Why this Oil-Price Bust will Drag Out a Lot Longer than the US Oil Industry Claims

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The flood of new money began re-surging.

Despite prolific jabbering about output cuts by various OPEC oil potentates, and despite promises by Saudi Arabia that Russia would cut in conjunction with OPEC, OPEC’s production in October rose to 33.64 million barrels per day, the highest in many years, up 1.05 million barrels per day from May, on surging production in Iran and Iraq and near record production in Saudi Arabia. Russia set a post-Soviet record in October, with 11.2 mmbpd.

Global demand for crude oil has crept up to 97.3 mmbpd in the third quarter, but production has risen to 98.3 mmbpd. In other words, in the quarter, the world produced 1 million barrels per day on average that went into storage, from where it will exert pressure on prices in the future.

On Sunday, Iran’s Oil Ministry cited President Hassan Rouhani at a ceremony to formally open the project west of the Karoun River, near the border with Iraq. Production there had jumped from 65,000 barrels per day in 2013 to 250,000 barrels per day now, Rouhani said. And it “must reach one million barrels per day.”

There will be more OPEC meetings, more jabbering, and more promises, but none of this is likely to make significant headway in cutting production.

And in the US, new money has begun to surge back into the sector. In select locations, production is soaring. The US matters because it has become the global “swing producer” – the oil producer with the most excess capacity that can be unleashed on short notice.

While production has begun to decline in May 2015, it has recently started to perk up again. The EIA, in its most recent Short-Term Energy Outlook, forecasts that production will continue to increase through the second quarter of 2017.

According to law firm Haynes and Boone, there have been 105 oil and gas bankruptcies in the US and Canada since the beginning of 2015, involving $67.9 billion in debt – so small fry. The US companies in bankruptcy account for only about 5% of US oil-and-gas production. None of the bigger whales have washed up on the beach.

These companies and the many companies that have held a gun to their bondholders’ heads and have “restructured” their debts outside of bankruptcy court have gotten fresh money, and they continue to exist. They’re drilling and producing, some in a zombie state, others with more vigor.

The flood of new money began re-surging months ago. In the US, oil production isn’t governed by one monolithic oil company, such as in Saudi Arabia, but by money flow and by numerous producers fighting against each other and the world.




But money flow and production growth has shifted to the Permian Basin (which ranges over parts of West Texas and into southeastern New Mexico), at the expense of other major oil fields in the US. The number of active drilling rigs in the Permian has soared 65% since the low point in April, to 218, compared to 234 rigs in the rest of the US combined!

This chart by the EIA shows the surge of production in the Permian, against the decline in other major regions:

us-oil-production-by-basin

And mergers and acquisition activity among exploration and production companies is picking up momentum, after passing the low point in 2015. The EIA attributes this to two factors:

  1. A price range of $40 to $55 a barrel of WTI (up from below $30 early this year). At this price range, oil has revived as a money-magnet;
  2. And “improved credit conditions.”

Which is an understatement. Energy junk bonds have staged a miraculous recovery since February, despite the bankruptcies, as hedge funds and private equity firms have plowed into them. The spreads between Treasury debt and energy junk bonds have collapsed as yields have plunged, and this has increased the appetite by banks and the bond market for more energy debt.

M&A activity – which includes the sale of assets from one entity to another – has surged along with the “improved credit conditions.” And the Permian has become to new El Dorado:

The 93 M&A announcements in the third quarter of 2016 totaled $16.6 billion, for an average of $179 million per deal, the largest per deal average since the third quarter of 2014. Although only 11 of the 49 deals so far in the fourth quarter of 2016 are in the Permian Basin, they accounted for more than half of total deal value.

The second half of 2016 through November 10, “already has more M&A spending than the first half of 2016, but on fewer deals,” according to the EIA. With energy credit conditions loosening and new money flowing into the sector, production is likely to continue to rise.

To top this off, US producers in just four oil-rich regions – Permian, Bakken, Eagle Ford, and Niobrara – currently sit on over 4,100 drilled but uncompleted (DUC) wells. It takes a lot less money and time to complete these wells and start producing. This is a production overhang that can come on line on short notice. All it would take is an oil price increase.

