The Phil Flynn Energy Report
Stunning Demand Destruction
Stabilization in the petroleum sector is harder when you see the extent of demand destruction in black and white. Oil prices were trying to stand tall even after the American Petroleum Institute Report (API) reported that U.S. crude supply increased by 13.143 million barrels last week. One reason is that the API said the U.S. gasoline supply increased by a less than expected 2.226 million barrels. Refiners have dramatically cut back the production of gasoline, which could create a tight market if and when we are allowed to leave our houses.
Yet that tepid rally was stopped in its tracks, and oil prices hit the lowest level since 2002 when the IEA reported that global oil demand would fall by 9.3 million barrels per day (BPD) in 2020. That is a number they say has wiped out almost a decade worth of oil demand growth. In April alone, they are saying that global oil demand has fallen by an unprecedented 29 million BPD. That is another reason why the API showed 5.361 million barrels increase in distillate supply. The IEA also made an ominous prediction about global oil storage, warning that global storage will be full by June even with the OPEC+ cuts that were the most significant production reduction promise in history.
The front end of the oil curve is most at risk. Reports that Saudi Arabia is going to pump its 12 million BPD until the oil cut officially begins on May 1. Saudi energy minister Prince Abdulaziz reportedly said that, "We were looking to escalate production and drastically cut export prices where necessary, to create a financial buffer for our economy." So while the Saudis have agreed to a significant production cut, they still seem to be in fighting mode when it comes to protecting its market share. The Saudis said yesterday that U.S. shale was not a target in its oil production war; the reality is that the U.S. shale has taken a significant hit.
The price crash has led to a major production pullback in the Permian basin and other formations. It's changing the way that the shale industry thinks about independence in oil production. Reuters reported that, "Texas energy regulators listened as top executives on Tuesday debated whether the state should cut oil output by 1 million BPD, but did not indicate how they might vote after more than 10 hours of sometimes dire testimony. Oil and gas companies are gushing red ink and cutting tens of thousands of workers as oil prices tumble. While the federal government has little power to influence oil production, many state regulators like the Texas Railroad Commission have powers that can include limiting output across the state.
The hearing, based on a request by executives from shale producers Pioneer Natural Resources and Parsley Energy, ignited a debate between those who favor free markets and those who worry that without intervention, small producers could get shut out of oil sales as storage fills next month. Some firms have already started closing wells, several executives said. The industry is facing a historic economic collapse with $3 per barrel to $10 per barrel oil in the coming weeks, and Pioneer Chief Executive Scott Sheffield warned commissioners on Tuesday. "Demand is not going to come roaring back," he said. Kirk Edwards, president of small producer Latigo Petroleum, argued uniform cuts could help thousands of firms like his continue to sell some of their oil production.
Producers have reduced spending as much as 50%, and output has started falling already, said Lee Tillman, CEO of Marathon Oil Corp, who opposed state-mandated cuts, arguing the market is taking care of the glut. The commissioners are expected to vote on the oil companies' motion on April 21. According to Reuters. Diamondback CEO said that Chief Financial Officer Kaes Van Hof noted the company already is in the process of shutting down 30% of its drilling and would take it to zero if the state clamps down on production.
So energy is trying to balance historic demand destruction versus what will eventually be the most significant drop in global oil production ever. Some of the cuts are by design, and some will be forced out due to the low price. In the big picture, if demand comes back faster than expected, we could see a significant price rally late in the year. If not, it looks bleak, yet the market will adjust.
We could see some exciting moves and trades. The front versus the back end spreads are all the rage. Options are also a way to play it. Today we will also get the EIA Weekly Petroleum Status Report, not to mention a lot of economic data.
Natural gas is also a spreader's dream. Andrew Weissman of EBW Analytics Group say that, “In the immediate term. A third consecutive bearish EIA Weekly Storage Report could send natural gas prices to retest recent lows. Record-cold temperatures, however, are boosting weather-driven spot demand to hide the extent of demand losses. Amid significant uncertainty, the injection season outlook tilts bearish for natural gas as severe demand losses could put storage on a trajectory to breach capacity limits. Anticipated supply shortfalls for winter 2020-21, however, may lead winter natural gas contracts higher—possibly allowing arbitrage transactions to support the front of the NYMEX forward curve until late summer or fall."
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