All eyes on stockpiles, supply decreasing not rapidly enough
All eyes on stockpiles, supply decreasing not rapidly enough
Oil prices are back to their lowest level, due to the increasing stockpiles around the world. Indeed stockpiles of oil are at a record 3 billion barrels. The increase comes despite demand growth of +1.8mbpd (a 5-year high) in 2015, but which is actually below the supply increase, at +2.4mbpd, with a strong contribution in H1.
The decline this week came from lower growth of demand over the last two months. China’s oil demand only grew by +1%. US production was also slightly up on a weekly basis (thank you Gulf of Mexico, not shale). With stockpiles at their highest level, each barrel of oversupply is an issue, storage is too high, and therefore the price mechanism doesn’t really work. What is actually happening to supply and demand around the world?
- Shale production decrease: -93kbpd in November, -118kbpd in December
In its latest drilling report, the EIA expects crude oil production in December from seven major US shale plays to drop by 118,000 b/d. The agency also projects a 93kbpd decrease for November. Our forecasts are 136kbpd and 165kbpd for November and December respectively, higher than the EIA. Nevertheless, the interesting point to note is there are no changes in EIA’s forecast: the acceleration of the shale decrease is clear, month after month; with oil prices below $50/bbl, shale loses production. Our 1.2mbpd loss in shale production target may be reached by mid-2016. According to Daniel Yergin, vice chairman of IHS, US crude output will retreat by about 10% in the 12 months (or 1mbpd).
So far, shale production in December may be down 600kbpd from the peak level of this summer.
The EIA figures are often criticized, but the latest forecasts have been correct. Indeed, North Dakota reported on Friday that actual production for September was down 25kbpd, in line with the EIA’s expectation. The agency slightly revised down its 2016 US production. On the latest forecast for 2015 from the EIA, for December, Eagle Ford production is expected to fall by 78kbpd, the Bakken is projected to drop by 27kbpd, and the Niobrara is projected to fall 22kbpd.
Shale production may be down 118kpd in December 2015. Oil prices at $25.5/bbl in North Dakota
In Pioneer Natural Resources’ November investors’ presentation, the company presented US shale oil production under various price scenarios based on data from energy think-tank, PIRA. The latest figures were not far from our latest estimates (Email 24/09/2015, see appendix). This chart is clear. At $40/bbl, WTI shale production decreases by 1mbpd a year, and as from 2017 by 0.5mbpd a year. At $50/bbl, the decrease is 0.5mbpd/year in 2016 and 2017. $60/bbl is the level where production restarts, and $70/bbl is where the increase could be as impressive as it was in the 2010-2015 period. In Q3 15, even some big players announced their production would decrease by 10% next year (HESS).
Recent transactions in the Permian basin (on acreage, not production) are based on a $90/bbl. It is therefore difficult to believe that these buyers will produce at $45/bbl today. Efficiency and technology would be needed, and oil prices would need to rise. One reason shale oil producers are still currently completing wells at current oil prices, is that they have extremely low expectations for oil prices in the next two years, and think that within this context they may not get much better prices in the near future. Another explanation we heard is that they want to benefit of the currently very low material costs: some of them expect a sharp increase in costs will also come the oil rebound to $60/bbl. The trade-off between completing now at $40-$45/bbl with current costs or completing at $60/bbl with higher cost is unclear for to us, as we believe costs will only rise by 10-15%.
Refracking may complicate the analysis, even if we believe this is not a big trend so far, but the Permian saw an 8% increase in recompletion permits, indicating a potential for refracs to occur.
- Production in mature fields
In a rush to lower costs and save some cash for shareholders, integrated oil companies have also cut short-term capex. As highlighted in our presentation in January 2015 (When $100/bbl becomes $50/bbl), some maturing fields have a cash cost above $45/bbl. According to people working in the industry in mature fields, the decrease may be close to 1.2mbdpd for 2015 (on flexible capex and opex cut).
Total SA, for example, has reduced its production growth outlook for 2017 by 200kbpd due to infill drilling.
