Company Updates

Springtime in the Oil Patch

Crude Oil Market

Last month, we wrote how Springtime would present the first true test of the health of the global oil market, as June will mark the end of the six-month OPEC+ production cut agreement that has propped up oil prices. We suggested that OPEC, led by Saudi Arabia, would work overtime to convince Russia to agree to an output cut extension as insurance against another buildup in oil inventories, should global economic activity slow, sending oil prices into the tank. Recent business news highlights conflicting economic outlooks around the globe. Germany’s economic growth is barely positive, while fears about slowing U.S. growth are being dispelled by strong monthly retail and new home sales. Elsewhere, China is pumping up its economy, while Japan’s slows, and in the European Union, 2019’s projected growth rate has been cut by half a percentage point to 1.5 percent. Weaker economies are not good for oil demand.

ont19 may allen chart2On the oil supply side, the crumbling infrastructure of Venezuela and continuing leadership battle has translated into a steady fall in output. The civil turmoil in Libya has escalated, prompting fears over its future output. But, the most important event was the Trump administration’s decision to allow waivers for the purchase of Iranian crude oil to expire. Beginning in May, eight countries – India, China, Turkey, Greece, Italy, Japan, South Korea and Taiwan – with waivers must seek new sources of crude oil, or risk continuing to trade with Iran, even surreptitiously, in defiance of U.S. sanctions. To offset concern about a potential supply shortfall and sharply higher oil prices, the United States announced that Saudi Arabia and the United Arab Emirates, long-standing supporters of U.S. Iranian policies, would increase their exports. The market expects this additional supply, coupled with continued U.S. oil production growth, will be sufficient to meet global oil needs.

The U.S. sanctions announcement sent global oil prices soaring, extending the market’s up-trend that began in February. Domestic oil prices have climbed above $66 per barrel, while Brent exceeded $74. Oil producers are enjoying the increased revenue from higher commodity prices, but this extra income has not created an activity frenzy – at least not yet. The recent second quarter earnings reports of leading oilfield service companies – Schlumberger and Halliburton – carried the message that the worst of the service pricing drop due to the 2018 oil market collapse is behind them. The key messages from the managements is that customers remain cautious about spending (forecasts call for modest declines this year), but they are looking increasingly for opportunities offshore and internationally. Both venues are more attractive now due to operational efficiencies and overall cost-cutting that have reduced breakeven prices.

In North America, higher oil prices have yet to boost drilling and production. The Grand Dame of the oil patch – the Permian Basin – remains hampered by the lack of pipeline capacity to move increased output to market. This constraint will ease as we enter the second half of 2019 when new pipelines begin operating. Then the test of managements’ financial discipline will begin. Producers will have more money for drilling, debt reduction, and to return to shareholders. Will stepped up activity be greeted with cheers or jeers? Whichever reaction emerges, it will influence future supply growth, and in turn future oil prices. More supply will cap the oil price advance. On the other hand, soaring oil prices will prompt a consumer reaction, sending demand down and causing another oil patch slump. The future of oil prices in the second half of 2019 and in 2020 will become clearer as we move through the ensuing weeks. Will the green shoots of higher oil prices thrive, or will they be suffocated by too much drilling and production?

Natural Gas Market

What once was merely a boring market may become a terrifying one. For months, gas producers have wondered why prices have not responded to the extremely low natural gas storage reports. Traditionally, when gas storage volumes are at or near record lows, prices rise to induce producers to bring on more supply. That additional supply was crucial if the industry was to satisfy current gas demand and rebuild storage for the following winter’s needs. Last year, and to date this year, gas prices have failed to respond to the sharply lower storage volumes.

This lack of concern over possible supply shortfalls was reinforced by the EIA gas storage report for the week ending April 12. It showed the industry not only meeting all current gas demands – home heating, electricity generation, LNG exports, and pipeline shipments to Canada and Mexico – but also injecting 92 billion cubic feet of gas into storage. That was more than four times the average for the comparable week during 2014-2018. All of this was accomplished as producers in the Permian flared record volumes of natural gas extracted in association with the crude oil.

ontchart3With the nation is finally moving out of winter’s cold and into more moderate weather, the absence of heating demand and electricity for air conditioning will foster several weeks of large gas storage injections. That expectation is reinforced by continuing gas production growth, even in basins where it is impossible to get the output to market, forcing it to be flared. There is so much gas being produced in the Permian that the price fell below zero, meaning producers were paying pipelines to haul the gas away rather than being paid for the commodity.

If gas injections remain at the April 12 level for the balance of April and May, gas storage will climb above last year’s level. More importantly, from the end of May through the end of the injection season in October, the industry needs to only average 60 Bcf/week of injections to reach last winter’s starting gas inventory. If weekly injections average one-third larger, storage would return to the 5-year maximum.

The EIA has predicted that average gas production during this year’s spring/summer injection season will increase by 8.3 Bcf/week over 2018’s volume. That additional supply will handle current gas needs plus meet an additional 2.7 Bcf/week of LNG and pipeline export demand. That signals there is plenty of gas supply – in fact, maybe a glut! That supply cushion begins to erode in 2020, however, gas prices have yet to recognize that trend.

In anticipation of the April 12 storage report, gas futures prices dropped precipitously. Gas prices currently are below $2.50 per thousand cubic feet. As the accompanying chart shows, since the 1990s, prices have only been below $2.50/Mcf, and even below $2/Mcf, four times, but none for any meaningful duration. That may not be the case this year. Could we be headed for $1+ natural gas prices? The next few weeks will prove crucial for the gas market.

By G. Allen Brooks | Author, Musings From the Oil Patch

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