But crude oil inventories in the US are at record levels for this time of the year and are about 40% above the normal multi-decade range. This chart by the EIA shows just how much of an outlier this storage situation has become:

us-oil-stocks-1990-2016

Oil storage facilities around the world are brimming with oil stocks, and in June, the International Energy Agency reported that another 95 million barrels were stored on tankers waiting for better days.

The oil bust has accomplished a lot of things globally, from propping up consumer spending on other items to driving Venezuela to the brink. But the one thing it hasn’t accomplished is a cut in global production. And unless the money dries up, the price of oil will continue to vacillate within a range that inflicts maximum pain for the longest possible amount of time.

Somewhat further in the future, the oil industry has an even more complex problem to deal with: demand will dry up. Read…  EVs May Send Big Oil into “Investor Death Spiral”: Fitch




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  26 comments for “Why this Oil-Price Bust will Drag Out a Lot Longer than the US Oil Industry Claims

  1. Chris
    November 15, 2016 at 3:38 pm

    How perverse that zirp/nirp monetary policies drive investment into industries that are in a perpetual zombified state. If CB’s raise interest rates then this and other industries die and jobs vanish. If rates stay where they are or go into the negative in the US then the day of reckoning will be that much worse. What an example of painting oneself into a corner.

    • Steve M
      November 15, 2016 at 4:52 pm

      Exactly. Reminds me of the joke in which the husband bursts into the bedroom to find his wife with his best friend.
      He pulls out a gun and they gasp.
      Then he puts the gun to his own head and they begin smirking.
      “Don’t laugh!” he warns. “You’re next!”
      But seriously, “wales” in para 7?
      Please provide a PO Box so i can buy you a spell check for Xmas!

      • Ricardo
        November 15, 2016 at 5:37 pm

        Maybe he was thinking of the Green green grass of home. :)

        • Ricardo
          November 15, 2016 at 5:41 pm

          Sorry I should have included for reference:
          But seriously, “wales” in para 7?

      • November 15, 2016 at 6:06 pm

        h fell through the cracks. Send me some grout to fill the cracks.

        :-]

        • Tim
          November 16, 2016 at 9:22 am

          Question Wolf – if Trump enacts the fiscal side of his plans alongside the Republican congress do we have a situation where tax cuts + infrastructure increase demand, and increasing bond yields + tightening fed finally cuts access to credit, achieving a materially tighter supply/demand scenario sooner than we think?

  2. matt
    November 15, 2016 at 3:53 pm

    article on Z H about Exxon being just about bankrupt over the weekend was worth reading. amazing how they have blown almost 185 billion on buybacks on 1/3 outstanding stock over the past 30 years and dividends. Profit is down for them 85 pct since 2012 and at current rate cash flow will be negative by 2020 to point they can no longer afford to operate. Sands ops in Canada are up for sale to raise money . seems that was missed in earnings report? . then this little blub that land storage in the E U is full

  3. Merlin
    November 15, 2016 at 5:37 pm

    the PE money has no other place to go, it seems. Check the asset sales in oil and gas and you will find PE firms behind the transactions. The buyers have only been incorporated for a year or so, if that, and will be “flippers” as the PE firms will want a ROI in a few years at most?

  4. OutLookingIn
    November 15, 2016 at 6:14 pm

    Land storage in N.W. Europe, UK, and the Med region is indeed approaching crises levels, as VLCC’s (very large crude carriers) tankers are being used in increasing numbers as floating storage.

    http://www.downstreamtoday.com/news/article.aspx?a_id=54289

  5. milking institute
    November 15, 2016 at 7:42 pm

    Have been trading Oil’s ups and downs fairly successfully but this is getting be a Roulette game. you’re long,the world falls into recession,you’re short,the Saudi oil fields go up in flames. signing out of this mess,sticking with Gold for now,as far as i can see the,the world wide CHAOS,turmoil and Fiat debasing is not going away anytime soon and should be bullish for the ONLY true currency you can’t print. other than that,short the Fangs,the first to be be liquidated in a downdraft imo. unless Apple comes up with a revolutionary product,their 700.00 i phone will be joining the TOASTER and the VCR in a long line of commodities available at Walmart for 19.95…..