Statoil is another example, which has decided to postpone projects with weak returns. The company has scrapped four years’ worth of drilling by cancelling or suspending rig contracts, according to Bloomberg’s calculations, with some interesting comments from the company: “Statoil’s responsibility is to secure long-term value creation on the Norwegian shelf … We don’t want to suspend or cancel rigs, but a part of that responsibility implies taking measures to reduce costs, so we can realize profitable projects.” The company has delayed the start of production at its Aasta Hansteen and Mariner fields to the second half of 2018 from 2017.
- Risk Premium accelerating below $45/bbl
On the OPEC side, the monthly Oil Market Report released last week showed the group’s production was slightly down by 256kbpd to 31.4mbpd (target of 30mbpd, or 31mbpd after the December meeting) with Iraq contributing the main part of the drop. Sabotage attacks have reduced flows through the Kurds’ export pipeline in the north, Bloomberg reported. Analysts have cautioned that record output from Iraq may not rise much further, with low prices and security costs constraining its producers.
In fact, rising production from places like Iraq offset the declines in the US shale over the past months. Bloomberg reports that at least 10 oil tankers from Iraq are set to arrive on US shores in November, a delivery of around 19-20mbbl. That is the largest delivery in such a short period of time since June 2012.
Iraq has contributed along with Saudi to the increase from OPEC since the collapse in oil prices with 600kbpd and 500kbpd added respectively between Q2 15 vs. and Q2 14
While Saudi is comfortable with Brent at $45/barrel compared to other countries, the country still requires $12bn per month to fund its budget deficit. The New York Times reports that Saudi’s foreign reserves have declined by $90bn, but they still are about $647bn. This is a level which may force the country to accelerate its restructuring (reducing dependence on hydrocarbons, subsidy reforms, taxes and privatization). Saudi officials say the Kingdom could increase debt levels to as much as 50%.
Saudi Arabia's cost of insuring its sovereign debt against default has reached its highest level since June 2009 with its 5-year CDS up to 154.2 bp last week, from 84 bp in mid-September.
We highlight Saudi’s situation as it is the most comfortable, but it looks much more difficult than expected a couple of weeks ago. For other players like Venezuela, the risks are high with elections coming soon. Low oil prices start to also cause problems for highly geared companies. Brazil’s largest workers’ union has been on strike in protest at asset sales by Petrobras and a dispute over salaries and rights for domestic staff.
- Conclusion: the market is rebalancing, but the very short term is unknown
How important are the 3bn barrels in stockpiles around the world?
As shown earlier in the chart on page 1, the 2010/2014 average stockpiles were close to 2.7bn. Based on the consensus for 2016, with a Brent price close to $52/bbl on average, supply should rise (including Iran, excluding a part of infill drilling) by 0.1mbpd, while demand should increase by 1.2mbpd (low range of expectations). Indeed, production from the US and other countries outside the OPEC cartel will decline next year for the first time since 2008, the US government said on Tuesday. The Middle East is already producing at maximum levels (excluding Libya and Iran).
A 1.1mbpd drawdown over 365 days would decrease OECD stocks to below their historical average. We believe that in the very short term, this is a key determinant to oil prices, but that oversupply concerns may disappear in one year.
In the very short term, there are signs that growth in oil demand is slowing significantly relative to earlier this year, and that US shale production may not be decreasing quickly enough. Again, at $45/bbl, both would be revised.
OPEC is the reason for the oversupply. But today we are in a situation where the potential for its production is very limited. Outside OPEC, it is the same: Russian fields have delivered 10.78mbpd, breaking the country's post-Soviet era production record for the fourth time this year. Output above this level may not be possible according to local analysts. The market is expecting Iranian oil to come back, and we believe it too (500kbpd in 6 months); there is a risk, however, that Iran does not comply with its side of the bargain when it comes to exports. In Iran, according to the Arab Petroleum Investments Corp. (APICORP), achievement of ambitious production targets set by the Iranian government is possible, but far from certain.
Oil prices carry no risk premium, but in my view, we are waiting for a catalyst. Keep an eye on the US weekly release every Wednesday; the $60/bbl remains our target for the first half of 2016, but oil demand growth must stabilize close to +1mbpd next year. Below that level, our scenario is at risk for 2016. Negative news adds to that risk: Japan, the world’s third-biggest oil consumer, reported today that its economy shrank at an annualized pace of 0.8% in Q3/15.