For the last 93 days, we watched as West Texas Intermediate (WTI) crude oil prices traded in a tight range between roughly $52 and $55 per barrel. Then, as the world waited for a positive signal out of the CERAWeek meetings in Houston, prices finally broke out of that range; but not in the direction most traders had hoped for. WTI prices closed on Wednesday of last week, below that range, at $50.28 per barrel, on comments from a somewhat defensive Saudi Energy Minister Khalid al-Falih when he said, “there is no guarantee OPEC will automatically roll over production cuts”. Most analysts were surprised that it wasn’t the Energy Information Agency or American Petroleum Institute reports that moved the market lower; it was the Saudi Oil Minister’s comments, and prices are still falling this morning as WTI crude oil trades in the low $47 to $48 range.
What’s happening here? Many thought the reduction in OPEC crude oil production would help raise prices. Instead, as prices rose, so did production in the US in response to the higher prices around the world. That in return brought prices back down, because it raised concerns about oversupply.
Markets tend to determine prices for a commodity like crude oil by balancing basic supply and demand factors called fundamentals in a market place. For commodities that trade internationally, the cost of production (in other words, supply) diverges or separates itself. That’s because the cost of production can vary wildly from region to region, while demand tends converge into one big number; it’s a “Double-edged Sword”.
What’s Causing Prices to Fall?
I’m not going to try and teach a lesson in economics, however, it’s important to understand that the price of a barrel of crude oil is a function of the amount of crude we need to meet refinery needs and how much crude oil supply we have available to meet those needs. Right now, we have way too much crude oil in storage, and that is forcing prices down… just like what we saw beginning to happen in 2015. As a matter of fact, today, the EIA reported US crude oil inventories were at 528.2 million barrels… that’s 193,000 barrels shy of the record set last week. According to the EIA, 521 million barrels equals 100% capacity in the US; however, it’s important to understand that there is an additional capacity of about 120 million barrels that goes unmeasured, because it resides in rail cars, ships, private storage and pipelines. With inventories at these record levels and production rising, the risk to the downside has grown tremendously; especially if demand doesn’t come back during this year’s drive season. Take a look at this chart showing inventory levels since the early 1980’s: shockingly high levels!
The concern here is that for the next 30 – 45 days, many of the refineries in the US will be in what is called “turnaround” at some point. Turnaround is a period of time the refineries use to take production down for maintenance, upgrades, repairs and expansion and they produce less refined products during that time. Look at the graph below, showing monthly changes in refinery runs. The problem here is this: refinery runs have been declining since December of last year, and they keep declining. Refinery runs are already falling, what effect will a refinery turn-around have?
The two graphs above show the effects of slowing demand from the refineries and the increasing price pressure that too high inventory levels can cause; a longer turnaround should mean prices for crude oil will go lower because production has no place to go but into storage. This is a major concern, especially if demand does not recover, as some analysts are predicting.
Mixed Signals from the Saudi’s and OPEC?
Also weighing heavily on the price of crude oil this week is the apparent discrepancy between the Saudi’s primary report on crude oil production and an independent report showing a substantially different number. Even though the Saudis are reportedly taking the lion’s share of production cuts so far for OPEC, I read one independent report that said the Saudi’s were producing at 9.8 million barrels per day, while the Saudi’s themselves quoted February production averaging 10.001 million barrels per day. That’s a fairly large variance. This kind of variance caused the markets to distrust all of the OPEC numbers and took the difference as a signal that the Saudis are losing their appetite for production cuts. As a matter of fact, without the Saudi cuts, OPEC would have only reached 50% of its production cut goal by the end of last month. This has been weighing heavily on the price of crude oil the last eight days.
Additionally, if the Saudis decide they are already tired of being the only member holding to the production cuts and they turn production back on, how much farther will crude prices go? Or, if they get their feathers get ruffled by continued in US production increases, what additional price pressures will that put on crude oil? I can tell you, it’s already happening. If analysts let this go unchecked, we could risk even lower prices, and that will push prices to lows we haven’t seen since the early 2000s.That will cripple the crude oil industry in the US and will push the US economy back out of its recovery.It’s funny that just one week ago, there were analysts that were calling for the low to middle $60s in WTI by the beginning of summer, but that doesn’t seem very likely now! It’s a double-edge sword because it cuts both ways.
Don’t Blame the “Shale”
There is one last point to be made here, and I know it will seem a bit nitpicky, but it is a misconception that must be corrected. I write a daily commentary for Crudefunders on the activities within the energy space focusing primarily on crude oil, the refined products and the renewables that make their way into the retail gasoline and diesel trade. Each day, I scan the news outlets for the fundamentals (news bits) that may be affecting the energy complex either pushing prices up or pulling them down. During my research time each day, I continue to read headlines calling new US production, “shale” production.
Nearly every news outlet blames the increase in production of US crude oil on the “shale” producer and they lump all new production into that same category. Here are a few facts that put this into perspective: Of the 9.109 million barrels of crude oil being produced each every day in the entirety of the US, 25% comes from the Permian Basin and nearly 75% of the “new” production that we’ve added since August of last year, comes from the Permian Basin. The point here is that not all new crude oil is shale production. You can see on the map below that only a small portion of the Permian Basin is shale production: The same goes for the Eagle Ford formation and others as well. Maybe it’s just easier to generalize and lump all production into the same category, but it’s still wrong. See the map below showing US “Shale” regions.
US “Shale” Regions:
As we tie up this week’s article, it is easy to see why analysts are concerned about the continued oversupply of crude oil in the US. Even this morning, the US Department of Energy released its most recent report on US crude oil stocks and production. While we saw a slight draw in crude oil inventories of 193,000 barrels, what concerns me most was the production number increased again. Refinery runs were lower yet again as well, down nearly 500,000 barrels per day and that’s lower than this time last year. This isn’t the time or price point to lower refinery runs… especially when US inventories are still at or near record levels!
If you want more information on the energy markets and what is making prices move every day, go to our website www.crudefunders.com and scroll down to where it says “Subscribe”. There you will find our link to the daily commentary “Energy Wise”, a comprehensive piece that includes both fundamental and technical analysis of the day’s energy markets and provides you with the detail that you need. For more on Energy Economist Tim Snyder and his company, go to www.matadoreconomics.com .
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