Top 12 Media Myths On Oil Prices

Jay OwenResource Efficiency

Top 12 Media Myths On Oil Prices

The upstream oil and gas industry is not a black hole. There’s no mystery
wrapped in an enigma here.

There are a lot of meetings with engineers, chemists and geologists. There’s
a constantly evolving learning curve. And then there’s all the regulations
and compliance. But all-in-all it’s pretty straight forward, that is, until
the media gets a hold of it. That’s when it becomes complicated. It’s as
though we are getting reports from the mysteries of the deep ocean or life
in the great galaxies beyond. There is so much hyperbole and unsupported
guesswork that investors don’t have a chance. So, in a small effort to set
the record straight, let’s see if we can’t dispel some of the
misinformation.

Misperception #1: goldman sachs knows what is going on. This is incorrect.
goldman sachs should not be quoted extensively. They are notoriously wrong
when forecasting tops and bottoms. What they are good at is jumping on the
band wagon and stoking fires. Their forecasting always seems to be done
through a rear view mirror and their calls for peaks and troughs are always
overdone. Back in July 2014 when WTI was peaking, they were calling for
more, even as the dollar was showing signs of strength (and we know what
happened there) and as oil inventories were beginning to wash up over our
ankles. And then when we are forming a bottom in January and retesting it in
March, they were calling for a deeper bottom. And then there was 2008.
Remember the calls for $150 and $200 oil from Goldman and Morgan Stanley?
That was right before we went to $40 and then some. (To be fair, Ed Morse
from Citi called the top but he overshot the bottom. We’re not going into
the 20s).

Misperception #2: The “non-productive rigs” are the first to go. This
statement is a little baffling because all drilling rigs are productive,
some are just more efficient. H&P’s Flex 4 and Flex 5 rigs are state of the
art. But these rigs are stacking up just as fast as the less efficient rigs
that require more man hours but are not as expensive to contract. Have a
drive past H&P’s Odessa yard. It’s stocked full of these Flex 4s. Rigs are
enormous which makes them costly to move around. You’re not going to bring
in a dozen or so tractor trailers and a few cranes for a rig move back to
Texas or Oklahoma, and hire the same sized fleet to bring in the newest
generation rig. The closer truth is that the ones that are running in
particular areas—that have not been let go—will continue running in those
areas. And what the oil companies are going to do is put pricing pressure on
their driller for not having supplied the cat’s ass in the first place.

Misperception #3: Supply keeps coming on because of innovations in fracking.
Yes, fracking has gotten much better in shale formations but the real
advances are already baked in. What has been occurring over the last 24
months or so is that more sand is being run per stage and stage intervals
are more densely packed. Other than some new chemistry and a few software
updates, that is the bulk of it. There really is no smoking gun between well
completions in July 2014 when oil was at $100 and now–9 months later–when
oil has been cut in half.

Misperception #4: Fracking has not gotten exponentially more efficient
resulting in outsized cost reductions. Yes and no, but more “no” than “yes.”
The 600 lb gorilla in the room is competition. Fracking has gotten
competitive, damned competitive. Five years ago fleet sizes were smaller and
there were nowhere near as many players. But then came the boom and service
companies did what they do best. They overbuilt. They were also cheered on
by cheap and plentiful money because everyone, especially bankers and
private equity, wanted in on this one. To get an idea of just how
competitive the shale landscape has become, a stage in a 2012 Marcellus well
fetched almost twice the same stage today. There have been multiple
improvements in both design and implementation, but the heavy lifting on
cheaper frack pricing has been competition.

Misperception #5: The Baker Hughes rig count has become irrelevant.
Incorrect. The Baker Hughes rig count is always relevant. Remember, this was
the weekly number that allowed us to hold a bottom at $43 in March. But
because supply didn’t immediately go lockstep with the falling count,
analysts lost patience. They are now theorizing that rigs are so
“productive” that the count no longer carries the weight that it once did.
That’s a tough position to take. We were at 1,600 rigs drilling for oil in
October and we’re now at 800. There is some truth that E&Ps are now favoring
sweet spots but that won’t make up for the 50% collapse in the count. Shale
extraction resembles an industrial process more than it does wildcatting.
There aren’t many dry holes with shale. Microseismic advances have put an
end to that as have data rooms stuffed full of old well logs that chart the
potential of shales. Thus, most shale wells drilled today have a much better
chance of being economic than step out and exploratory wells of the past.
There is no legitimate model for 800 rigs growing US production past 8.9 mm
BOPD in the Lower 48. And because its shale, and because shale is “tight”,
drilling must continue at a breakneck pace to grow production. Analysts
looking for a more ‘spot on’ number should start following the activity of
fuel distributors who run nonstop between depots and frack jobs. Watch their
sales for a more immediate indication of future production.

