Specious Argument

A good friend Paul Precht recommended that I view a YouTube video “Tony Seba: Clean Disruption – Energy & Transportation.” Seba offers a fascinating presentation of how he sees the future of energy and transportation unfolding. Even if he is only half correct, there will be dramatic changes for society and especially Alberta. After viewing fifteen minutes of this hour-long video, you will be hooked. I urge you, though, to set aside an entire hour—you’ll not be disappointed.

Precht and I met during the 1990s when we worked together to create a new fiscal framework for the oil sands industry. At that time, he was working at Alberta Energy, a ministry of the Government of Alberta, and I was working at Syncrude. We have remained in touch throughout the years and have collaborated on several projects as consultants.

On the topic of energy, my WTI oil price expectations for the next several weeks to range between $45–$55 per barrel, a slight increase from my expectations of last month. After reading a few articles—for example, “Mission Accomplished? OPEC banishes contango: John Kemp”—that claimed reduced oil inventory levels in advanced economies, I am slightly more bullish.

The next few weeks will be interesting because this is typically a shoulder period between high demand from summer driving and high demand for winter heating. Refineries are often shut down for maintenance to take advantage of this slow time. With the recent storms in the Gulf Coast, I am curious to see how this year’s shoulder period evolves. Also higher prices may provide incentive for drilled but uncompleted wells (DUCs) to be brought on stream, not to mention that higher prices might inspire new drilling. Unless there is a spike in demand, these events ought to have a moderating effect on a steep oil price rise. Given this backdrop, I am have raised my expectations from last month.

I am staying with my WTI oil price expectations for the next several weeks to range between $43–$53 per barrel. With the continuing fallout from the tropical storm Harvey, I expect increased volatility in oil prices.

I have updated my graph. As a refresher, one of the benchmarks that I track is the US Energy Information Administration’s Short Term Energy Outlook data for US crude oil and liquid fuels production as shown in the next graph, which is an updated version from the prior month. Every month the EIA releases a new forecast. The January forecast is the lowest line along the horizontal axis, and the August forecast is near the top for much, but not all, of the graph. Solid-line portions represent historical data, and the dotted-line portions are forecasts. Because of data revisions, not all months start from the same point. Please note that liquid fuels include ethanol, natural gas plant liquids, and biodiesel.

EIA Short Term Energy Outlook Forecasts

Looking at the updated graph, we note that the last four months—May, June, July, and August—seem to be clustered together. In other words, the forecasts seem to be converging.

Dan Dicker in his article “It’s Finally Time to Look at Oil Stocks” (subscription might be required) states that oil prices are likely to rise by year-end.

The trend for oil is finally about to change. Oil has been range-bound for all of 2017, with rigs continuing to increase and stockpiles continuing to swell. But rigs are beginning to roll over and are, I believe, going to decrease through the rest of the year. And more importantly, stockpiles are beginning to sink, finally going under the 10-year average for the first time in 4 years. That trend is going to continue as well.

Oil is about to break out of its range — to the upside.

Of course, the oil companies deciding to cut production and capex will accelerate both of these trends, making oil even more likely to rise to $60 by year end — maybe even $70.

In a subsequent article “Oil Will Turn Soon, But Not All Oil Companies Will Follow,” (again, subscription might be required) Dicker states the following:

I believe oil prices will get constructive soon, overcoming their year-long range between $43 and $54 dollars a barrel. We can see three factors that are going to push oil out of this range to the upside. First, we see oil stockpiles falling under the 5-year average, signifying the rebalancing is coming. Second, we see rig counts beginning to roll over, making the projections for increased production in 2018 far too optimistic. And third, major rollbacks of capex from oil producers, announced in their second-quarter reports, are going to accelerate both of these trends.

I disagree with Dicker. We have just examined the graph for expected production. As discussed, recent forecasts have converged. There is a time lag between drilling and production. So, I expect that much of the remaining production for 2017 is already set in the forecast. According to a Wall Street Journal article “Investors Eager to Hear Shale Companies’ Plans for Rest of 2017,” (subscription required) many oil companies have already hedging contracts in place, and there are many drilled-but-uncompleted wells waiting to be connected to pipelines. Furthermore, a Financial Times article “Oil Traders grapple with US crude conundrum” (subscription required) suggests that prices are likely to stay low.

Behind this, analysts and traders say, is seemingly unstoppable US oil production. Those betting the industry will continue ramping up output are — for now — firmly winning the biggest debate in the oil sector regarding just how much production, led by the shale revolution, can grow despite prices languishing below $50 a barrel.

