Friday, January 16, 2015

Why oil may be slower to come back than 2009

Oil is plunging in price, and one might be tempted to make comparisons to 2008-2009. During that time, oil fell from $145 in July 2008 to $35 in January 2009, only to recover back to $70 by July 2009.

As prices fell in 2008-2009, so did rig counts, as producers in the US pulled in their horns until they could lock in better prices. It didn't take long for those rig counts to start sneaking back up though as the price recovery was relatively quick.

The big difference is that this time OPEC isn't playing along. In 2008-2009 they cut production by 4 million barrels/day. This time they aren't cutting at all. Given we are over-supplied by almost 2 MBD there isn't a clear impetus for what will end that oversupply in the short term. In fact, chances are good that OPEC wants to keep prices low for a good long time to let the US shale industry wash out.

The basic problem is this - the market is almost two million barrels/day out of balance. This means every day, even with no more production growth, two million barrels need to find a home. Even if rig counts dropped to zero in the US, US production would only drop by about 350K barrels/day per month. And as of January, rig counts have only fallen about 15% - therefore production is still growing in shale even though price has now fallen to $50/barrel. Simply put, the dropping rig count is not enough to put the market into balance in the short term.

Finally, the "nuclear option" (pun intended) is if an (admittedly unlikely) agreement between Iran and the G5 comes in June. This would send one million barrels of oil back onto the market - just when it didn't need it the most.

My projection: I think the drill rigs will continue to fall in the US at a steady rate of 50-60 rigs/week. US production will stop growing in February and will then start to decline modestly. If prices are in the $30-$50/barrel range than drill rigs will continue to fall apace. At 900 rigs in April production will be falling at 100 kbd. At 400 rigs in July production will be falling at 250 kbd, while demand grows at 100 kbd throughout the year. I project stocks will build about 285 MBD between now and August - and that prices for storage will max out in June or July.

World supply ex US will be essentially unchanged. Libya is a wild card could be bullish or bearish. Iran is a wild card bearish but unlikely. If Iran starts pumping 1 MBD, then production wouldn't come into balance with demand until November and stocks would force the issue, resulting in shut-ins to balance the market. This second scenario, albeit unlikely would create huge contango in the market. Saudis/Kuwait/UAE might decide to cut but I doubt it - only below $20.

World demand may pick up but only slowly - when oil price falls it does stimulate the economy but the shock of lower prices will offset this for at least a couple of quarters (the economy responds negatively to uncertainty even if it is positive).

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