Whither the price of oil?

Saturday, Dec 20 2014 by

The price of oil (and energy in general) is significant for all investors, not just those invested in oil companies, as energy costs are a key input to the economics of many businesses. Hence the recent sharp decline in prices will have widespread economic ramifications, not just the obvious impact it has already had on the share prices of businesses linked to the sector. A key question is therefore "are we there yet?" - have we reached the bottom after the declines of the last few months and are we likely to see a rebound?

As my Twitter followers will know, I have been bearish on the oil price for some time now, since it became clear that the world was facing an oversupply. To a significant degree this oversupply has been driven by recent rapid growth in US oil production, to such an extent that it has now overtaken Saudi Arabia as the world's largest oil producer, combined with lacklustre global demand in a slowly growing world economy. The dramatic recent US production growth can be seen in this chart:


Much of this production growth is driven by the application of recently refined horizontal drilling and fracking techniques to shale oil deposits. Such techniques, however, have an interesting characteristic: shale wells typically have strong initial flows, followed by a steep decline in production, typically declining by 70% within the first year. The implication of that is that whilst drilling proceeds at a rapid pace, production too will rise rapidly - but when drilling slows, production can decline equally rapidly, as the rate at which wells decline starts to exceed the amount of new production coming on stream

I have therefore considered the weekly rig count figures published by Baker Hughes as an important leading indicator for production, which in turn will drive prices, and have been monitoring the rig count closely. The latest figures suggest that we might finally be starting to see some slowdown in drilling activities, as more and more producers find drilling to be uneconomic at current prices. I wished, however, to get a clearer picture of whether the recent cutback was significant or merely seasonal (year on year rig counts are still substantially above prior year figures for North America as a whole, though down for Canada). I therefore…

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The author may hold shares in this company, all opinions are his own and you should check any statements that appear factual and not rely on them before making an investment decision. The author is NOT a qualified analyst nor authorised to give investment advice. Whilst the author is a director of ShareSoc, all views expressed are entirely his own and not necessarily those of ShareSoc.

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30 Posts on this Thread show/hide all

schober 21st Dec '14 11 of 30

There is a strong contango in the futures! Anyone got a tanker to lend fora year?

The large specs have been wrong footed since august
Oil will probably recover when the large specs have finished taking their losses and new specs are going long again; it looks as though we might be close? However there are still alot of long contarcts still out there.

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marben100 18th Feb '15 12 of 30

 Time for an update since my original post in December. Things seem to be playing out pretty much as I had expected then, so far. Here's the latest rig count chart:


Click here for an enlarged version.

We can see that in 2015 the oil rig count has plunged dramatically, as I expected. Natural gas prices have weakened further and currently stand below $3/mmbtu. Despite the continuing slow decline in the gas rig count, production has held up (see http://www.eia.gov/naturalgas/weekly/#tabs-supply-... ) and remains 13% above the year-ago figure, implying increasing productivity per rig. This bodes ill for US focussed drilling service companies.

Oil prices do seem to have stabilised and rebounded somewhat. There is some very interesting evidence on the likely future trajectory of drilling and prices in Nighthawk Energy (LON:HAWK) 's news release today. I do not currently hold Nighthawk, as I feel that its current share price does not fully reflect the impact on future earnings of the oil price trajectory I expect, despite its successes. In a recent presentation, Nighthawk claims to be one of the lowest all-in cost producers in the US. Nevertheless, today's release shows that the company has decided to suspend drilling operations in the first half of 2015, pending a recovery in the oil price. It will focus instead on lower cost recompletion activities, to maintain current production.

If Nighthawk's action can be taken as a microcosm of the US oil industry, this has the following implications, in my eyes:

  • Rig counts will continue to fall whilst prices remain low. This will result in a sharp slow down in production growth, but production will be maintained.
  • As soon as the oil price rises sufficiently (I'd guess ITRO $70/bbl sustained, in the case of Nighthawk, this figure will vary from company to company), drilling will recommence and production growth will resume.

This suggests that the US really has taken over the role of "swing producer" from Saudi Arabia and will put a cap on prices, as oil traders will know that demand can be met, quite rapidly, if prices are sufficiently high.

It may be a long time (years) until prices pass $80/bbl again.



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marben100 5th Mar '15 13 of 30

It seems that my views have support from high places, namely Rex Tillerson, Exxon's CEO: http://www.ft.com/cms/s/0/20fda1f8-c285-11e4-bd9f-...

"...The fall of about 50 per cent in oil prices since last summer has led to expectations that US production, which has grown rapidly in recent years, will soon level off and perhaps go into decline if prices do not rebound quickly.

