Oil Set For Another Sharp Rise

It’s been a rough couple of weeks in the energy market. Pretty near every negative sentiment-Recession, Fed tightening, Dollar strength, China demand, Inventory builds, or what amounts to the entire oil price Closet of Anxieties, came to pass this week. Oil-WTI took a tumble below $80 for the first time since Jan 11th of this year, closing Friday below its 200-day moving average of $89.00.This move has WTI nearing an important psychological level in the lower $ 70s, past which producers will sharply curtail capex to raise prices. The selling is WAY overdone and neglects one basic truth about the oil market. It is under-supplied, and it is only the SPR releases that have been masking that fact. We are on the verge of an energy calamity that will begin to manifest itself in the coming months. As the economy of the world begins to accelerate in 2023, the era of energy insecurity will begin. The important takeaway is that there is nothing that can be done to prevent this “train from barreling into the station.” A recent NY Times article put it succinctly-

“That’s because there’s just no extra supply out there today at all. There’s a very little extra supply that the Saudis and the Emiratis can put on the market. And that’s about it. We’ve used the strategic petroleum reserve, and that’s coming to an end in the next several months. There’s just no extra cushion in the oil market right now. The short answer is that for the period since 2014, producers have been disincentivized to explore for or sanction the mega-project that was the mainstay of the 2000-2013 era. Oil prices will rebound toward the end of the year and the beginging of next, as the SPR releases that have put excess oil on the market come to a halt. Since March when the government announced the SPR releases to bring down domestic gas prices, inventories have risen about 15 mm barrels. If you back out the 172 mm barrels withdrawn from the SPR over this time, inventories would have shrunk to ~248 mm bbls. That may sound like a lot, but in reality with our ~19 mm BOD habit, it’s a ~13-day supply.  Not only are inventories being artificially inflated by SPR releases, the productivity of new wells as reported in the EIA-Drilling Productivity Report is on the decline.  Across every key basin with the exception of the North Dakota and New Mexico basins, there is a pronounced decline in spite of steady growth in the rig count for most of this year. Drilled but Uncompleted well-DUC, count withdrawal that occurred from mid-2021 through January of this year was largely responsible for gains in production registered so far this year. There is certainly an observable trend that well performance in the shale basins began to fall off as DUCs declined. The data from the DPR is confirmed by information compiled from the EIA 914-monthly report. Only in North Dakota and in the Gulf of Mexico-GoM, do we see a gain from May to June. In the case of the GoM Murphy Oil’s, (NYSE:MUR) Kings Quay production contributed about 80K BOPD, and BP’s Herschel provided another 20K BOEPD, toward the 179K BOEPD shown for the month. Higher drilling costs are also beginning to impact profitability as was noted in an even more recent WSJ article. What this means is that maintaining or increasing production will come under a sharper lens as margins compress, and operator’s balance sheet priorities come into play.  U.S. production will rise to 12.6 mm BOEPD in 2023 as the EIA suggests in this month’s edition of the STEO, isn’t very high. Current trends are heading in the other direction. v The current weakness in oil prices has producers sharpening their budgetary knives. Inflation is eating at already tight budgets, and nature itself may intervene with poorer quality rock than was available in the past. OPEC and its sometime collaborator when interests align, Russia have fallen short of producing up to full quota levels by a significant amount. Some reports have this shortfall at more than 3 mm BOPD at present. In fact the CEO of Aramco made a widely read pronouncement earlier this month that the world was on the precipice of an energy shock of massive proportions. “But when the global economy recovers, we can expect demand to rebound further, eliminating the little spare oil production capacity out there. And by the time the world wakes up to these blind spots, it may be too late to change course.”  The Dallas Fed put out a report documenting the OPEC shortfall as well that points to key source of underperformance at the feet of none-other than Saudi Arabia. It only runs through February of this year, but shows clearly the Kingdom of Saudi Arabia producing about 1.2 mm BOPD below quota. Prince Mohammed bin Salmon, also known as MbS- said: “The kingdom will do its part in this regard, as it announced an increase in its production capacity to 13 million barrels per day, after which the kingdom will not have any additional capacity to increase production,” he said in a wide-ranging speech.”