This time last year I was embarrassingly silent about oil, which I considered to have poor prospects–and still do. So naturally I’m going to go overboard in the other direction now.
If there’s a method to my madness, it’s that an interesting buying opportunity may emerge at some point during next year. Especially so, if the current imbalance between supply and demand causes the price to fall significantly again. That could happen as early as 1Q16.
Because many large oilfields are multi-decade projects that depend on a steady flow of output to the surface to maximize recovery of the underground oil, and because producers need the money to fund national spending or (in the case of small wildcatters) to service debt, the supply of oil into the market is relatively steady.
Not so demand. We’re now in the high season for buyers, as the winter heating season in the northern hemisphere unfolds. Late January through March are the lowest points of the year for demand. Heating fuel has already been delivered to customers and driving is in its winter lull. From April on, demand beings to build into the summer. It plateaus from there until autumn heating demand causes the price to reach its yearly high point.
In a normal year, the oil price should be rising today. But it’s falling instead–suggesting that the market could get ugly once the peak heating oil season is over.
What happens to the excess oil that’s now being produced? It’s bought by arbitrageurs who store the stuff for future sale, while simultaneously entering into futures contracts to lock in a price. The trouble is that, although no one has good numbers, global onshore storage appears to be getting close to being completely full.
There’s lots of offshore storage available–in oil tankers–but current rental rates imply crude would have to fall by $5 – $10 a barrel to make arbitrage trades economic.
the slow convergence of supply and demand
Ignoring seasonality, there’s probably on average 2 million barrels of excess crude oil now being produced each day. That may rise by another 500,000 – 1,000,000 once Iranian sanctions are lifted next year. Then there’s the temptation for government-owned producers to put a little extra on the market to help close the national budget deficit. And there’s the creditor pressure on independent producers to continue to service their debt.
Demand is probably rising by about 1.2 million daily barrels annually. The gradual removal of supply by high-cost producers is shrinking supply by maybe 500,000 – 1,000,000 daily barrels a year. This would imply that we’d come back into supply-demand balance at the end of next year or in 2017. Given all the moving parts–especially seasonality and Iran–it’s possible that there’ll be another price spike downward before we come back into equilibrium. That’s where the buying opportunity thing comes in.
sensitivity to oil price changes
from low to high…
big international integrateds
smaller independent explorers
service companies–development and maintenance
service companies–new drilling
service companies–new drilling, offshore or hostile environments
Refiners don’t fit on this table. They’re currently enjoying a field day because they’re not passing on all of the benefit of lower input prices to customers. There are also non-energy companies, like steel producers, who may have important subsidiaries that make oilfield tools and supplies.
Two other important notes:
–integrateds aren’t quite in the favorable defensive positions that my table would imply. That’s because for years they’ve been devoting large chunks of their massive cash flows to developing gigantic high-cost oil projects that may no longer have any economic justification
–some independents have enormous debt burdens. While the most speculative may arguably have the highest return potential during a future selloff, that’s no good if they go into Chapter 11 before that potential can be realized.