However, Mr Tillerson said the precedent of the shale gas industry, where production has continued to grow even as prices slumped and the number of rigs drilling wells dropped sharply, suggested that US oil output would be more robust than assumed.

The same companies that had cut costs and increased productivity in shale gas were often involved in shale or “tight" oil as well, he added, meaning that the industry would not be crushed by low prices and competition from other regions. “I think you're going to see some of the same resilience on the tight oil side, too. And therefore it will compete globally," he said..."

Has he been reading this blog? :0)

Some more support here: http://washpost.bloomberg.com/Story?docId=1376-NKA...

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alano20 5th Mar '15 14 of 30


John Mauldin's latest Outside the Box has the interesting point that merely counting rig numbers "is of limited use":

"Unfortunately, these efforts have yet to actually cut production; year-over-year production is still up. Companies have idled rigs for 12 consecutive weeks, bringing the rig count to its lowest level in five years, but they will need to do much more to stop the growth in production. The same improving technology that gave rise to the fracking boom and the ability to exploit the most promising acreage has rendered the rig count of limited use as an indicator of future production." (my Bold)

http://www.mauldineconomics.com/outsidethebox/the-kingdom-of-denmark  ,about 2 thirds the way through.  Michael Lewitt's views on the massive build-up of debt, the main thrust of the article, are very interesting too.

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kenobi 6th Mar '15 15 of 30

In reply to post #92379

This suggests that the US really has taken over the role of "swing producer" from Saudi Arabia and will put a cap on prices, as oil traders will know that demand can be met, quite rapidly, if prices are sufficiently high.

It may be a long time (years) until prices pass $80/bbl again.

This is exactly my analysis, the provisor being that oil prices are driven by sentiment and geo political instability plays a significant part, so I would expect spikes beyond 80 but for them to be pretty short lived as there is plenty of capacity that can be bought on line at $70-80 to satisfy demand. We keep hearing about poor demand, if europe starts recovering this will make a significant difference both in their demand, and the demand they create for manufacturing and transportation elsewhere.

This is a fantastic situation for the US, and the world economy, if not the world of oil investors, effectively enough supply at a reasonable price and protection from oil shocks for a generation.


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marben100 10th Mar '15 16 of 30

An interesting article here: http://www.ft.com/cms/s/0/1977c546-c639-11e4-add0-...

Whilst I knew that the broadening contango had led to traders stockpiling oil on VLCCs, I was not aware that they had recently been selling that stockpiled oil, following price gains over the last few weeks and a narrowing of the contango.

Suggests to me that this trading will act as a natural damper on price movements: when the short-term price falls too low and the contango widens, the price fall will be damped by traders buying oil for storage and later delivery, and acting as support. Should that reverse, those stockpiles get released, which will act as resistance to rises in the short-term price.


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marben100 17th Mar '15 17 of 30

Here's the latest rig count chart:


Click here for an enlarged version.

I've posted again because the pace at which both the oil and gas rig counts are falling is now truly dramatic, as you can see. Counts are falling off a cliff, with oil rigs down by 42% since the start of this year, and gas rigs by 22%. There are a couple of implications I can see. Firstly for oil service companies serving the North American market, the impact & outlook must be truly dire. Secondly, it is causing me to modify my view on the mid-term oil price outlook, as follows.

Whilst efficiency gains can improve output per well, it strikes me that the rate at which such gains can be obtained is unlikely to be able to keep pace with such a dramatic drop in drilling. Therefore, I foresee production growth stalling and perhaps reversing sooner than I had previously expected. Once the market sees that, we might start to see a reversal in the current price declines. I don't expect a terribly big bounce, because traders know that if the price rebounds too much, it won't take long for drilling to resume. Nevertheless, a sustained bounce of some sort within the next few months looks increasingly likely to me. I still doubt we'll see an average WTI price above $55 for 2015, nor much above $60 for 2016, which is below most current analyst forecasts I've seen.



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Fangorn 17th Mar '15 18 of 30

What about the substantial storage glut everyone is talking about Mark?

What do you make of that- quickly digestible?

Brent comes off 6-week low to rise above $54, but glut worries drag


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marben100 17th Mar '15 19 of 30

In reply to post #94672

A good refutation of the "herd" storage glut view here: http://oilprice.com/Energy/Energy-General/The-Truth-About-U.S.-Crude-Storage.html H/T to @Conkers3 on Twitter.

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Fangorn 17th Mar '15 20 of 30

Cheers Mark,

An interesting read.....

