Trade Talks And Bears Balk

Oil rebounded a second day as the U.S sent diplomats to China on Monday to talk trade. After the close, we saw a massive 10.96-million-barrel crude oil drawdown reported by the American Petroleum Institute (API). While the API’s larger than expected 4.436-million-barrel increase in gasoline supply and 1.42 million barrels increase in distillate supply tempered bullish enthusiasm, not to mention the U.S. is trying to dampen expectations for the trade talks, the reality is that the U.S. is headed towards some major crude draws in the coming weeks. The market is still trying to asses geopolitical risk factors and price in risk premium. The International Energy Agency (IEA) stated that they were standing ready to release oil from their global reserve was reassuring but extended disruption of supply in a world where consumption is almost 99 million barrels a day is not going to cover us forever

On the road again. I can’t wait to get on the road again! The big API build in gasoline supply was probably due to imports and not so much weak demand. In fact, data shows quite the opposite. Reuters News reports that U.S. traffic volumes rose by +1.2% in the three months from March to May 2019 compared with the same period a year earlier, the fastest year-on-year growth since Jul-Sep 2017. Another sign that the U.S. economy is rolling along and the U.S. consumer strong and on the road again!

Or better yet, come fly with me, let's fly, let's fly away. Jet fuel demand is also strong. Reuters reports that Asian refining margins for jet fuel edged higher on Wednesday, hovering near their strongest levels in over seven months, buoyed by summer aviation demand and tightness in supply amid steady arbitrage shipments from the region towards the west. The refining profit margins for aviation fuel, which have gained more than 20% over the last two months, are currently at their highest seasonal levels in the last six years, Refinitiv Eikon data showed.

The jet fuel market in Asia usually gets support from the region's booming aviation market that has grown substantially in recent years, backed by new and expanded airports and increased route options connecting more cities for travelers. During summer months the aviation market typically picks up on seasonal passenger demand for holiday travels. Currently, there is also the usual flow of jet fuel from Asia to the United States with at least three medium-range (MR) tankers scheduled to be heading for the U.S. West Coast from South Korea at the moment, a Singapore-based shipbroker said. "It is one of the common routes for MRs and gets even more active during some months with 10-12 shipments too," he added.

While geopolitical risk tension with Iran and Venezuela seem high, there is still hope that we can avoid an all-out conflict. The Wall Street Journal reports that “With no resolution in sight for Venezuela’s leadership six months after the leader of the national assembly declared himself president, the Trump administration appears willing to offer guarantees to Nicolas Maduro that the U.S. will leave him alone if he leaves Venezuela. A senior Trump administration official suggested that the U.S. would consider not indicting Maduro if he leaves power.” This reminds me of a deal the U.S. tried to make with Saddam Hussein. How the world would have been different if he took that deal. 

As I said yesterday, it is looking like the oil market is trying to make a major bottom. We seeing increased geopolitical risk, global central bank policy of lower interest rates and economic stimulus spending that will heat up and reverse faltering demand. At the same time, more pain in the shale patch will cause U.S. oil output to miss market expectations.  Based upon recent drilling productivity reports from the EIA and warnings from Kayrros, a data analytics company serving the energy markets, hydraulic fracturing (fracking) activity was underreported by 21 percent in the U.S.’s most prolific basin in 2018. As reported by Rigzone, “Kayrros claims that more than 1,100 wells were completed in the Permian Basin but not reported through state commissions or FracFocus – a public repository for information on chemicals used during fracking. Kayrros said it uses optical and synthetic aperture radar imagery tracking along with proprietary algorithms to identify rigs and frack crews. Using those methods, they counted a total of 6,394 completed wells in the Permian in 2018 – a 21 percent increase from the FracFocus estimate of 5,272 wells as of June 20, 2019.

The discrepancy in the reported wells means the industry has failed to capture the full scale of fracking, Kayrros contends. This implies two things: Oil inventory is smaller than believed. Kayrro estimates the Permian’s drilled but uncompleted (DUC) wells inventory is 1,000 wells each month with most of the rolling inventory coming from regular drilling and completions operations. Over time the number of drilled wells matches completed wells, leaving DUC inventories unchanged. The belief is that shale operators have a large backlog of DUCs that can quickly be brought to production in the event of an oil crisis without further drilling is misleading.

Transformation of perception of tight oil economics, based on Kayrros’ measurements, the average well is less productive and of higher cost than what is reflected in public data.

“For all its revolutionary impact on the oil industry, shale remains poorly understood,” Kayrros chief analyst and co-founder Antoine Halff said in a release sent to Rigzone. “Publicly available data based on old-fashioned company reporting have their limits. Hard measurements unlocked by new data technologies show that contrary to public belief, there is no great buildup of DUCs just waiting to be brought online. The whole idea that the market can rely on this sort of de facto spare production capacity is an illusion. The industry is actually running on a much tighter leash than that.”

Kayrros also contends that their findings imply the Permian may not be as efficient as assumed. This is due to the fact that it took more wells to account for 2018 production than what was reported. Assuming a cost of $5 million per horizontal completion, 2018 operator capital expenditures (CAPEX) is also underestimated by as much as $4.1 billion. Andrew Gould, former BG chairman and chairman CEO of Schlumberger and current Kayrros advisory board chairman added, “misperceptions about shale oil in general and the Permian, in particular, have consequences, hence the importance of these measurements that show Permian production per well has been substantially overestimated. By the same token, average production costs per well are understated. With far more wells contributing to Permian and U.S. oil production than accounted for, current shale oil production is substantially more water and sand intensive than is commonly believed.”

As far as the markets are concerned, we are waiting for the Energy Information Administration (EIA) report to help us confirm an oil price bottom.  As I said yesterday, technically we are holding above key support and if we hold, oil should revisit the $61.00 a barrel resistance. More importantly, if we hold the recent lows and build off of it, it is very possible that crude oil has set a low that won’t be tested for the rest of this year. On top of that, we have a new tropical disturbance in the Gulf of Mexico. Not the one that was off of the East Coast of Florida that dissipated but a new one, right in the Gulf.

The National Hurricane Center reports that "Disorganized cloudiness and showers located over the northwestern Gulf of Mexico are associated with a frontal boundary. A non-tropical low is expected to form along this boundary tonight or Thursday, and environmental conditions could support some subtropical or tropical development late this week while the disturbance meanders near the northwestern Gulf Coast. Formation chance through 48 hours...low...20 percent. Formation chance through 5 days...low...20 percent.

Natural gas liked the fact that the one storm risk fell and can now focus on the weather. Still, record production is going to continue to raise challenges for this market.