Exploring Hydrocarbon Depletion
Page added on April 6, 2017
OPEC production declines.
U.S. energy independence is for real.
Producers satisfied with $50.
Consumers satisfied with $50.
A sweet spot for compromise.
Henry Clay was the prominent figure in American history. Aside from running for president unsuccessfully five times, he was a representative and senator from the State of Kentucky and served as the Speaker of the House of Representatives. Clay served as Secretary of State under John Quincy Adams, but his greatest legacy may have been his ability to broker an agreement during the Nullification Crisis when South Carolina declared that Federal tariffs were unconstitutional and therefore null and void within the borders of the sovereign state in the 1830s. Clay also brokered agreements on slavery; he was instrumental in the Missouri Compromise of 1820, the Compromise Tariff of 1830, and the Compromise of 1850 to ease social tensions. Clay was “the great compromiser” who said that “I’d rather be right than be President.”
In an episode of Curb Your Enthusiasm comedian Larry David quoted Clay incorrectly by saying that, “a good compromise is one where both sides are dissatisfied with the result.” Clay may have never uttered those words, but he lived his life and legislated on behalf of the American people in that spirit. When it comes to the $50 price level for crude oil, it is starting to look and feel like a great compromise. After all crude oil at fifty bucks is half the price it was in June 2014 which is a price that makes consumers reasonably happy. At the same time, it is almost double the price it was on February 11, 2016, making it acceptable for the world’s producers. While the price makes neither the producer nor consumer wild with glee, it is a level both can tolerate which amounts to a great compromise.
OPEC production declines
It was the surprise announcement on November 30, 2016 from OPEC that caused the price of crude oil to move back above the $50 level. With the assistance of the Russians, Saudi Arabia, Iran, and other members of the international oil cartel threw in the towel on their strategy of flooding the market with output. The production cut took effect at the start of 2017, and the data shows that most members have lived up to the new quotas over recent months.
The cut was the first in nine years, so the oil market responded by rallying past $50, and the premium for Brent crude over West Texas Intermediate moved higher. While OPEC members and the Russians were slapping each other on the backs, the U.S. shale producers kicked into high gear as the price surpassed the half century mark. Increased U.S. production caused the price to slow its ascent and from December 19 until early March the price of the energy commodity traded in a $4.53 per barrel range on the nearby NYMEX futures contract.
U.S. energy independence is for real
Advances in drilling and fracking technology over recent years put U.S. petroleum producers in a position to respond quickly to the price above the $50 per barrel level. Crude oil inventories and the number of rigs in operation climbed. As of March 31, the number of rigs operating stood at 662,300 higher than the previous year at the end of the first quarter. Each week that the price was north of $50, both the American Petroleum Institute and the Energy Information Administration reported increases in U.S. crude oil inventories. The EIA numbers rose to a record high of 543 million barrels just a few weeks ago. All of the shale oil finally broke the back of the market, and crude oil fell from its trading range on March 8, and the price moved lower to $47.01 per barrel on March 22. Source: CQG
The almost three-month period of price consolidation above the $50 level came to a halt as deferred hedging, and physical selling caused open interest in the futures market to rise to an all-time high and inventories to do the same.
However, over recent weeks, the API and EIA numbers reflected the price fall and production and selling slowed. On Tuesday, April 04 the API reported a withdrawal of 1.83 million barrels from inventories for the previous week. The EIA reported less bullish numbers of April 5 when they said that stocks rose by 1.566 million barrels but the price of oil remained around the $51 per barrel level in the wake of the EIA numbers. The API withdrawal was the second straight week that stockpiles of crude oil in the U.S. fell in a sign that production is now responding to changes in price with lightning speed. The ability to turn on and off the oil spigot in response to price use to be the privilege of only the lowest cost producers like Saudi Arabia and other Middle Eastern nation members of OPEC. However, the U.S. has become a serious player in the world of oil output and now has achieved energy independence as a result of technology.
The balance of power in the oil market has shifted from OPEC to a triad composed of Russia, Saudi Arabia, and the United States. For all three parties, $50 is a price that maintains their dominant position in the market.
Producers satisfied with $50
On February 11, 2016, the price of oil fell to the lowest level since 2003 when nearby NYMEX futures traded at $26.05 per barrel. The price level was a disaster for producers around the world. The Russians found themselves struggling for cash flow. The Saudis cut back on social programs and began borrowing money in the international debt markets. Weaker OPEC member nations found themselves on the brink of economic disaster. U.S. shale production ground to a halt as rig counts plunged as the price fell to a level that was below average production cost. The only winner was China, the monstrous consuming nation that began to build strategic stockpiles of the energy commodity. At $26.05 per barrel, the price was over $80 lower than it was in June 2014. For China, oil was on sale, and it was a case of buy one barrel and get three for free in February 2016.
The rise back to the $50 per barrel level has been a godsend for producers. While they would love to see the price back at $100 per barrel or higher, the events of early 2016 have made them realize that $50 is a number with which they can live and survive. For consumers, $50 is not such a bad deal either.
Consumers satisfied with $50
No matter what the product, a buy one get, three free sale is something that does not go on for very long. I remember going to the supermarket in November 2016 right after the price of lean hog futures plunged to the lowest level since 2002. Every pork product was on sale, buy one get three free, but it did not last very long as the price of hogs rallied from those lows. My pork experience was exactly what the Chinese received as a bonus in oil back in February 2016.
Meanwhile, oil is still cheap for the Chinese and consumers around the world these days when comparing the price to where it was in June 2014 at over $100 per barrel. Consumers would love to see the price back at under $30 but $50 per barrel is a price that they can accept.
A sweet spot for compromise
Henry Clay would have looked at the current situation in the oil market, a price of $50 per barrel, as a great compromise for the producers and consumers of the world. The oil market that used to be under the control of the international oil cartel is now in the hands of a triad composed of Russian-Saudi-American influence with Russia and the U.S. holding the upper hand. The Saudis need to play ball and keep the price stable at $50 if they hope to pull off the biggest IPO in history in 2018 when they sell shares in Aramco to capitalize their sovereign wealth fund.
$50 per barrel amounts to a great compromise for the oil market. I expect that the price will trade either side of that pivot point and remain in the $45 to $55 per barrel range as long as the Middle East remains calm and the global economy continues to grow at a moderate pace.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.