RBOB gas futures were rip roaring, driving ethanol and crude along with it after the Energy Information Administration(EIA) reported a 3.7 million barrel drop in crude oil supply and another surge higher in refinery runs operating at 89.3%. Crude supply did hit another record, but I am no longer a lone voice in the wilderness raising concerns about a coming crude supply crunch. The myth that shale can replace the loss of more traditional projects is dangerous even as the trade is intoxicated with the real terms record supply.
Bloomberg News reported that, “The oil market is risking a supply crunch as producers cut spending on major projects to focus on short-term low-cost shale output in the United States, some of the top crude and products traders said." They also point to a report by the International Energy Agency saying that, “After jumping 20 percent in the weeks following the decision by OPEC and 11 allies to curtail output to end a three-year surplus, prices have slipped as U.S. shale producers fill the gap." Oil companies are reviving investment after a two-year rout, easing but not eliminating the risk of a future supply crunch, the International Energy Agency said earlier this month.
The reason, as I have said before, is the severe decline rate of the shale well. The average shale well produces on the high side maybe 3,000 barrels a day. Watching two years that may fall to 200 barrels a day. To keep production rising, drilling must continue. Too keep up it’s like a hamster on a wheel that must keep running to keep the lights on. More traditional projects that have a slower decline rate, some in the U.S., have been producing for more than 100 years.
Still, these projects need to be replaced because the decline rates on conventional oil fields account for more than 90% of global production. When the U.S. energy industry cut back over a trillion dollar in cap x spending, it in effect accelerated the decline rates. Decline rates will cut output by several million barrels per day each year in 2017 and 2018. Production is already falling in places Asia and other markets will look to shale to try to replace it. The problem is we may need to find a lot more hamsters.
On top of that, the increase in crude supply, according to the EIA, was smaller than analysts predicted and even smaller if you consider a drop in the U.S. Strategic Petroleum Reserve supply. Supplies in the Strategic Petroleum Reserve fell by more than 700,000 barrels and if you add that to commercial-oil inventories, the increase in supply looks smaller.
The crude oil three week high also came as refiner consumer demand went crazy. The EIA reported that U.S. crude oil refinery inputs averaged more than 16.2 million barrels per day, 425,000 barrels per day more than last week. Overall, product demand averaged 19.6 million barrels per day, up by 0.7% from last year’s record pace. Gasoline demand increased to .324 million barrels a day to 9.524 million barrels a day! That helped drive the four-week moving average to only 1% below year ago levels reversing concerns that gasoline demand was somehow faltering. The national average retail regular gasoline price decreased to $2.315 per gallon on March 27, 2017, $0.006 less than last week’s price but $0.249 more than a year ago. Distillate fuel production also increased last week, averaging about 4.9 million barrels per day.
Natural gas is surging as cold March temperatures are raising concerns about a structural under supply. Once again in real terms supplies seem to be ample but supply should have been a lot higher after the warmest February in terms of heating degree days on record. If we get a hot summer even President Trump’s relaxing of regulations might not be fast enough to save this market. If we get a cold summer then we will continue to kick the problem done the road. Out of sight out of mind.
One year ago crude oil was in the $30 per barrel region per barrel. Many said we were in a new era of low prices and we would not see $50 again. They were wrong. I predicted that we were at a generational bottom that despite the wicked-ups and downs, will ultimate lead prices much higher. Many say that this time is different because of shale. I say more fortunes have been lost believing that this time is different. They said in the nineties it was different because of computers keeping prices low forever, or it was different because of oil rigs that could drill for oil keeping prices low forever. It did not. Still, technically to repair chart damage, in the short term we need to see a close above $50.00.