Production destruction

April 21, 2016 08:37 AM

Oil production and oil demand are like two ships that pass in the night.

What I mean by that is the trend for oil production is falling and demand is rising. The cutbacks in capital spending are creating what I call "production destruction" on an epic scale. The oil market wiped out early losses yesterday and notched nearly a five month high after the Energy Information Administration (EIA) reported that U.S. oil production fell for the sixth week in a row, hitting a two year low, refinery demand for oil increased and distillate demand exploded.

The International Energy Agency (IEA) is also warning that 2016 will see the biggest fall in non-OPEC production in the last 25 years. Add to that a report from the Iraqi oil minister saying there may be another OPEC/non-OPEC summit in May in Russia, even though Russia denies it, and all is coming into play to give bulls new control over the market.

The EIA set the stage for a major comeback in oil prices. They reported that the supply of overall inventories of all petroleum products fell. The drop led to a surge in distillate demand and a huge 3.6-million-barrel drop in distillate supply. That brought demand from a huge deficit from the five-year average to down just .7% below the five-year average.

Farmers were busy planting their crops using a lot of diesel, but exports also appeared to be very strong. Gasoline demand fell slightly last week but is still averaging 9.4 million barrels per day, up by 3.9% from the same period last year. Crude supply did increase by 2.1 million barrels but a drop in Cushing, Oklahoma and strong demand from refiners gave oil an edge.

Refiners are on fire. The EIA reported that U.S. crude oil refinery inputs averaged 16.1 million barrels per day during the week, up 163,000 barrels per day more than the previous week’s average. Runs came in at 89.4% of their operable capacity last week. Gasoline production jumped, averaging over 9.7 million barrels per day. Distillate fuel production fell last week, averaging over 4.7 million barrels per day.This is very strong demand, which looks to be gaining momentum. On the other hand, U.S. production of crude fell for the sixth straight week to 8.95 million barrels a day.

The International Energy Agency is seeing "production destruction" start to take hold. The Fox Business Network reported that IEA chief Faith Birol said low oil prices had cut investment by about 40% in the past two years, with sharp falls in the United States, Canada, Latin America and Russia. They did say that some of the supply drop from some producers could be offset by increased production in countries, including Russia and Iran. While that may be true, these countries are struggling economically and it may be hard to find investment. There is a historic retrenchment in energy spending and it may be hard to raise output unless prices are higher.

In the meantime, the strongest force in Saudi Arabia, Prince Mohammed bin Salman, the man that killed the Doha freeze, is changing Saudi politics and the Saudi oil industry forever. Bloomberg News is reporting, "Saudi Arabia is considering a dual listing as a way to reach investors beyond the local stock market for the sale of shares in state-owned oil giant Aramco, which could be the world’s largest initial public offering, the kingdom’s deputy crown prince said."

"We are thinking about several options," Prince Mohammed bin Salman, who heads Saudi Arabian Oil Co.’s supreme council, said in an interview last week at King Salman’s private farm in Diriyah, the original home of the Al Saud royal family. "Either it will be double listed or maybe we can have a fund in the U.S. market that can only trade and invest in Saudi Aramco, like some of the funds that are already out there that trade in gold or oil," he said, without giving further details.

Prince Mohammed is leading the planning for the sale of less than 5% in Aramco, which is targeted for 2017-2018. It could raise as much as $106 billion, according to the Sovereign Wealth Fund Institute, making the company the largest publicly traded one in the world, with a market capitalization over $2 trillion. Even a small stake would dominate the tightly regulated Saudi stock market, the Tadawul, which has a capitalization of $398 billion.

"If speculation of the size of the deal is correct, they will have to look for liquidity outside the Kingdom," James Bannan, who manages $170 million in frontier markets at Coeli Asset Management SA, said by e-mail from Malmo, Sweden. "Some structure in the U.S. or London makes sense," he added.

Is the freeze back? Maybe it’s too hot to get a freeze deal in Qatar, maybe we will have a better shot in Russia. Iraq says a meeting is happening in May in Russia. Russia says there is not going to be a meeting. Where there is smoke, is there ice? Nigeria says it will hold talks with Saudi Arabia, Iran and other producers by May, hoping to reach a deal on an output freeze at the next OPEC meeting in June, according to Reuters. Stay tuned.

Commodities are on fire! Oil is up 70% from the lows. We have been saying that this is a historic end of the bust cycle and have recommended to position for the long term We feel that the move is just beginning. Natural gas may also participate as falling production risks price spike this summer if we get some hot weather! Call for strategies to take advantage of the new bull cycle.

I hope this was not caused by cost cutting. The AP reports that the State oil company Petroleos Mexicanos, or Pemex, said 58 workers had been hurt in the midafternoon blast in the industrial port city of Coatzacoalcos. The blast happened in a petrochemical plant.

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.