As a long-time investor in the energy sector, the current quarter has been one of the worst I can recall. It seemed like the market had turned the corner in 2016 when energy was the top-performing sector following two difficult years, but the price of West Texas Intermediate (WTI) is now down 20% from this year’s highs. Many are wondering why the bear market has returned.
There is one fundamental reason for the weakness in oil prices and that is record global crude oil inventories. These record inventory levels resulted from two primary causes. The first is that since 2008, the U.S. shale oil boom has put about five million barrels per day (BPD) of additional oil on the markets.
The market largely discounted this unexpected surge of U.S. production, and crude oil prices held steady at around $100/bbl for far longer than they should have. Lingering high prices worsened the oversupply situation by keeping too much marginal production on the market.
But in mid-2014, the market could no longer ignore growing crude oil inventories, and oil prices finally broke decisively below $100/bbl. In November 2014, following a $25/bbl decline in crude oil prices, OPEC decided that instead of attempting to balance the market, it would defend market share. Over the next two years, the group added two million more BPD of crude into an already oversupplied market.
Even though global crude oil demand continued to grow at a healthy rate, it couldn’t keep pace with the surge of production from U.S. shale producers and from OPEC. The world built a massive oversupply of crude oil, and that oversupply just continued to grow. OPEC finally reversed course in November 2016 and instituted production cuts, but at the same time, U.S. shale oil production — which had dipped in response to low prices — began to bounce back.
Several fears will likely drive the market for the foreseeable future. One is that crude oil inventories will remain high for a long time. Thus, the upside potential for an investor is limited. Second is that U.S. production gains will nullify the impact of OPEC’s production cuts. Should that happen (and it may), then OPEC is going to have to decide whether to make deeper cuts or return to the strategy of defending market share (which could send oil back into the $20s).
Further weighing on investors’ minds is the constant drumbeat of stories suggesting that the world is on the cusp of peak oil demand. In that scenario, oil prices may never recover. (That’s certainly not something I believe; see my previous Forbes article Peak Oil Demand Is Millions Of Barrels Away).
The peak demand belief is that in essence alternatives to oil will soon result in falling demand (as has been the case in the coal industry), which will render oil far less valuable. That this belief is helping suppress oil prices is somewhat ironic, considering that a decade ago peak supply fears helped drive up the price of oil.
Global inventories will be impacted by OPEC’s cuts, gains in U.S. shale production, and increases in demand. I can rationalize why I think the impact of growing demand and OPEC’s cuts will trump the growth in U.S. shale production, but the theory ultimately has to manifest itself in lower inventories.
Conclusions
So the bottom line comes down to crude oil in storage. What the market needs to see are major reductions in crude oil inventories, but that’s going to take time. Inventories are coming down, but in a bear market like this bad news has a far larger impact that positive news. The bullish news of five straight inventory declines can be undone by one surprise inventory build, sending prices reeling.
That’s likely to be the status quo for a while. It’s hard to say where the bottom is on oil prices. The current price is unsustainable long-term for producers (long-term investors take note), but the only thing that’s going to turn this market around is lower crude oil inventories.
rockman on Tue, 20th Jun 2017 11:33 pm
Yes, the latest future oil contract bid has “plunged” as of June 20, 2017 to $43.23 per barrel. Which is still higher then the inflation adjusted price of oil for 17 of the 18 years between 1986 and 2005. And almost twice the inflation adjusted price for the 28 years between 1946 and 1974.
IOW I gather a “plugging oil price” could also be described as a return to the “normal” price still above that seen during 45 of the last 71 years. Or about 63% of the time.
bobinget on Wed, 21st Jun 2017 9:35 am
Reading Forbes, not once did my inner ear hear any noun sound that came close to ‘SaudiArabia’.
Crude oil is traded internationally. (Duh)
KSA did renunciate its sacred role as swing producer two years ago. KSA threw fellow OPEC members under a speeding Mercedes.
Forbes never mentions how KSA has been larding on discounted crude into US markets artificially
holding crude prices in check.
Since the beginning of this year KSA has increased US imports over 2016 by selling from reserves of its own at deep discounts in order to jack up US
surplus. Technically, Saudi Arabia, caught once again cheating on fellow OPEC members.
One could say it’s faulty reasoning to ignore rising demand, concentrating primarily on inventories.
There, I just said it.
Now, US can export as much as a million BB p/d crude, we have a mechanism to lower
robust storage. If the Saudis keep this game of chicken going much longer they will have that suicide they desire.
As for alternative energies: Build out of all the mechanical devices, construction, change overs,
won’t happen over-night. We may use more oil, not less during transition.
bobinget on Wed, 21st Jun 2017 9:38 am
Here’s the latest skinny;
Summary of Weekly Petroleum Data for the Week Ending June 16, 2017
U.S. crude oil refinery inputs averaged about 17.2 million barrels per day during the
week ending June 16, 2017, 104,000 barrels per day less than the previous week’s
average. Refineries operated at 94.0% of their operable capacity last week. Gasoline
production increased last week, averaging about 10.2 million barrels per day. Distillate
fuel production increased last week, averaging about 5.3 million barrels per day.