    • Coaster Noster
      November 16, 2016 at 12:06 am

      I still cannot figure out how, when CHAOS comes to the world, that having a hoard of gold will help. If you and your abode are known to be the only house for ten blocks (or, rural, ten miles) in possession of gold, who would be willing to come over and trade, say, a case of wine, and a case of canned beans, for a …..well, lets say… a little dot of gold, the size of a hole punched in notebook paper. Why would I take a “dot of gold”? I cannot eat it, or trade it…is this even a fair trade, and is it 24k gold, or lead with gold foil on top, and, by the way, how did you get this gold???

      Uh-huh, and what about those guys with guns, looking for the dude that, “Stole my GOLD!!” Maybe it’s not you, but…if I even own a dot, they may decide to waterboard me until I tell them where the rest of “their gold” is hidden!
      I think I’ll trade my case of wine for a drum of gasoline, so’s I can ride around helping find that guy that “stole the gold!!” :^0

      • Quade
        November 16, 2016 at 12:28 pm

        [QUOTE]I still cannot figure out how, when CHAOS comes to the world, that having a hoard of gold will help.[/QUOTE]

        Yeah I wonder about that too. I have a backup-generator and a backup-backup generator (my old one) a well, chickens and enough money on hand to keep going for a couple months if things go bad.

        Can’t eat your gold but I have chickens enough to get by.

        I’m not expecting any kind of long term Chaos but wouldn’t be surprised if the banks freeze up for weeks at a time.

        • John k
          November 16, 2016 at 1:11 pm

          The one thing we won’t run out of is cash, pretty much unlimited and easy to send from one place to another. Chickens might be in short supply.

  6. Greatful again
    November 15, 2016 at 7:42 pm

    I’ve heard that many opec members have so much debt that they can’t restrain production. They need the money. Like little boy blue.
    It’s kind of funny that when there’s a rise in price, the production jumps up to take advantage of it and then all the production drives the price back down. Like people running from One side of a ship to the other.

    • night-train
      November 16, 2016 at 3:55 am

      Very much like running from one side of a ship to the other. In this case, the ship is an oil super-tanker.

    • robt
      November 16, 2016 at 9:28 am

      It’s not really funny, it’s the market.
      That is why OPEC means nothing and never has. They simply adjust their so-called ‘benchmark’ to whatever the spot price is, as they have always done. Then members sell for whatever they can get, under the table if their quota has been reached. If the market is silly they get higher prices, if everybody’s loaded up they get lower prices, with the marginal under-the-table prices the ultimate determiner. The idea of ‘setting prices’ for anything always results in failure. The black or grey market is the real market.
      Futures provide some volatility but are just temporary effects from speculations. All that really matters is spot, and acquiring physical product.

  7. subunit
    November 15, 2016 at 10:31 pm

    Hey Wolf- do you have a sense of how susceptible the various storage figures are to gaming? I was reading over at macrobusiness (aus) the other day that the PRC figures are probably significantly understated- I guess some analysts compared the volumes in the tanks inferred from the positions of the floating “lids” on the liquids in the tank column as observed by satellite. Apparently the PRC has been engaging in a fairly large storage build without reporting it. It seems like many nations would have a strong incentive to underreport storage buildups.

    • November 15, 2016 at 11:41 pm

      The PRC numbers we see, if any, are all guesses. And yes, there have been numerous reports on how the PRC increased its Strategic Petroleum Reserve quietly, both building new capacity and filling it up with cheap oil. Some reports said that the SPR was now near capacity. But no one outside some people in the PRC government knows how large the SPR is and to that extent it is filled. It’s all just guesses. But we assume it is big. And we assume that when China stops buying cheap oil for its SPR that it will move the needle.

  8. night-train
    November 16, 2016 at 4:02 am

    This is a production “overhand” that can come on line on short notice.

    Wolf, should overhand be overhang? If so, I have successfully nitpicked. Those who can do. Those who can’t, nitpick. :)

    • November 16, 2016 at 8:12 am

      Thanks. Overhang, most decidedly. I carefully insert these typos to provide some additional amusement for my readers in tough times.

      :-]

      • night-train
        November 17, 2016 at 3:00 am

        Well played Sir. I take amusement where I can find it these days.

  9. Chicken
    November 16, 2016 at 9:20 am

    US DOLLAR INDEX HITS 14 YEAR HIGHS!

    • ERG
      November 16, 2016 at 11:44 am

      Because the Socialist will finally be leaving the White House….

  10. mike
    November 29, 2016 at 4:55 pm

    95 million in floating storage – less than one day of consumption

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