Thursday, April 21, 2016

Crude Oil: No April Freeze

One of our savvy accounts sent me an email early Monday morning with a terse message: “Doha: Ha, Ha!” He correctly predicted that there wouldn’t be a deal over the weekend to freeze oil production. Apparently, he wasn’t alone. Lots of traders must have shorted the oil market last week expecting no deal. The nimble ones must have covered their positions quickly Monday morning on the initial swoon in the oil price; after the low made on the open of the regular session, a rally swept the price north to close down only 0.4%.

Giving the market a boost on Monday was news that Kuwait’s oil workers went on strike to demand more pay. On Wednesday, oil prices fell in the morning as oversupply worries returned after Kuwaiti oil workers ended their three-day strike and American Petroleum Institute data indicated a larger-than-expected build in US crude inventories last week. By Wednesday afternoon, prices hit new 2016 highs after the US Energy Department (DOE) reported a smaller-than-expected US crude build, which more than offset glut worries stirred by the end of a Kuwaiti strike.

In addition, as CNBC reported on Wednesday, “Markets also got lift from reports that OPEC members and other crude-producing nations could meet in Russia in May following a failed attempt to freeze output at a gathering in Doha this week. But Russian Energy Minister Alexander Novak on Wednesday denied media reports of the potential meeting, RIA news agency reported. ‘There is no such agreement,’ RIA quoted him as saying.”

I also didn’t expect a Doha deal. On March 31, I wrote that it’s “[h]ard to see a freeze in April.” I wasn’t predicting the weather, but rather the likelihood that the Iranians would balk at the Saudis’ insistence that they freeze their production at pre-sanction levels. Sure enough, the Saudis continued to press their demand prior to the meeting, so the Iranians simply didn’t show up. What now? Consider the following:

(1) Production. The Saudis are threatening to increase their production. So are the Russians. On the other hand, everyone is waiting for US oil production to decline in reaction to the plunge in oil prices. However, the rebound in prices since the start of the year might allow many US producers to keep pumping.

The bulls are taking comfort from a chart showing that the US oil rig count leads oil field production by roughly 18 months. This relationship suggests an imminent plunge in US output. So does the relationship between US oil field production and railcar loadings of chemicals and petroleum products.

On the other hand, US frackers have DUCs, or “drilled but uncompleted” wells. “When oil prices started their long slide in mid-2014, many producers kept drilling wells, but halted expensive fracking work that brings them online, waiting for prices to bounce back,” Reuters explained on 3/21. As the price of oil increases, drillers can easily bring those uncompleted wells online. “Wood Mackenzie reckons that the backlog of excess DUCs will decline over the next two years, and return to normal levels by the end of 2017,” the article states. This ready-and-waiting supply in the wings is likely to keep crude oil prices closer to today’s levels than north of $100 per barrel. I agree with this conclusion.

Meanwhile, data compiled by Oil Market Intelligence (OMI) show that during March, crude oil output in the US and Canada combined rose to a record 13.6 million barrels per day (mbd). Russian and Saudi production remained in record-high territory at 11.4mbd and 10.2mbd. The same can be said of Iraq’s output at 4.3mbd. Iran’s production was up 0.7mbd y/y to 3.3mbd during March, with the country aiming to increase it to 4.0mbd before considering joining other suppliers in “re-balancing” the market.

(2) Inventories. Notwithstanding the positive reaction to yesterday’s DOE crude oil report, US crude oil stocks rose to yet another record high and are up 10.1% y/y. Total petroleum inventories were flat during the latest week at a record high and remain 10.3% above last year. (See our US Petroleum Weekly.)

(3) Demand/supply. Global oil demand rose to a record high during March. However, over the latest three-month period it rose just 1.4% y/y, while oil supply on a comparable basis increased 2.3%. The demand/supply ratio, which we calculate using OMI data, turned bearish in early 2014. It remains bearish, but ticked up during March. (See our Global Oil Demand & Supply.)

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