Yves here. I e-mailed Wolf today after seeing a new Wall Street Journal story on bullish IEA oil price forecasts for the second half of the year. From his reply:
The fundamentals are clearly against any kind of quick rise in the price of oil. That said, with enough speculative money piling in, prices could rise (they already did by 20%). But that would just support more production and higher storage levels, which would then be the next shoe to drop.
In my experience in the oil patch in the mid 1980s and on, this will take a while to work out. But as we say, nothing goes to heck in a straight line.
As you mentioned, the rig count drop is irrelevant near term.
But even long term, the rig count drop is misleading. Drillers cut out the oldest most inefficient rigs, and they stopped drilling in the most inefficient and expensive plays (wells that produce a lot of water, for example). They’re cutting the least productive wells and the worst equipment, but they are maximizing their most productive wells and the best equipment. I don’t know what the net difference might be, but it’s not equal to the total number of rigs that they idled…
Wall Street is already pumping up prices for next year. In 2016, a lot of junk-rated drillers are going to run out of liquidity. At the current oil prices or below, they’re unlikely to obtain more funding at reasonable terms. Vultures will be moving in with senior secured debt at extortionary rates and tight terms to where they get most of the company when it defaults and restructures. This will hurt banks, investment banks, PE firms, etc. So they WANT oil prices to go up, after a big tradable crash to end no later than in Q3.
That’s my interpretation.
The entire industry, the IEA, EIA, the Russians, everyone in the game wants prices to go up. So they’re talking them up. But if prices go up and drilling restarts in full, now with a focus on efficiency, it’s going to be a much bigger mess shortly thereafter than what we have now.
I don’t know where prices might go, but I doubt all those industry voices that claim that prices will soon go back to a “sustainable” level. That’s not how real oil busts get worked out. Last time, 700 banks failed, real estate in the oil patch crashed, restaurants closed, young people left because there were no jobs, terrible things happened…. And I haven’t seen any of it so far.
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
The price of oil has bounced 20% since January 29 when the benchmark West Texas Intermediate had dipped below $44 a barrel, but according to Edward Morse, Citigroup’s global head of commodity research, that dizzying bounce is a “head-fake.”
Because the fundamentals are still terrible. Oil production in the US is still rising, despite drillers shutting down drilling activities at a record pace. Drilling fewer new wells is hurting oil field services companies, and the pain is fanning out across the oil patch and beyond. It hit private equity firms, it sank energy junk bonds, it triggered layoffs, but it isn’t curtailing oil production. Not yet.
So the US remains by far the largest contributor to “global oil supply growth,” the US Energy Information Administration just pointed out, with production in 2014 jumping by 1.59 million barrels a day. By comparison: in Iraq, the second largest contributor to global oil supply growth, production edged up by 0.33 million barrels a day.
“Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia,” explained the Citi report, cited by Bloomberg. “The market is oversupplied, and storage tanks are topping out.”
Production will continue to rise, despite plunging drilling activity, and won’t slow down until the third quarter this year. As the oil glut is growing, it wreaks havoc on the price of oil, potentially pushing it, according to the report, into the neighborhood of $20 a barrel – “for a while.”
Analysts, faced with the oil glut that resulted from the US shale oil revolution, are scrambling to bring their erstwhile sky-high expectations into line with reality. They have slashed their projections for the energy sector; and according to FactSet, revenues are expected to plunge 36% in the first quarter. The plunge is so steep that it will drag revenue “growth” for all S&P 500 companies combined into the negative, -2.3% in Q1 and -2.6% in Q2.
And the US shale oil revolution has defanged OPEC. It can no longer control oil prices at will to maximize profits for oil-producing countries, including the US. A sort of an unpleasant free market has suddenly re-broken out. “It looks exceedingly unlikely for OPEC to return to its old way of doing business,” Citi’s report said. “While many analysts have seen in past market crises ‘the end of OPEC,’ this time around might well be different.”
But Citi is an integral part of Wall Street, and Wall Street dreams of a V-shaped recovery of everything because that’s where the quick and big bucks are to be made. Prices even in the current range are unsustainable for the industry, the report pointed out, and will entail a wave of “disinvestment from oil,” of the type we’re already seeing. But then, after oil plunges into the $20-range, presumably by no later than the third quarter, mirabile dictu, the price will soar, according to the report, and I mean SOAR, with Brent hitting $75 a barrel by the end of this year – more than tripling in a little over a quarter.
From $52 a barrel to $20 and then to $75 in just one year? That’s the kind of V-shaped recovery that dreams are made of. Every trader lusts for this. Wall Street lusts for it. Hedge funds can hardly contain themselves at the mere thought of it. So whose book is Citi talking up?