“The train has left the station in terms of shale,” said Gary Ross, head of Pira Energy, a unit of S&P Global Platts.

The so-called Brent-WTI spread, which measures the price difference between the two big crude markers, is just one indicator that points to traders betting that US shale output will grow in excess of 1m barrels a day next year, or enough to meet about 75 per cent of anticipated global demand growth.

And just today, the Wall Street Journal published an article “Saudi Arabia, Russia Pushing for Three-Month Extension to Oil Cut Deal” (subscription required). If these two countries expected prices to recover above $60 by year-end, they likely would not have called for an extension.

The end of 2017 is only a few short months away. We will soon learn if $60 per barrel has been achieved. My expectation is that, with already anticipated increased production, oil prices will remain below $60 per barrel.

I am updating my WTI oil price expectations for the next several weeks to range between $43–$53 per barrel, two dollars per barrel lower than before. The reasons for changing are increased production from Libya and Nigeria, Ecuador straying outside its production cap, and general cynicism toward OPEC being able to reduce global inventories as quickly as expected.

Although I have reduced my expectations, should OPEC announce significant changes to its policy after meeting this weekend in Saint Petersburg, Russia, then all bets are off.

If the current situation persists, however, then I am comfortable with my updated values.

US Weekly Oil Production Versus US Oil Rig Count

With the recent release of the US Energy Information Administration’s Short Term Energy Outlook, I have revised downward my forecast for WTI oil price to between $45 and $55 per barrel for the next several weeks, until midsummer. The reason for lowering my forecast is that the EIA has forecast more production between now and roughly the end of 2018. Furthermore, in its “Forecast Highlights” it says the following: “EIA forecasts that implied global petroleum and liquid fuels inventories will decline by about 0.2 million b/d in 2017 and then increase by an average of 0.1 million b/d in 2018.” I anticipate that the forecasted build in inventories in 2018 might keep a lid on oil prices.

Let’s take a quick review of some data. You’ve likely seen a variation of the following graph where oil production has almost recovered to pre-downturn levels, yet the number of oil rigs being used is roughly half that at the peak of production. The key point from this graph is that production efficiency per rig has increased. It’s important to remember that this graph represents all rigs involved in US oil production, not just those used for shale oil.

One of the benchmarks that I track is the US Energy Information Administration’s Short Term Energy Outlook data for US crude oil and liquid fuels production as shown in the next graph, which is an updated version from the prior month. Every month the EIA releases a new forecast. The January forecast is the lowest line along the horizontal axis, and the June forecast is the top line for much, but not all, of the graph. Solid-line portions represent historical data, and the dotted-line portions are forecasts. Because of data revisions, not all months start from the same point. Please note that liquid fuels include ethanol, natural gas plant liquids, and biodiesel, and this total volume is different from just the oil volume shown in the prior graph.

EIA Short Term Energy Outlook Forecasts

In February and March, the EIA revised substantially upward its December 2018 production forecast. In the last four months, the December 2018 production forecast remained relatively constant, but the production volume leading up to December 2018 was increased with each new forecast.

With production forecasts increasing each month and with the EIA forecasting a slight build in global inventories, I am more cautious. I want to wait for more data throughout the summer. Do global inventories draw down faster than many expect, or do they remain relatively stable?

In this weekend’s Barron’s magazine article (subscription required) “Energy Shares Could Soon Heat Up,” Andrew Bary discusses bullish comments made by Morgan Stanley’s energy analyst Evan Calio.

The Energy Select Sector SPDR exchange-traded fund (ticker: XLE), which tracks the energy stocks in the Standard & Poor’s 500 index, is off 12% so far in 2017, compared with a 9% gain in the broad market. The more volatile SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is down 21% after hitting a new 52-week low last week. “This is one of the worst beginnings to the year ever,” says Evan Calio, an energy analyst at Morgan Stanley. “Investor sentiment is horrible.”

Nevertheless, Calio remains upbeat on U.S. exploration-and-production stocks, seeing about 15% upside on average from current levels. He expects oil prices to rise to the mid-to-high $50s over the summer and into the fall, supported by drawdowns of crude inventories and the effect of output reductions announced by the Organization of Petroleum Exporting Countries. A rally in energy stocks could be under way, after their 2% gain on Friday.

Calio is more bullish than I am at present. If, however, global inventories deplete faster than expected over the summer, I will reverse my current position and go back to my prior expected range of $50–$60 per barrel.