Most of the publicly traded upstream oil-and-gas companies' share prices have moved up off the lows they set in December and January as crude oil prices have stabilized. Although it is encouraging, I do expect to see lots of share price movement (up and down) as the oil & gas sector struggles during the first half of 2015. We are not out of the woods yet, but there is definitely light at the end of the tunnel and investors are beginning to return to the sector.
The oil markets should tighten in the third quarter. The International Energy Agency (IEA) is predicting a sharp increase in crude oil demand in the third quarter, about the same time reduced upstream spending begins to impact oil supplies in the United States. Saudi Arabia says they are seeing an increase in demand from Asia, which is definitely an encouraging sign.
Fear and greed drive the markets and "speculators" determine the daily moves in crude oil prices that are traded on NYMEX.
You may have noticed that the oil traders are reacting to each mid-week crude oil storage report and each Friday's active rig count report from Baker Hughes (BHI). There are also an increasing number of "experts" telling us why oil prices will go up or down. I recently saw an article that forecast crude would drop to $10/bbl. When you see wild predictions, keep in mind that a lot of the articles with sensational titles are posted on the internet by individuals that get paid by the "hit'. I'm sure the doomsday predictions and volatility in the oil markets will continue, but fundamentals do eventually matter when it comes to any commodity's price.
Crude oil storage is building in the U.S. because we have too much light oil coming from the shale plays for our refineries to handle and it is still illegal to export oil, except for a small amount of condensate. The political reason forbidding oil exports is outdated, but the gang we have in Washington doesn't favor the domestic oil producers and no politician wants to be tied to a bill that might increase gasoline prices for consumers. Storage levels are also building because there is a lot of money to be made by those accumulating oil at today's price.
Known as the "Pipeline Crossroads of the World," Cushing, Okla., is home to the nation's largest oil storage facility, a massive complex of tanks and pipes capable of holding more than 80 million barrels of crude.
Cushing is also the price point for domestic benchmark West Texas Intermediate (WTI) crude. If you buy a NYMEX futures contract for WTI and hold it to the expiration date, "your oil" will be delivered to Cushing and you will be getting a call asking you how you want to handle it. A lot more individuals are taking physical ownership of oil these days because the oil markets are in "contango" (front month oil price is lower than the prices for future delivery). On Feb. 27, the April 2016 WTI futures contract settled at $61.95/bbl, more than a $12.00/bbl premium to the front month (April 2015) contract. This encourages refineries and speculators to build inventory since all indications are that oil will cost more in the future.
As the price of oil has plummeted over the past eight months, companies and individuals have stockpiled as much as 2.2 million barrels a week at Cushing, rapidly filling it to more than half capacity. As of Feb. 20, Cushing's storage tanks held nearly 49 million barrels of crude, according to the U.S. Energy Information Administration. As storage fills up at Cushing, the gap between WTI and Brent widens. Cushing also raises their storage fees as inventory levels approach capacity.
As you can see in the chart below, refiners begin drawing more oil from storage each year in May. This is because they need to ramp up gasoline production.
Lower Demand Period Just Ahead
During March and April a lot of refineries shut down for a couple of weeks to do annual maintenance and make adjustments necessary to produce summer blends of gasoline. Crude oil demand by the refiners is reduced during this period. Since there is a record amount of crude oil in storage today, we will see pressure on the oil markets until storage levels return to normal.
Summer driving season in the U.S. is just a few months away. Each year there is a sharp increase in demand for crude oil from the second quarter to the third quarter. This is primarily driven by the increased demand for transportation fuels. Also, refiners cannot blend as many NGLs with crude oil for the summer blends of gasoline, increasing the demand for black oil. Take a look at the IEA Oil Market Report and you will see that the IEA is now forecasting more than a 1.5 million barrel per day spike in oil demand during the third quarter.
Weather does have some impact on crude oil supply/demand. The official start of spring is about a month away. For those of you living in the Northeast it can't come soon enough. This is the region's second very cold winter in a row. If cold weather continues through March, as predicted by Dr. Joe Bastardi, it will put pressure on heating oil supplies in March. You can hear Joe's weekly forecast at www.weatherbell.com.
