Crude: It’s not all its fracked up to be

Daily Energy Market Analysis

While the market starts to come to grips with the new sanctions on Iran and a larger than expected crude draw, as reported by the American Petroleum Institute (API), what should concern them is that U.S. crude oil production is not quite what it was fracked up to be

The latest evidence of that fact is the Energy Information Administration’s (EIA) “Short-Term Energy Outlook” released Tuesday. The EIA cut its crude oil production estimate for this year down to 10.68 million barrel a day from 10.79 million barrels a day. They also lowered their forecast for next year to 11.7 million barrels of oil a day down from 11.8 million barrels a day.  

While the decreases in their production estimate is rather modest, I believe that the downward revision may be the first of many. In the past, I have written how EIA methodology tends to overestimate production and we are now seeing the EIA start to move their numbers back down to reality. The EIA underestimates shale oil decline rates and it fails to account for the geographical and geological differences from well to well. Pipeline logistics and labor problems can be underestimated as well. We predict that we will see downward revisions in coming reports.

That makes the next EIA statement even more bullish. The EIA said that “Even though EIA sees oil prices continuing to moderate in the coming months, global oil inventories are below five-year average levels and OPEC spare capacity is low, which could contribute to price volatility and possible price increases if supply disruptions occur.” 

The moderating oil price that the EIA sees is from higher production from OPEC and Russia, compared with the first half of this year, and they are looking for spot prices to fall towards $70 per barrel by the end of 2018, as the market appears to be fairly balanced in the coming months.

The API provided a mixed bag for oil bulls and bears last night. While the Headline 6 million barrel drop in crude supply should have been very bullish. The fact that Cushing, Okla., supply fell less than expected, 576,000 barrels and gasoline supply surging by 3.1 million barrels and distillates by 1.8 million barrels equalized the bull versus bear playing field. 

The crude draw offset last week’s surprise increase and shows that on average, crude supply is falling. Private forecasters had a bigger Cushing draw as well. Strong refining margins have refiners cranking out product and the supply build makes some worry about the refiners outstripping demand. Yet, with distillate inventories at very low levels they better keep the pedal to the metal if they are going to meet very strong demand.

For RBOB and Gasoline the EIA says that “If crude oil prices continue to come down or remain flat in the coming months, EIA expects that U.S. gasoline prices will have reached their 2018 peak in May and, at this time, EIA continues to forecast that retail gasoline will average below $2.80 per gallon through the end of next year.” 

Is it time to buy natural gas or is the run done? If you are tempted to buy natural gas because supply is below normal, Andy Weissman of EBW analytics says not so fast. He says that while gas was higher over the past week, it was aided by a third-consecutive bullish EIA Weekly Storage Report and the second-hottest week of the summer. During the next 30 to 45 days, however, the combination of Atlantic Sunrise entering service and potential FERC approval of Rover supply laterals may spur gas production to surge higher—loosening supply/demand fundamentals. He points to scheduled LNG maintenance, the demand-destroying heart of hurricane season, waning summer heat, and a bearish fall forecast may combine to weigh on Nymex gas futures. He also says that legal decisions and regulatory setbacks may lead to further delays for the Mountain Valley and potentially Atlantic Coast pipelines.

The EIA agrees. They say that “With U.S. natural gas production rising to record levels this year, prices will likely be lower than they would be otherwise, against a backdrop of low inventory levels and increased demand from the power sector. Continuing developments in natural gas, including drilling productivity improvements and new infrastructure, factored into EIA’s August forecast for U.S. dry natural gas production, which we currently expect will exceed 84 billion cubic feet per day for all of 2019.”

At the same time, according to the EIA, U.S. natural gas exports are poised to reach record levels in 2018 and 2019. EIA’s August forecast expects new pipelines to Mexico will help push pipeline exports in 2018 to nearly 7 billion cubic feet per day, before topping 8 billion cubic feet per day in 2019.”

The EIA releases its weekly status report. The market is going to try to assess the real impact of the Trump Sanctions. The odds of a pre-winter rally is high. Hedging is advised strongly during the next few weeks. 

About the Author

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor.