and Brent have been in backwardation for much of 2017 (and only in weak contango during two relatively brief periods this year. The Sept 5 contango curve below only increased a few dollars out several years).
If I am right about continued tight supply in 2018, the likely structure will remain backwardation.
All the best,
Art
Hi Art,
Thanks for sharing your analysis with us. Do you think the large Brent/WTI spread is telling us that foreign supply and demand are in better balance than domestic supply and demand? In other words, is crude oversupply mainly a US problem and the rest of the world is already in balance?
Joe,
Thanks for your question. If anything, U.S. supply is in better balance than than international supply with consistent reductions in comparative inventory of almost 4 mmb/week.
The Brent-WTI spread has always been somewhat of a mystery. WTI is lighter than Brent and, therefore, should trade at a premium and did before the boom in U.S. tight oil. Limited U.S. and global refining capacity for ultra-light oil and early take-away limitations resulted in a Brent premium of almost $30 per barrel for awhile in 2011.
The recent increase in Brent premium is because of Middle East uncertainties from Qatar-GCC split and the Iraqi Kurd referendum on independence. Also, Cushing inventories have increased steadily while overall U.S. stocks have been decreasing. I don’t really understand that.
All the best,
Art
Thank you Art, for your article. Always value your insights & data driven predictions. Are we going to see oil above 60 in the next two years ?
Ajay,
If current trends in inventory reduction continue, I would not be surprised to see $60 WTI in the first half of 2018.
All the best,
Art
Art, very nice article!
Regarding WTI/Brent spread: As OPEC/NOPEC get paid primarily in Brent, they have a very strong vested interest in Brent being way higher than WTI. US oil companies will then not grow production (as fast) and are faced with the competitive disadvantage of paying for transport over the Atlantic for the little oil they do have the possibility to export. Now, my question is, what levers do OPEC/NOPEC have to keep Brent much higher than WTI? Can you see any evidence of these levers being used? Is it imaginable that they push the spread even wider, as you estimate the US max export capability to be around 2 mmb/d which we are pretty much at right now? (As a side note: an interesting investment to consider is in the us oil companies that get paid in Brent, e.g. CRC)
Pendo,
I don’t believe that OPEC-NOPEC have much control over the Brent-WTI price spread. The main historical reasons for the spread are inventory buildups at Cushing, Oklahoma and geopolitical supply insecurity in the Middle East. The spread reached a maximum 3 weeks ago and is shrinking rapidly.
All the best,
Art
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“The causes are not entirely clear but rising inventories at Cushing especially when its storage exceeds 80% is generally a negative factor for WTI prices.”
Is there a good, practical way to figure out what type of oil is filling up Cushing storage? The reason I’m asking is because:
– US exports are rising, with production realtively flat
– there “should” be somekind of inventory drawdown in Cushing, given these circumstances, unless….
– due to a lack of processing capacity, a large part of the Cushing inventory coming from the Canadian Oilsands, via the Dilbit or WCS type blends.
Do you have any insight on this? Is there even a way to determine?
[…] crude oil have reduced U.S. inventories more quickly than I expected a month ago when I wrote Higher Oil Prices Likely in Early 2018. Higher consumption levels were well established at that time but evidence for a trend of elevated […]
[…] crude oil have reduced U.S. inventories more quickly than I expected a month ago when I wrote Higher Oil Prices Likely in Early 2018. Higher consumption levels were well established at that time but evidence for a trend of elevated […]