The third quarter spike in demand will help to balance global supply/demand, but it will take a while to work off the big build in crude oil storage. I think we will have a much tighter oil market by year-end, but stock prices should move higher months before that happens.
U.S. Oil Production Will Peak in 6-9 Months
By now you all know that the global supply of oil increased much faster than demand growth in 2014, resulting in a temporary "glut" that is the primary reason for the sharp drop in oil prices. A strong U.S. dollar and Saudi Arabia's refusal to lower exports accelerated the price decline. Many people believe speculators, which now dominate oil markets, have over-reacted and pushed oil prices lower than justified by the physical market. The global market for oil has already moved back over $60/bbl. On Feb. 28, Brent crude closed at $60.60/bbl.
"The cure for low oil prices is low oil prices." Upstream companies are slashing capital expenditures and drilling rigs are moving back to the yard in record numbers. Last Friday, Baker Hughes reported that the number of rigs drilling for oil in the United States dropped to 986, compared to 1,430 a year ago. I believe the number of rigs drilling for oil in the U.S. will drop below 800 in April. That is not enough to maintain our current level of production. The U.S. Energy Information Administration (EIA) is predicting U.S. onshore production will peak within six months.
Demand Growth Is Relentless
Demand for refined products goes up by about a million barrels per day each year. I believe demand will increase by more than 1.5 million barrels per day this year as lower fuel costs and increasing SUV sales increase demand. We are already seeing increasing demand in Asia.
On Friday, Feb. 20, I attended an Energy Summit at Rice University. There were a lot of knowledgeable speakers and they all forecast that West Texas Intermediate (WTI) will be trading in the $60-$80 range by year-end. In my opinion, it will be over $60/bbl early in the third quarter, but we may see a dip back to the mid-$40's during the next few months.
I do not see much chance of oil prices moving back to $100/bbl anytime soon, unless there is a major supply disruption in the Middle East. Of course this is quite possible. Libya is already a mess and their exports have been slashed because of terrorist activity. Within the territory held by the Islamic State in Syria & Iraq there are no major oilfields, but there is no telling what those idiots will do. I'm sure they realize that attacks on pipelines or large oilfields in Southern Iraq or Saudi Arabia would send oil prices higher and threaten the economies of the "infidels". ISIS also benefits directly from higher oil prices as they sell oil into the black market that ends up in Turkey.
OPEC production capacity actually declined slightly in 2014 and is expected to decline again in 2015. Future OPEC supply growth is highly dependent on Iraq. In fact, according to IEA, more than half of OPEC's supply growth will be coming from Iraq from 2016 to 2020. Unless ISIS is pushed back I don't see it happening. The major oilfield services and supply firms will not risk their capital and people in Iraq if the violence continues. Most of the OPEC nations are expected to report falling production during the next six years.
Now is the time to do your homework and add high quality upstream oil & gas companies to your portfolio. Look for companies that have strong balance sheets, a solid base of proven reserves and hedges in place to insulate them from low oil & gas prices during 2015. Three companies that have impressed me recently are:
- Gulfport Energy (GPOR): Although this company is primarily a natural gas producer, they have incredible growth locked in and some of the best acreage in the Utica Shale.
- Newfield Exploration (NFX): Their 4th quarter results beat my forecast and their guidance is for approximately 35% crude oil production growth in 2015. I really like their "STACK" play in Central Oklahoma.
- SM Energy (SM): The Company is now focused on developing their core acreage in the Eagle Ford Shale. SM is getting much better results by using more frac sand per well and they have been successful in driving down their drilling & completion cost.
- Hi-Crush Partners LP (HCLP): This MLP is a leading supplier of Northern White frac sand. Most of their revenues are locked in by long-term supply contracts to the major oilfield service firms. Upstream companies are getting much better results in the tight oil plays by using a lot more sand per frac stage. I do not see a significant decline in demand for frac sand despite the decline in active rigs. Hi-Crush pays quarterly dividends that are expected to increase again this year. HCLP is one of my top picks for growth and high yield.
If oil prices do rebound in the third quarter as supply/demand tighten, there are going to be a lot of gains harvested in the upstream oil & gas sector by year's end.
By Dan Steffens for Oilprice.com