Some time ago we discussed whether US independents could become the new “swing producers”. It does not seem so. Or maybe it is going to happen. April figures and new information leave us in the middle of nowhere, as no piece of the puzzle seems to fit into the other.
EIA and IEA have each revised upwards their 2015 oil demand forecast (respectively to 1 and 1.1 million bbl/day). This should be good news in terms of market rebalancing; and it heralds a potential for price increase. Except that oversupply keeps raiding on top of the increase in demand and stays around 1.7 million bbl/day. Forecasts suggest that it should lower in the second half of the year; but all or almost all forecasts confirm that oversupply is here to stay, and so at least for the whole of 2015.
The other side of oversupply, i.e. commercial inventories, keep to pile up in the meantime. In the States alone they are at 483.7 million barrels, 62% of the overall capacity, the “highest level for this time of the year in at least the last 80 years” (EIA, April 10). This would normally act as a price depressive; but this April it does not.
The Brent price landed below fifty dollars in January (45.13 on January 13), and is now back over 63. WTI was below 45 (43.39 on March 17, 2015), and now above 56 (with the spread Brent WTI often influenced by the Cushing terminal issues, amongst which an unprecedented level of Cushing inventories that was largely responsible for the March floor).
There must be a missing piece. May be on the supply, and not on the demand side. Some expectation of supply slowing down somewhere. The problem with that is in the “somewhere”. One should not look at OPEC, to start with. They have decided to defend rents through preserving volumes and market share. Prices cannot go up simply on the expectation that the Saudi will change their mind. May be then the market is, instead, looking forward to some major disruption, capable - like in Lybia years ago - to de facto curtail production. But this also is not enough. Nobody would rally on prices, betting on a disruption that is not even announced. Which leaves us with a last suspect. LTO (Light Tight Oil). Is US tight oil production on the verge of declining? Will it swing (although involuntarily) and join the increase in demand to rebalance the market?
Here, too, we get mixed signals. Rig count in the States went down by 50% year on year (from 2030 to 1034). And decline in oil wells (from 1,510 to 734) outpaced the decline in gas wells (from 316 to 217), clearly indicating that the price slump is hitting harder on the oil side. Considering that the average production profile of a shale/tight well shows a 60% production decline in the first year, a halving of the drilling density should be herald to a major production collapse. In real life this is not the case. New wells productivity has increased within the major basins from 20 to peaks of over 40% since the beginning of 2014. The decrease in horizontal wells (from 1,224 to 741) is significantly below 50 %, while onshore vertical drilling has crashed (from 391 to 122).
Producers have reacted to the slump through a better selection of drilling spots, further redefining of well design, and, in general, by trying to optimize their operating practices. So far, i.e., they have been able to compensate rig count with enhanced well productivity.
Will it last? Whatever the answer, it will surely have a material impact on the 2015 (and may be further) price dynamics. The announcement that US production will decline in May (note: month on month) for the first time after 2009 sent up WTI by 3 dollars per barrel almost instantly. The problem with that being that enjoying a world daily oversupply of 1.7 million bbl/day, the market reacted enthusiastically to the announcement of a US production decline of 59,000 barrels a day. May be, you could argue, it was simply that someone was looking at it just as the beginning of a bigger story.
If LTO production declines sharply, the rebound on price will be rather material. This is not, however, the prevailing forecast. EIA predicts till the end of 2016 a sort of ondulated plateau production, whereby year on year US production will even slightly increase in 2015, and then remain stable with minor ups and downs for the year to follow.
Time will tell. Today we can only register that the uncertainty is such that not only this comment, but even and even more the market has serious problems in fitting together the pieces of the puzzle.
Or, at least, this is the story that tells you the 95% confidence interval for monthly average WTI prices. Last year it ranged between 85 and 115 dollars per barrel, i.e. an implied 17% volatility. Now (for June prices) we are at 35 to 78, i.e. an implied volatility of 46%; and for December deliveries the spread is between 32 and 97. Confronting June and December, you may argue that it looks bullish; but we are not sure that in real life you would bet on it.
There are times when the direction you are going is irrelevant; provided you never leave home unhedged.