When Will Oil Bounce Back?

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By David Messler

Last week saw oil move jump in the largest two-day percentage increase in history. A similar movement was seen in Brent, moving back into the mid-$30’s. In a market hungry for good news, there were cautiously optimistic murmurings out of the two ‘cage-fighting’ oil producers, Saudi Arabia, and Russia. ‘Murmurings,’ that they might, emphasis on might, be willing to reach a production compromise that would bring some stability to an oil market in freefall. On such ‘weak tea’, a historic rally was seen in the oil market.

I can only imagine the rally that would come with an actual meaningful cut in output between these two hydrocarbon heavy-weights. We shouldn’t have long to wait as they will have a delayed from Monday, virtual meeting on the schedule for Thursday, April-9th, with an announcement expected that day.

I am pessimistic that this announcement, assuming that one comes-remember the effect of the lack of such an announcement on March-6th, will bring the kind of relief to the oil over-supply issue I discussed in a recent OilPrice article. Quite simply there is an ocean full of oil floating in oil tankers just waiting to offload, at ports that are already chock-a-block. This does not bode well for the beleaguered oil market that is desperately searching for good news.

Even in the positive case where the announcement covers a substantial portion of the 18-20 mm BOPD global supply excess forecast for the second quarter, that I discussed last week, we are not yet at point where the oil price will rise meaningfully enough to balance the budgets of our two key players. Which was the point of all of this kerfuffle to begin with.

In this article we will put aside further discussion of the outcome of Thursday’s virtual meeting to focus on other signs coming from the oil market. Signs that could bring some the relief for which the market is so anxiously seeking.

A decline in shale production, finally!

This could be it. The long-awaited shale decline is finally registering in the data. For Jan, 2020 total U.S. production is 12,744 mm BOPD, a decline of about 60 K BOPD from December. Not huge, but a change in the direction of the curve.  Natty showed a similar fall off from previous highs.

If you look at the entire report you will see that the losses all came from shale plays. Offshore was up modestly, offsetting some of the decline. The fact that the decline came from shale is critical.

In an earlier OilPrice article I argued “The bottom will be firmly set in when production from shale plays actually turns south.”

There is so much noise in the market right now, and the decline was so modest, that this moment passed largely unnoticed. It will be the end of April before we get another snapshot of activity from the shale patch to confirm that down is now the trend, or what happened in March was a head-fake.

Tariffs on imported oil are a bad idea

I discussed recently that crude production was likely to be shut-in in a desperate attempt to raise prices. Now, the CEO’s of Pioneer Energy, (PXD) and Parsley Energy, (PE) have made a plea to the Texas Railroad Commission to order a cut in production.

“We need dramatic government action, because we know the operators cannot uniformly talk together,” Matt Gallagher, chief executive officer at Austin, Texas-based Parsley, said in an interview. The pair of shale explorers believe a 20% cut to the state’s production would be most helpful for the industry, Gallagher said. Pioneer is led by Scott Sheffield, whose son Bryan is Parsley’s chairman.

Bloomberg

This one of the sillier ideas I’ve heard put forth. You want less oil? Stop drilling. The problem will take care of itself. This to me, seems like a self-serving attempt by a couple of fairly well capitalized companies, to put pressure on weaker ones by starving them of any revenue.

Now there is a dichotomy in the oil industry’s voice. The big guys Chevron, (NYSE: CVX), ExxonMobil, NYSE: (XOM) are saying one thing, and as you might suspect, the little guys like Parsley Energy are saying something entirely different, as noted above.

A meeting was held in the last week between the big oil chiefs and the president. The subject was intervention in the spat between Saudi and the Russians.

“While some in the industry want the Trump administration to pressure the Saudis and Russians, many large U.S. oil companies oppose cooperation between the world’s three biggest crude-producing nations, which would be unprecedented. Exxon Mobil and Chevron have lobbied against any market intervention, and the possibility wasn’t discussed in the first part of the meeting.”

