Crude: The Saudi shake down

It seems the move by Saudi Arabia’s Crown Prince Mohammed bin Salman to arrest members of the royal family and their business associates in a corruption crackdown is proving to be wildly popular among the Saudis young population. Yet, at the same time, it is adding a new sense of an oil price risk against a backdrop of a tighten global petroleum market.

Most Saudi citizens are in their 30’s and have grown to be upset with the lavish lifestyles of the multitudes of royal family members and cousins while they struggle to make ends meet. The move by bin Salman to purge and drain the Saudi swamp is playing well at home even as it raises fears internationally of a potentially unstable Saudi Arabia, a long time American ally.

It also raises concerns about a more aggressive Saudi Foreign policy that could lead to an expansion of the war in Yemen as well as a direct confrontation with Iran. The Saudi’s say a missile strike from Yemen on the capital of Riyadh was from Iran and that they would soon respond in an appropriate manner. Concern that an escalation of the War in Yemen could directly impact oil routes and even Saudi or Iranian oil production. Not to mention the risk oil of transportation through the Strait of Hormuz or the Bab el-Mandeb Strait.

Yet, even without the Saudi oil drama, the fundamentals of oil are exceeding bullish. Oil supply and product supply are draining at a record rate as demand goes on a surge that cash-strapped shale producers can’t keep up with. Huge decline rates of shale and the inability to raise cash or get frac crews are creating a logistical nightmare making it difficult if not impossible to respond quickly to the current market situation.

Still, U.S. shale producers still say that they can have their cake and eat it too. Reuters reported that U.S. shale producers are telling investors, impatient for better returns, that they can keep boosting oil output aggressively and do so while still making money for shareholders.

Reuters says that investors have pushed top U.S. shale companies to focus on returns, rather than higher production in a move that threatened to slow the breakneck growth in supply. Reuters says that in comments during recent third-quarter earnings calls, shale executives signaled they expect to deliver both higher returns and output.

At least seven of the largest U.S. shale companies, including Noble Energy Inc (NBL.N) and Devon Energy Corp, forecast 10 percent or better production gains this quarter in the Permian Basin of West Texas and New Mexico, the largest U.S. oilfield.  Yet is 10 percent enough to offset growing demand and OPEC and Non-OPEC cuts. Absolutely not.

While shale producers say they are proving they can drive output higher even after several last summer’s reported some Permian wells had begun delivering more natural gas, a sign of aging fields many I talk to in the industry still has their doubts.

The FT reported that U.S. oil production growth this year is on course to be significantly lower than government forecasts, as companies struggle to find the operators and equipment they need to complete the wells they have drilled, according to a new energy research firm. The steady rise in shale oil output from the U.S. has weighed on global crude prices but the projections Kayrros, a Paris-based research firm, backed by former Schlumberger chief executive Andrew Gould, suggest there may be less oil coming than expected on to world markets over the next few months.

The signs of capacity shortages are also good news for oilfield services companies such as Halliburton and Schlumberger, enabling them to raise rates after steep cuts during the industry downturn that began in 2014, but suggest the profitability of U.S. oil and gas producers will remain under pressure.

Once a shale well has been drilled it needs hydraulic fracturing or fracking and other procedures to start production. The number of drilled but uncompleted wells, often known as DUCs, in the U.S. main shale oil and gas regions has been rising sharply this year, going from 4,944 last December to 6,031 in June, according to the U.S. government’s Energy Information Administration.

Reuters reported that U.S. shale output is expected to hit 6.1 million barrels of oil per day (bpd) this month, up 35 percent from a year earlier, according to the U.S. Energy Information Administration. Yet many doubt the accuracy of these figures. Harold Hamm of Continental Resources says that the EIA has consistently overestimated shale oil production because it has a flawed way of measuring the decline and flush rates of newer wells.  Regardless of what shale scenario you believe, the truth is that it won’t change the fact that U.S. oil inventories are going to continue to plummet into the end of this year.

While everyone kept a focus on supply everyone forgot about demand. An improving U.S. economy and the global economy is driving demand through the roof. Oil Prices says that oil consumption reached a 10-year record of 21 million barrels a day during the summer of 2017. August consumption was 300,000 barrel a day ahead of the year before. The IBD reminds us International Energy Agency said last month that global supply and demand will balance next year as demand growth rises 1.4% in 2018. Gasoline demand from China remains especially robust thanks to a 17% increase in SUV sales. And in the U.S., trucks and SUVs remain popular

AAA reported yesterday that U.S. gasoline demand in October hit the highest level since 2006. That is one of the reasons why we have seen gas price go up at the pump. AAA says that according to the Energy Information Administration (EIA), the latest gasoline demand measurement is the highest for the end of October since 2006. At $2.53, today’s gas price is six cents more than a week ago, two cents more than a month ago and 31 cents more than a year ago.

“October has seen strong demand numbers likely, in part, due to consumers taking advantage of the unseasonably warm weather rather than spending time indoors,” said Jeanette Casselano, AAA spokesperson. “As consumers fill up their tanks more frequently, we are seeing supply levels tighten and gas prices increase. However, we don’t expect this increase to be long-term.”

All and all it is why we have seen oil hit a two year high. The last time when oil prices failed two years ago July was because of three historic oil events that set prices tumbling. First, it was the July 4th Greek exit vote. You know when Greece voted to leave the EU and decided to stay when their banks ran out of cash. That set back EU growth and slowed demand.  Then later in that month, President Obama started the process of lifting oil sanctions on Iran.  Another bearish event. Then came the Chinese currency devaluation that set the stage for global economic stability leading to a slowdown in growth so dire that 6 months later lead to one of the worst starts in U.S. stock market history.

We are now in a much different world. Global growth is on fire. Oil demand should not stop growing unless we get an economic shock.  If you look back at the double bottom at $26 a barrel and where we are now it is clear that, that was the bottom of an oil cycle. And now we are behind the curve.

We said natural gas bottomed last week and it sure looks like it. Weather demand and supply tightness in storage have set the stage for further gains. Tonight, we get the API report! We are looking for big draws on oil gas and distillates. We have some interesting plays coming up going into the end of this year.

FuturesMag