By David Yager
The current market and mood indicates the industry is most likely at the bottom of the current contraction cycle. But for things to get better, they must first quit getting worse. All major indicators seem to lead to a floor (or, given the severity of the current downtun, a basement), summarized as follows.
- After a “dead cat bounce” in June, oil prices slid lower through August but have recovered in recent weeks. Futures again show higher prices one and two years out. Not great, but better.
- Light tight oil (LTO) production in the U.S. has rolled over and is in steady decline. This will be a major contributor to a reduction in global supply.
- The International Energy Agency (IEA) is forecasting that by late 2016, global supply/demand curves will either meet or cross depending upon how much new oil Iran puts on the market once sanctions are lifted (September’s report forecast a shortage in Q4 2016. October’s report including a provision for Iran is closer to balance and/or the smallest surplus in two years). This will lead to higher oil prices. Spurred by low prices and non-industrialized demand growth, demand continues to increase in the IEA scenario, while the same low prices impact current and future supplies. Massive capital spending cutbacks worldwide will accelerate this process in 2016 and 2017.
- Oil stock values are in the dumpster. Although there has been some recovery in recent weeks, the S&P / TSX Equal Weight Oil & Gas Index reached a five-year low on August 24.
- U.S. and Canadian active rig counts are at low levels not seen in five years.
- Sales of Crown mineral rights in B.C. and of Canada lands are at 20-year lows, while purchases in Alberta and Saskatchewan are the lowest in a decade.
- Layoffs continue in the exploration and production (E&P) sector, after the service sector has laid off thousands and prices for goods and services are vastly reduced.
- Banks are tightening credit for E&P companies because low prices have reduced reserve values and for oilfield services (OFS) because of diminished cashflow.
- The general mood of the people who work in the industry is one of near despair, with “lower for longer” being the current mantra. It is awful and it always will be awful.
- Suncor Energy Inc. made a $6.6-billion unsolicited bid for all the shares of Canadian Oil Sands Ltd., the largest partner in the Syncrude Canada consortium. A big move by such a big player shows at least one company figures oil sands production won’t get much cheaper.
Like the 1971 dirge The Doors wailed so appropriately, “I’ve been down so goddam long that it looks like up to me.” The worst is over. Likely over. Call this protection from future apologies.
Even OPEC is speaking optimistically about rising oil prices without restraining production. In remarks to the International Monetary Fund on October 6, Bloomberg reported, OPEC Secretary-General Abdallah Salem el-Badri said demand will increase by 1.5 million barrels per day this year, but oil inventories in developed countries remained some 190 million barrels above the five-year average. This overhang remains an issue.
Crude oil inventories and bulging storage
This is a newer element of the current price collapse everyone has had to learn about. Last spring, oil storage at Cushing, Oklahoma, was said to be brimming and ready to overflow, which further depressed prices. Each week when the American Petroleum Institute and Energy Information Administration (EIA) releases the increase or decrease in U.S. oil storage, benchmark oil price West Texas Intermediate reacts either postively or negatively.
Iran is said to have tens of millions of barrels sitting offshore in tankers ready to flood world oil markets the moment sanctions are lifted. Commodity traders have exploited the crude price contango (when the future price is higher than the current price) by buying physical crude and storing it to sell for profit (after deducting storage costs) at a future date. This includes leasing offshore tankers which are paid to sit and wait to deliver the cargo at some future date to close out a contract.
How big a problem is crude oil storage?
Many bearish future traders figure it is significant because this oil overhangs the market. The storage surplus has to go before prices will rise.
But what is an appropriate surplus? This is complicated. Is it a problem or just another element of the oil business the uninformed are learning about for the first time in today’s tumultuous markets?
Crude oil storage is essential to the business. It is stored everywhere. It starts in the reservoir where it has been stored for hundreds of millions of years. There are storage tanks near producing wells, either on the lease or the nearest battery. Pipelines hold millions of barrels of crude in strorage as petroleum makes its way from the source of production to refineries. Pipeline terminals store oil in giant tanks, as do refineries. Every full crude oil tanker in the world – anchored or travelling to market – is in fact holding crude in storage.
Then there are strategic petroleum reserves where governments store oil to mitigate price shocks caused by unplanned supply disruptions. The U.S. Strategic Petroleum Reserve is the best known and news reports indicate China is buying and storing more oil because of low prices. However, this oil is not meant for the market, unless something serious occurs. When we read about the Chinese government filling oil storage caverns, this is not likely a large-scale contango exploitation opportunity.
According to the IEA, the total oil in storage – commercial and strategic – in all the OECD countries last summer was 4.5 billion barrels, up from a five-year average of nearly 4.3 billion barrels.
The current market turmoil has created a once in a generation opportunity for savvy energy investors. Whilst the mainstream media prints scare stories of oil prices falling through the floor smart investors are setting up their next winning oil plays. So how much is too much?
Media oil storage reports are unsettling. The EIA reported last spring non-strategic oil storage in that country had hit an almost 100-year peak. A quote from BusinessInsider read, “U.S. crude oil inventories are at the highest level for this time of year in at least the last 80 years.” This implies the last time the U.S. had this much crude oil in storage was in the 1930s. But detailed storage data on the EIA website only goes back to 1982.
While I am in no position to argue with the EIA, this statement seems inconceivable.
According to the same EIA data, U.S. oil production in 1935 was only 2.7 million b/d and the U.S. was an oil exporter. Imports were nominal. For storage to be as high 80 years ago as today, the U.S. would have to have been producing over 1 million b/d more than it consumed, not exporting any and storing it in tanks that didn’t exist.
Regardless of the shock value, U.S. oil stocks are at a multi-year high for the years which data is easily available. At 461 million barrels on October 2, the EIA reports oil in storage is some 100 million barrels higher than the five-year average for this time of year. There is no differentiation between normal storage on its way to market and contango or speculative storage. Companies operating commercial storage do not disclose if their storage space is being rented by crude speculators. That’s about 11 days of production at current U.S. output of 9 million b/d.
The IEA also publishes regular reports on crude oil storage. The following charts show the situation last month for OECD countries which, for the purposes of crude oil markets, are all the non-OPEC producers.
These inventory reports do not include strategic reserve storage. The five-year average oil in storage by mid-year (right chart) is about 2.75 billion barrels and this year is at about 2.93 billion barrels. This would be the 190 million barrels the OPEC boss was speaking of. This is a 7 percent increase over the five-year average of total OECD storage volumes.
The other figure (left chart) is number of days of oil supply in storage. In mid-year, the average has been about 59 days; this year is just over three days more, slightly below 63 days.
With demand rising by 1.5 million b/d this year and forecast to be much the same in 2016, it is not intuitive a 7 percent total increase in storage alone is a good enough reason for oil prices in the first half of 2015 to be half or less of the price in the first half of 2014. On the other hand, with 190 million extra barrels to consume to bring storage down to average levels, it would take 190 days at 1 million b/d to bring the figures into line.
So has the bottom of this oil cycle been reached?
Yes. The light at the end of the tunnel is clearly not an oncoming train.
But what really matters is how long it is going to take for prices, economics, activity and confidence to ramp up to a level at which oil companies, service companies and their employees can again secure consistent positive cashflow and stable employment.
If global oil storage is a factor – and it appears it is, at least to futures traders who increasingly drive the price – it will take some time for the tide to turn, even if supply and demand fall into line sooner than the IEA is forecasting.