Misperception #6: We are running out of storage space for crude. We’re not.
We’re going to be OK. Volumes have increased, especially at the oft
mentioned Cushing, but Cushing accounts for only about 10% of US storage.
Other storage areas are up but nowhere near as much. The reason is that
physical traders like to park their inventory close to market and Cushing
gives them that proximity. Also, Cushing is not a dead end. There are large
pipelines that connect it to the Gulf Coast where storage is more plentiful
and not nearly as full. Additionally, large inventory draws will be coming
shortly with the advent of warmer weather.

Misperception #7: Shale wells have a productive life of only a few years.
The truth on this one is slowly being sorted out and commentators are
finally getting it right. Shale lacks permeability. Which means it’s very
“tight”. It requires a frack job to free up the oil and gas trapped in its
pore space. Fracking creates and sustains permeability and permeability is
the pathway to the wellbore. Like any tight formation, oil and gas
production is front loaded, meaning that most production will come right
after stimulation. This results in excellent up front results but production
tails off quickly, maybe even falling as much as 75% in year one and
settling into something less for the next 10 or 20 years. This is called the
tail and the tail is profitable, but only if the flush pays for most of the
well.

Misperception #8: You can turn shale on and off. That’s wrong. Shale takes
time like any other industrial activity. Slowing down its progress is a bit
like stopping a supertanker. You can do it, but you need a lot of room. Most
drillers require contracts and breaking them can be painful. Sand can pile
up at rail sidings and result in demurrages. Layoffs can take time.
Regulatory penalties may force an operator into activity whether he wants
activity or not. All this takes time to work out. And then there’s always
the stronger balance sheets that will drill regardless of price or that will
drill and create a “fracklog” which is a newly minted MBA speak for a
backlog of wells to frack. There is no switch you can flip.

Misperception #9: Oil is inversely related to the dollar. It is. This was a
head fake. It’s not a misperception. Match the DXY to Brent and WTI over the
last 12 months. It’s a perfect divergence. You want to bet on oil, then bet
on the Euro.

Misperception #10: OPEC is done. Maybe, but the Gulf Cooperation Council is
not. Collectively, the 4 GCC members pump more than half of all OPEC
production. They also have very low lifting costs and enormous cash
reserves. Additionally, they have stamina and are going to maintain OPECs
position of no cuts. There’s a long history of russia or Venezuela filling
reduced quotas. This time around the GCC is not going to let that happen. If
russia concedes there may be a cut in June. But it is looking unlikely even
if they do. Look for saudi arabia to pick up market share.

Misperception #11: American shale producers are the new swing producers. No,
their banks are.

Misperception #12: A deal with Iran will lower prices. Sort of. It will take
Iran a year or two to add anything meaningful to our 93 MMBOPD global market
but the fear of a nuclear Iran will create enough tension to offset the
supply addition. Worries over a nuclear Iran, whether real or perceived,
will create enough fear in the markets to more than counter balance the
additional million barrels a day of supply that may come on.

In short, oil prices will increase as weekly EIA production numbers begin
posting declines as we saw last week. Demand will increase. Inventories will
start getting eaten into by midyear. Europe will contribute as will Asia and
the Middle East. A shrinking Chinese market is still growing at 7% a year,
and that market is much bigger now than when it was posting 10% yearly
growth five years ago. Rich Kinder was right in calling the bottom in the
low 40s and John Hofmeiser (former President of Shell Oil) and T. Boone
Pickens are probably pretty close to being right with their call of $80 as
the top in the next year or so. A solid $65 to $70 by year end is the more
reasonable number and is just enough to hold off development of some
offshore projects, oil sands work and a good amount of the non-core shale
plays. A stronger dollar will also do its work here as will a saudi arabia
hell bent on market share. There will be less and less for shorts to hold
onto and very few will want to be stuck on the same side of the trade as the
big investment banks.

Source:
http://oilprice.com/Energy/Oil-Prices/Top-12-Media-Myths-On-Oil-Prices.html

By Dan Doyle for Oilprice.com