An eventful year has passed in the oil industry since I published my opinion piece entitled “US tight oil production and the future oil price” in the Saudi Gazette on 12 January 2015, a piece which was updated in my article “The oil price rally and US tight oil production” on June 27, 2015. Oil prices fell to a near 13-year low on Jan. 20, 2016 when month-ahead price for West Texas Intermediary (WTI) and Brent crudes dropped to $26.55 and $27.88 per barrel respectively. The big question is: What market drivers are now setting the oil price?
Crude oversupply is only one answer to the question and can be explained via a number of factors. In the US Lower 48 states total crude oil production has been unexpectedly resilient, despite the declining number of active rings. On Jan. 29 2016 active oil rigs in the US totaled 498, less than half of the 1223 a year ago. And yet, crude oil output decline is moderate, mainly concentrated in the Eagle Ford Basin, while Permian oil production projections show a rise in output in 2016 and North Dakota production is expected to more or less even out. Why is that? The Permian oil production is a case of improved operational and design efficiencies on the part of the producers, a phenomenon which I have covered extensively in my previous published pieces. There is now one further important reason.
Out of the 4,000 drilled and uncompleted wells onshore in the US Lower 48 states, 969 wells are in the Williston Basin (Bakken and Three Forks tight oil formations) in North Dakota. Up until 2015 North Dakota state law required a well to be completed within a year of it being drilled. To help financially pressed oil producers this time limit has now been extended to two years. These 969 wells can be expected to be gradually completed, mainly in 2016, but some also in 2017 and, hence, help keep up oil production in the Williston Basin. This is the case, despite there only being 44 active rigs in this basin, less than a third of the 148 a year ago. The remaining 3000 or so drilled and uncompleted wells are located across the US and are also likely to come into play at some point over the next couple of years, even if the owners of these wells are cash-strapped or should end up in bankruptcy.
In Eagle Ford crude oil and condensate production will likely be slowing down further since these ultralight crude qualities has a lower market value than Permian Sweet and North Dakota Light Sweet crude oils. Although US crude oil export restrictions have been lifted, the WTI/Brent differential does still not make it economic for light/ultralight crude exports into Europe or even into Asian markets, unless the blending of such ultralight crudes with lower cost heavier crudes increases their attractiveness for specific refiners.
Furthermore, according to the latest forecasts of US Department of Energy’s Energy Information Administration, total US Lower 48 crude oil production is projected to only decline to around 8.7 million barrels per day in 2016 from 9.4 million barrels per day in 2015. Adding to this, Canadian oil exports are increasing, having reached a record of 3.4 million barrels of oil per day given that large- scale, long lead time, oil sands projects are completed and adding hundreds of thousands of heavy crude barrels destined for exports to US refineries.
OPEC production has also increased in an effort to maintain suppliers’ market shares. The latest news on the OPEC front is that Iraq has announced its intention to increase oil exports from the southern region by 400,000 barrels a day to a total of some 4 million barrels per day in 2016. Crude oil exports from Kurdistan and the northern part of the country is running at more than 600,000 barrels per day.
The Iranian capacity question is a different story. Ever since it became clear that Iran would meet the conditions imposed on its nuclear program, oil traders had already started pricing in the return of unrestricted Iranian oil supplies to the market. But what commodities traders had failed to remember is that US financial sanctions imposed on Iran long before the nuclear sanctions came into force some four years ago had not yet been lifted. The US financial sanctions will keep on preventing Iran from insuring their ships carrying oil cargoes for exports and oil traders and refiners from paying for Iranian crude in US dollars. When traders realized the impact of such conditions on Iranian crude exports, they re-adjusted the oil price to reflect that Iranian crude was unlikely to flood markets any time soon.
Global crude oil and petroleum product storage capacity is another factor, which prematurely impacted on oil traders’ perception of the fair value of oil. Although crude oil storage facilities in many countries have been reaching their highest levels for some 80 years, there is still ample room to store large quantities of oil and oil products around the world, although at increasing costs. Many traders failed to understand this initially and reduced oil prices too much too soon by perceived storage effects. Lately this has been recognized, a situation adding to the currently observed oil price correction.
Oil supply remains, however, only one side of the equation. In order to fully appreciate what sets crude oil prices one also needs to consider demand. And the demand for crude has fallen significantly worldwide. This is not only due to the global economic uncertainty. In some regions such as the Gulf Cooperation Council countries of the Arabian Gulf or Asian countries, the phenomenon is a direct result of the gradual removal of petrol price subsidies, a move, which should otherwise lead to healthier internal markets for the local economies, but will inevitably also impact on crude demand.
The price of oil is driven more by sentiment than by logic. The factors likely to have caused the oil price bounce on 21 January 2016 could be summarized as follows: The European Central Bank’s announcement that further stimulus would be applied within the European Union; the official Chinese data that GDP in 4Q 2015 had grown by 6.8 percent year-on-year and oil demand by 2.5% in 2015; and the fact that oil traders had realized that hurdles still existed before even Iranian crude in floating storage, could reach markets. This led to hedge funds’ and oil traders’ starting to reduce their large short oil positions, which in turn triggered a market bounce driven up by computer based trading. However, only time will tell for how long these sentiments will lift the oil price.
The notion of Peak Oil has long gone. While the oil price is trying to find its floor, we should now concentrate our attention on Peak Oil Demand. After all, the price of all commodities, goods and services, is set when supply and demand are balanced. Crude oil is no exception.
— The writer is the senior partner of Morten Frisch Consulting, UK. He can be contacted at: morten.frisch@yahoo.co.uk Website: www.mfcgas.com