The process begins

February 22, 2016 08:49 AM

Saudi Arabia is calling it the beginning of a process and it looks like progress is being made. The move towards a production freeze became closer to a reality after Nigeria said they were on board and it's understood that Iran and Iraq may need some special treatment in any agreement. Russia also said they believe that a freeze agreement will be finalized by March 1st.

At the same time the U.S. oil rig-count continues to tank, falling by 26 rigs. This is the 9th drop in a row and it drove the U.S. oil rig count to the lowest level since December, 2009. This massive cutback in rigs is taking its toll as we have seen 123 oil rigs idled just since the beginning of this young year. That means U.S. output is in the process of topping and the price of oil is in the process of bottoming.

The International Energy Agency (IEA) also sees U.S. oil output falling in the short term but not in the long term. The IEA is saying that market volatility is making it very hard to predict oil prices in their latest report and now feels like the market may not get in balance until next year. They say that U.S. production is seen reaching an all-time high of 14.2 million barrels per day (mb/d) by the end of the forecast period, which is 2021 but only after falling in the short term. They are looking for output to fall by 600,000 barrels this year and by an additional 2000,00 barrels next year.

LTO output declines by 0.6 mb/d this year and by a further 0.2 mb/d in 2017 before a gradual recovery in oil prices, combined with further improvements in operational efficiencies and cost cutting, allows production to resume its upward climb. The United States remains the largest contributor to supply growth during the forecast period, accounting for more than two-thirds of the net non-OPEC increase. Freed from sanctions, Iran leads OPEC gains: Iranian oil output rises 1.0 mb/d to 3.9 mb/d by 2021.

The IEA report says that while oil prices should start to rise gradually once the market begins rebalancing, the availability of resources that can be easily and quickly be tapped will limit the scope of rallies – at least in the near term. Yet they also say there are risks of an oil price spike in the later part of the outlook period arising from insufficient investment.

The IEA reports, “It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts we are seeing raise the odds of unpleasant oil-security surprises in the not-too-distant-future,” said IEA Executive Director Fatih Birol.

The report sees 4.1 million barrels a day (mb/d) being added to global oil supply between 2015 and 2021, down sharply from the total growth of 11 mb/d in the period 2009-2015. The drop in supply growth comes as upstream investment dries up in response to the current glut that is pressuring prices. Global oil exploration and production capital expenditures (capex) are expected to fall 17% in 2016, following a 24% cut in 2015 – which would be the first time since 1986 that upstream investment has fallen for two consecutive years.

The report sees global oil demand growing at an average rate of 1.2 mb/d through 2021, crossing the symbolic 100 mb/d mark towards the end of the decade before reaching 101.6 mb/d by 2021. Indian consumption races ahead as more motorists take to the roads, while Chinese demand growth cools in tandem with the economy. Global oil trade continues its pivot towards Asia.

In the meantime, gas prices continue to fall but will it last? Trilby Lundberg, the princess of petroleum and publisher of Lundberg Survey said, “The average gasoline price at the pump for regular grade is down eight cents over two weeks, and it’s down 23 cents over the past month. It’s 37 cents under what it was one year ago,” she said. Regular grade gas fell to around $1.77 per gallon in the Feb. 19 survey, from $1.82 on Feb. 7, when the previous survey was taken. The price was the lowest since Dec. 19, 2008, when it was roughly $1.66 per gallon.

Yet weaker refining margins may cause refiners to cut back, leading to higher prices. Suzanne Minter Manager, Oil & Gas Consulting, Platts Bentek products warns that refiners are continuing  to see margins decline. She says that despite the fact that WTI & LLS feedstock is approximately 35% lower year over year, refiners on the Gulf Coast who comprise approximately 75% of U.S. refining capacity, continue to see their margins erode.

In 2015, Gulf Coast refiners saw feedstock costs fall 67% while their margins only increased by 8% vs. 2014 signaling lack of downstream weakness. The trend continues in 2016.  Year to date, crude prices are down by approximately one third, yet margins are falling in step with feedstock costs – not rising as one would expect .  Year-to-date refining margins at the U.S. Gulf Coast for a barrel of WTI Are $2.90 vs $6.63 for the same period last year. For a barrel of LLS, the same relationship holds true with YTD margins at $6.13 vs $9.40 for the same period last year.

She says that it is also important to remember that these margins are only recognized if refiners are actually able to sell their barrels. Slowing domestic and export demand is resulting in swelling refined product inventories. 

For product in inventory, not only does a refiner not recognize revenue, but pays carrying costs for storage. 

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.