If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets. And beyond that, investment banks stand to lose a lot: in 2014, Citi earned $492 million in energy-related investment-banking revenues – more than any other bank! More even than JP Morgan [How Wall Street Drove the Oil & Gas Drilling Boom That’s Turning into a Disaster].
So Wall Street must have a V-shaped recovery in place by 2016, or else.
We have watched the price of natural gas drop to ludicrously low levels – and stay there. Natural gas producers have been bleeding for years. Those that could, switched production to shale plays that were rich in oil, condensate, and natural-gas liquids that brought much higher prices and allowed some of these gas wells to be profitable. But now, their prices have plunged as well, and that solution has gone up in vapors. Yet, production continues to soar from record to record! There has been no V-shaped recovery in the price of natural gas. And if or when there is a price spike, it won’t be the right side of a “V,” but a spike after years of terrible bleeding.
OK, oil is different. It’s a global commodity, which landlocked US natural gas is not. And there was a V-shaped recovery after the financial crisis as the central-bank money-printing binge around the world inflated nearly all assets. This time around, there isn’t a financial crisis, and no sudden collapse in global demand. Instead we have lackluster demand, rising production, and increasingly a glut. And the Fed, the biggest perpetrator at the time, is sitting on its hands. So that breath-taking, stunning V-shaped recovery back to paradise might remain what dreams are made of.
Meanwhile, far from Wall Street, and out in the oil patch, the cutbacks in the exploration-and-production sector are hitting oil-field services companies hard. They too are cutting back. The impact is rippling out further. And the bloodletting will go on. Read… Oil Rig Count Plunges 29% from Peak. Halfway to Bottom?
I love how an OPEC that refused to cut production in the face of falling prices is “de-fanged”.
Or a lot of “junk-rated drillers are going to run out of liquidity”, isn’t this the whole shale patch? Or as long as the debt keeps pumping nothing’s really junk? Thats the first lesson of modern finance.
Anyway, the past is no window on the future of oil, and everyone does themselves a disservice by looking at the oil industry from a financial perspective first.
In the absence of new pipeline capacity, rail road transport of crude to existing refineries should be more telling than rig count. As Mr. Wolf points out the net result of maximizing the best wells and with the best equipment and cutting off the worst can keep production of barrels of oil per day up while rig count goes down. This link show the dramatic growth of monthly crude by rail across the US.
If also tells the tale of coal being displaced if you click on coal by rail and see the exact opposite, a steady decline in coal by rails due to the retiring of many coal fired electric power plants not able to meet EPA clean burning requirements. Natural gas is displacing coal and crude oil is turned into refined fuels. Not only is the crude oil a glut, but once refined, as gasoline, this refined product is not subject to export restrictions and is sold outside of the USA. Private ship building has been revived on the Delaware River with the Aker ship yard producing double hulled tankers for fuel transport for Exxon and others through 2018. So, the telling indicators would be the railroad cars in demand for crude by rail to refineries and the tankers manufactured for storage or export of refined crude. If these start to taper off and decline, that would signal that even the best wells with the best equipment can no longer produce at the levels necessary for debt service in the short term to stay in business and avert financial collapse. And the ancillary activity of railroad cars, highly specialized for safety concerns over unstable natgas vapors in the Bakken crude and double hulled oil tankers on backlog at shipyards for export or Jones act transport among USA territories will rise or fall depending on the high level of existing drilled wells or almost complete wells whose productivity remains to be seen.
thanks for that!
on Friday, Baker Hughes also released international rig counts for January 2015, which showed 1,258 gas & oil rigs operating outside of the US and Canada, which was down 55 from the 1,313 counted in December, and down 67 from the 1,325 count of January a year ago…interestingly, the active rig count fell in every area worldwide except in the Middle East, where 12 rigs were added, to bring the Persian Gulf area rig count up to 415…that they’ve added rigs in January at a time when prices were below $50 and dropping is indicative of OPEC’s intention to carry out this price war to the end, until such time as inefficient tar sands and horizontal shale operators are driven out of business…
For anyone who was paying attention to the oil industry in the mid-1980’s, as Wolf says he was, that experience will be implanted forever in memory as the archetype of an energy bust. But this isn’t the mid-1980’s. His observations about the motivation of the various players are astute and worth reading, as are his comments about the effects of speculation in paper barrels, but IMO he’s wrong about the supply/demand fundamentals over any but the very short term. Shale oil is simply not big enough to have “defanged OPEC” sufficiently to maintain prices anywhere near current levels . That story is part of the hype.
For a good recent discussion by Art Berman, who when it comes to US shale knows the territory better than Richter, see here: