It’s been a tough few weeks in the energy market. As potential investors in energy companies, we are not sorry to see last week’s return in particular. It’s the understatement of the year. Almost every negative sentiment – recession, Fed tightening, dollar strength, Chinese demand, inventory build-up, or what amounts to the entire Oil Price Closet of Anxieties, happened this week. Oil-WTI fell below $80 for the first time since Jan. 11 this year, closing Friday below its 200-day mark moving average of $89.00. The move brings WTI closer to an important psychological level in the lower $70s, beyond which producers will drastically cut capital expenditures to raise prices.
In this article, I will argue that the sell is overstated and overlooks a fundamental truth about the oil market. It is undersupplied and it was only the SPR releases that masked this fact. We are on the brink of an energetic calamity that will begin to manifest in the months to come. As the global economy begins to pick up speed in 2023, the era of energy insecurity will begin. The important point to remember is that there is nothing you can do to stop this “train from hurtling into the station”. A recent NY Times the article summed it up succinctly-
“That’s because there’s just no extra supply out there today. There is very little additional supply that the Saudis and Emiratis can bring to market. And that’s about it. We have used the strategic petroleum reserve, and that will end in the next few months. There is simply no additional cushion in the oil market right now.
How did we come here?
The short answer is that for the period since 2014, producers have been discouraged from exploring or sanctioning the mega-project that was the mainstay of the 2000-2013 era.
The graph above tells us that for many reasons – low oil prices for much of the period, government preferences shifting towards alternative energy and discouraging the production of “fossil fuels”, and the restriction of capital by producers around the world in which we have underinvested upstream supply by the hundreds of billions.
Longer term, we are confident that oil prices will rebound, likely towards the end of the year, as the SPR releases that put excess oil on the market come to a halt. The graph above, compiled from global MS and Worldometer tells a fascinating story. Every year around 80mm new people join the roughly 7.9 billion people already here, all of whom need (but not always) the energy to power their lives. In six years, from 2014 to 2020, spending on new upstream sources fell by 55%, while the world’s population grew by about 8%. The calculation does not work.
The oil market is undersupplied as shown in the EIA chart below. Since March, when the government announced the SPR press releases to lower domestic gas prices, inventories increased by about 15 mm barrels. If you remove the 172mm barrels removed from the SPR during this time, stocks would have decreased to ~248mm bbls. That might sound like a lot, but in reality with our usual ~19mm BOD, it’s a ~13 day supply. Less than 2 weeks!
Not only are stocks artificially inflated by SPR releases, but the productivity of new wells as reported in the EIA-Drilling Productivity Report is on the decline. This is an admittedly simplistic measure, as it only takes active rigs at any given time and splits into new well production, as reported by various sources, usually state regulators. . The fact that the stallion is done in 4e note arithmetic without sophisticated modeling, doesn’t mean it’s not instructive. It reveals an undeniable trend in the production of new wells. In all key basins except the North Dakota and New Mexico basins, there is a steep decline despite steady growth in rig counts for most of this year.
Reading it carefully, it can be said that the shrinkage in the number of drilled but uncompleted wells-DUC, which occurred from mid-2021 to January of this year, was largely responsible for the production gains recorded so far. now this year. There is certainly an observable trend that well performance in shale basins began to decline as CIDs decreased.
This is true regardless of the underlying reason I have postulated in the past could be due to the depletion of premium drilling inventory. This has been documented several times recently in widely read publications, including the Wall Street Journal. here and here.
The DPR data is confirmed by information compiled from the monthly EIA 914 report. Only in North Dakota and Gulf of Mexico-GoM do we see a gain from May to June. In the case of GoM Murphy Oil, (NYSE:MUR), Kings Quay production contributed approximately 80,000 BOPDs, and BP’s Herschel provided an additional 20,000 BOEPDs, compared to the 179,000 BOEPDs reported for the month.
Higher drilling costs are also starting to impact profitability, as noted in an even more recent study. WSJ article. This means that maintaining or increasing production will shift into a sharper focus as margins squeeze and operator balance sheet priorities come into play. Almost without exception, shale drillers told us that their priorities were to return capital to shareholders through special dividends and share buybacks, to pay down debt and to keep production at low single digit growth. If oil prices hover in the $70s at any time, expect operating budget cuts to show up in rig counts soon.
The takeaway from this section is that US production will increase to 12.6mm BOEPD in 2023, as the EIA suggests in this month’s edition of STEO, is not very high. Current trends are going the other way, and the catalysts for a reversal are simply not there. The current low oil prices are pushing producers to sharpen their fiscal knives. Inflation eats away at already tight budgets, and nature itself can step in with lower quality rock than was available in the past.
Does help come from OPEC?
OPEC and its occasional collaborator when interests align, Russia failed to produce until full quota levels per a significant amount. Some reports have this deficit at over 3 mm BOPD at present. In fact, the CEO of Aramco made a widely read statement earlier this month that the world was on the brink of an energy shock of massive proportions.
“But when the global economy recovers, we can expect demand to rebound further, wiping out the little spare oil production capacity. And by the time the world realizes these blind spots, it may be too late to change course. »
The Dallas Fed also released a report documenting OPEC’s shortfall that points to the main source of underperformance at the feet of none other than Saudi Arabia. It only lasts until February this year, but clearly shows that the Kingdom of Saudi Arabia is producing around 1.2mm of BOPD below the quota.
To end this discussion of the Kingdom’s ability to dig deep and produce more oil when the world needs it, we have comment of the de facto Saudi leader himself, Prince Mohammed bin Salmon, also known as MbS-
“The kingdom will do its part in this regard, as it has announced an increase in its production capacity to 13 million barrels per day, after which the kingdom will have no additional capacity to increase production,” he said. he declared in a broad speech. .”
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In his address, the Prince noted that he would not be able to reach BOPD’s 13mm capability level until 2027. This should overturn any notion that OPEC or its main member, Saudi Arabia , can turn a valve and add significantly to world oil. supplies soon.
Your takeaway meals
Nobody can predict what the oil market will do in the short term over the next few months. There are so many factors, many of which have been noted in the opening paragraphs of this article, that it is impossible to say when this selling pressure will be relieved. My best guess this will happen with a massive drawdown of stocks when SPR releases finally cease.
Maybe that could be a Fed pivot. These interest rate hikes are crushing consumers and driving up variable rate mortgages and HELOC payments every month. At some point, the Fed will take a break if history is to judge. A stock market that has fallen by 50% in a few months, hundreds of thousands of unemployed, double-digit inflation… everyone will demand it. This will trigger an intense rally in oil prices in my view.
Or it could be something else entirely within the scope of the things I highlighted or an outlier I missed. What I can say with confidence is that when market sentiment changes, we expect oil prices to rise sharply. It will be driven by overwhelming global demand for oil and gas, the steady supply of which is increasingly uncertain.
By David Messler for Oilprice.com
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