"how much storage volume is actually available at Cushing. The answer is 71 million barrels (with more storage under construction). So even if inventories there continued to build at the recent pace, it would be nearly four months before Cushing would actually be full. But, there are several mitigating factors that minimize this possibility."

"We are currently in the season when refinery utilization is lowest. Refiners take equipment offline in fall and spring to do maintenance, so they use less crude oil at this time of year. This maintenance usually peaks in March, and then crude oil demand picks back up as refiners gear up for the summer driving season. The difference in refinery demand between this time of year and summer is generally around a million barrels per day, so even if nothing else changes that storage build should start to flatten."

Have those strikes ended at the refiners - tken my eye of that. Last I saw Shell, for example, were still negotiating...

Pretty clear that with the 71m storage,and refiners set to make their return in the next couple of weeks the scaremongering about Storgae Glut is just that - a tad "over exuberant"

Appreciate the link......

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Novice Investor 17th Mar '15 21 of 30

I wonder if there will be much impact on production levels as higher priced hedges expire.

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marben100 17th Mar '15 22 of 30

In reply to post #94717

Not immediately, but it's concerns about expiring hedges that are driving producers to slash their drilling expenditure, which is reflected in the rig count.

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gibson330 20th Mar '15 23 of 30

Hi Mark

Another big decline in the rig count.

The number of US rig counts fell by 41 last week to 825, according to the latest data from oil driller Baker Hughes. This is the lowest oil rigs in use since March 2011.
Combined oil and gas rigs fell by 56 to 1,069, the lowest since October 2009.
Since hitting a peak of 1,609 in late October, the number of oil rigs is use is down about 49%.


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arkleseizure 10th Apr '15 24 of 30

Baker Hughes rig count down another 42 this week, total now 760

It seems remarkable that storage is about to fill up at Cushing:
even with BOGOF POO . Had the Saudis not acted, surely this in itself would have caused a price crash?
(The cheery source quoted in this article thinks 30USD WTI will be the bottom).
If Cushing (WTI) oil reaches 30usd, what would the well head price be for a remote Dakota field that ships by rail?


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Fangorn 14th Apr '15 25 of 30

Prodcution holding up well despite the incessant fall in the rig count.

These inefficient rigs beign binned first really mus be bad.

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marben100 15th Apr '15 26 of 30

In reply to post #96570

It's not just inefficient rigs, but also switching focus from combined explo./development, to concentrating on optimising production from the "sweet spots" in shale fields. Eventually all the sweet spot locations will be fully exploited, and then the declines will set in, absent more explo., but that could take years, rather than the months most analysts seem to be expecting.

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janebolacha 15th Apr '15 27 of 30

The article below is forecasting there to be a rather abrupt end to the shale boom. However, with 3,000 uncompleted wells ready to be brought into use whenever prices allow, this will surely be replaced by a de facto cap mechanism on oil prices, outside of OPEC's control and whatever the Saudis decide to do?

"Temporary Relief
The relief may prove temporary as U.S. drillers are building a backlog of drilled wells that they plan to hydraulically fracture and place into service as soon as prices rebound. Analysts including Wood Mackenzie Ltd. have estimated that the inventory has grown to more than 3,000 uncompleted wells."


This would also mean, perhaps, the worst possible scenario for oil services companies supplying the shale producers, one of uncertainty, permanent pressure on pricing of oil and gas and of equipment and services, lack of long-term visibility?

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arkleseizure 18th Apr '15 28 of 30

Found by Ohisay on TMF:


An exhaustive analysis of the US shale plays.

Baker Hughes US oil rig count down 26 to 734 on 17/4/2015

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arkleseizure 19th Apr '15 29 of 30

Whilst the RBC piece was positive on the future of US shale oil output and economics, this article is not:


Shale economics crash porn.

Shame on has to pay to read part 2.

According to the director of the Department of Mineral Resources in North Dakota the average realised price for Baken crude has been in the thirties for months:


Be a while till those producers hedges run out, and then we will see who's figures are backed up by reality. The Saudis no doubt have a shrewd idea.

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arkleseizure 24th Apr '15 30 of 30

Baker Hughes oil rig count down 31 on the week at 703.
Art Burman suggests that on past performance the rig count fall should see US tight oil production fall 600k BOPD 'by June'.

Burman is skeptical on the financial viability of much unconventional oil and gas production away from the few sweet spots. The majority of companies were cash flow negative at 90+ dollar WTI. And yet now the realised price is apparently in the 30s for Baken oil, punters are lining up to buy new 'hi yield' bond and share issues.

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