WSJ

What is on the table is an import fee (tariff) on oil coming to the U.S. The idea is that this will establish a floor price for the commodity that will allow U.S shale producers to drill and produce profitably. In fact, it will do nothing of the kind as the parties being discussed, (OPEC+) will cheat on any quotas established and the big guys know this-hence their opposition.

There are strong arguments to be made against raising tariffs. It is interesting to me that these arguments are being forcefully made by one of the governing bodies of the industry itself, the American Petroleum Institute-API. In an op-ed, Mike Sommers, CEO of the API wrote-

“In the short term, tariffs would inflict significant damage at home. They would raise costs for U.S. refineries, create even more uncertainty for global supply chains and likely result in increased prices for consumers. Vital energy projects would be delayed because of the increased cost of “critical production materials not available in the U.S.”

The Hill.com

I agree with this standpoint and have previously made the point in a prior OilPrice article that variations of what basically amounts to ‘price controls’ has all been tried before and produced nothing but disaster. I don’t really have a lot to add to that position, except to emphasize: Let the free market forces work.

The president is originally a ‘free marketer’ who was against big government. Hopefully he hasn’t been infected by the swamp he pledged to drain.

Rig and Frac Spread Counts for the week

You can see the driller’s reaction to $20 oil fairly easily with the Baker Hughes one-week rig count decline. 64 in one week! In an earlier version of this chart I had guestimated a final of 677 at the end of April. I was too modest in my expectations, and now think we’ll exit April somewhere around 550.

It is the same story with frac spreads. Another precipitous decline extended the trend of the prior week. I don’t see anything to stop it before the count reaches 2016 lows of ~150 or so. As noted in the chart below it should happen very quickly.

LNG and Gas

Like oil, right now the world is swimming in gas. At some point this must result in well shut-ins and production curtailments. You can see in the latest EIA 914, the numbers are off a hair, so we could be seeing the start of this cycle.

“This unprecedented surge of LNG supply to Europe is certain to cause knock-on effects,” said Shankari Srinivasan, vice president of gas and power at IHS Markit. “Storage inventories will build up earlier than normal and that will put additional downward pressure on prices in the third quarter and winter delivery months. It is a chain reaction.”

SP Global Platts

My view on anything gas related; LNG, pipeline companies, etc, is to wait for some sign of market bottoming i.e. prices starting to rise just a bit. I understand the dividends yield are compelling, but probably most of them are going to be cut in the near future, if sales volumes fall off. What’s low now, could get lower still.

Your takeaway

As your mom used to say, “It’s as plain at the nose on your face.” (Well, that’s what my mom said anyway.) Meaning market forces are already at work. Ruthlessly I will admit, but it’s what has to happen to eventually allow the oil market to come into balance.

Government intervention will not save the failing shale producers. I understand why they are reaching out, but only consolidation and efficiency increases can save (what will be) a smaller industry.

The world can live with some shale production, but the 9-mm plus BOD we are currently producing is creating an excess and cheaper oil is going to drive it down.

How we are playing this historic decline in upstream producers and service suppliers

We think the beleaguered upstream service providers, (NYSE:HAL, NYSE:SLB, NYSE:BKR) and major operators, (NYSE:BP, NYSE:RDS.A,B, NYSE:XOM, NYSE:OXY, and NYSE:CVX) are the ways to play this unprecedented decline.

They will be among the first to rebound when oil starts to increase in price. Additionally you can collect sizeable dividends while waiting for improvement in share prices from the oil majors. All of those mentioned above, save for OXY which slashed their dividend for the second quarter, and have gone to the debt market recently to preserve them. It’s worth noting that this is a bullish sign long term for oil prices that they are willing to do this, as this sort of action is not sustainable beyond a few quarters.

In fact the big oil companies and big service providers have already made a significant move higher from their recent lows. I’m not buying the bounce, as I believe there is more pain to come when quarterly results are announced and oil falls…again.

We are awash in product as previously noted and that is going to have an impact on activity. Until shale volumes start to fall markedly and estimates of global demand start to increase, it’s best to wait for rock bottom prices for all of these companies. Anything higher will result in minimizing gains when the real recovery begins.

Crude Oil

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