U.S. crude oil imports averaged 7.9 million barrels per day last week, down by 149,000
barrels per day from the previous week. Over the last four weeks, crude oil imports
averaged about 8.1 million barrels per day, 2.0% above the same four-week period last
year. Total motor gasoline imports (including both finished gasoline and gasoline
blending components) last week averaged 909,000 barrels per day. Distillate fuel imports
averaged 87,000 barrels per day last week.
U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum
Reserve) decreased by 2.5 million barrels from the previous week. At 509.1 million
barrels, U.S. crude oil inventories are in the upper half of the average range for this time
of year. Total motor gasoline inventories decreased by 0.6 million barrels last week, but
are above the upper limit of the average range.
Finished gasoline inventories decreased
while blending components inventories increased last week. Distillate fuel inventories
increased by 1.1 million barrels last week and are above the upper limit of the average
range for this time of year. Propane/propylene inventories increased by 1.8 million
barrels last week but are in the lower half of the average range. Total commercial
petroleum inventories decreased by 1.9 million barrels last week.
Total products supplied over the last four-week period averaged about 20.2 million
barrels per day, down by 0.4% from the same period last year. Over the last four weeks,
motor gasoline product supplied averaged about 9.6 million barrels per day, down by
1.6% from the same period last year. Distillate fuel product supplied averaged over 3.9
million barrels per day over the last four weeks, up by 4.0% from the same period last
year. Jet fuel product supplied is up 6.2% compared to the same four-week period last
year.
bobinget on Wed, 21st Jun 2017 9:58 am
Here’s what I was blabbering about;
“U.S. crude oil imports averaged 7.9 million barrels per day last week, down by 149,000 barrels per day from the previous week. Over the last four weeks, crude oil imports averaged about 8.1 million barrels per day, 2.0% above the same four-week period last year. Total motor gasoline imports (including both finished gasoline and gasoline blending components) last week averaged 909,000 barrels per day. Distillate fuel imports averaged 87,000 barrels per day last week.”
Note, increase of 2% year over year.
Consumption:
Total products supplied over the last four-week period averaged about 20.2 million
barrels per day, down by 0.4% from the same period last year. Over the last four weeks,
motor gasoline product supplied averaged about 9.6 million barrels per day, down by
1.6% from the same period last year. Distillate fuel product supplied averaged over 3.9
million barrels per day over the last four weeks, up by 4.0% from the same period last
year. Jet fuel product supplied is up 6.2% compared to the same four-week period last
year.
Jet fuel up 6.2%
Diesel up 4.0%
Gasoline down 1,6%. BTW about the percentage of fuel mileage improvements.
20.2 Million Barrels (abt. 90 million gallons),per DAY, runs the world’s largest economy.
bobinget on Wed, 21st Jun 2017 10:24 am
Once again, despite a reasonably bullish report,
crude, once again, keeps falling in price.
Americans, Chinese, Indians will not be slowed buying so many SUV’s Extra shifts needed.
Imports keep piling on.
This time from ‘unaccounted’ sources. (Iran?)
Apparently, only another ME war will slow the flow.
Kenz300 on Wed, 21st Jun 2017 10:52 am
Electric cars and trucks are coming.
q on Wed, 21st Jun 2017 10:59 am
rockman: “I gather a “plugging oil price” could also be described as a return to the “normal” price still above that seen during 45 of the last 71 years. Or about 63% of the time.”
Was not cost of production many years ago significantly lower than today?
rockman on Wed, 21st Jun 2017 12:49 pm
q – “Was not cost of production many years ago significantly lower than today?” I think I get your point but let me correct your terminology. The cost of production is the LOE…Lease Operating Expense. IOW the actual cost to produce EXISTING WELLS. Correct me if I’m wrong but I think your referring to development costs: what it cost to drill NEW WELLS.
This isn’t a picky point: those two costs differ greatly. No, LOE changes very little over time. Which is why the US still has hundreds of thousands of wells producing averaging 15 bopd despite oil prices that have been much lower then the current price.
Now the cost to drill wells over time. That’s a tricky question. Obviously it costs much more to drill a horizontal well with a 5,000′ lateral at 12,000′ and then pump 36 frac stages into it then drill a straight a straight hole to 8,000′ and do a conventional completion. But that doesn’t take into account the cost per bbl produced: the hz well comes on at 800 bopd and the straight hole at 80 bopd.
So which well is really more “expensive”? Now compare that hz well which costs much less then a Deep Water GOM well that comes on at 15,000 bopd. And now take into account how cost vary with competition over time: a Deep Water rig might cost $300,000/day and then when drilling activity picks up 5 years later the same rig costs $700,000/day.
But I can guarantee this: that 5,000′ lateral in a 12,000′ deep hz well with 36 frac stages costs significantly less today the it did 4 years ago due to less competition.
Comparing drill costs vs time can be done. But you need to know exactly what you’re comparing and how the dynamics can alter those costs.
q on Wed, 21st Jun 2017 2:33 pm
rockman: Thanks. Yes, I meant development costs.