American Oil and Gas Reporter - April 2015 - 37

MARKETMATTERS
Oil Markets
Undergo Departure
From Normal
Sustained crude oil production in the face of declining prices
has introduced a new element into traditional thinking about price
levels. Heretofore, analysts looked on the sharp price drop as a
unique departure from normal. That is to say, prices might fall,
even sharply, but eventually production would be shut in and surplus product would be consumed by demand at lower prices. The
recovery in price would re-equilibrate at some level.
The current situation flies in the face of this pattern. Some producers have announced initiatives to deal with new production
in a low price environment. Lower prices have led to reduced capital spending. Independent shale oil producers reportedly have cut
drilling plans by $50 billion this year. Nonetheless, they expect
to increase output by focusing on their most promising fields.
Producers could achieve this by strategies that allow them to
pump more crude as prices start to rise. They would drill wells,
but defer stimulation. This, in effect, would allow them to store
oil in place and get to it rapidly in response to higher prices. This
could tend to cap prices as well. One observer notes, "We are in
slightly unexplored territory. It's a big, big experiment."
One producer reportedly is drilling 285 wells that will remain
unfinished until crude oil prices recover to $60-$65. This thinking is becoming very common. Five large producers that have indicated interest in this strategy account for nearly 10 percent of
U.S. crude oil production. There are reportedly at least 3,000 wells
in Texas and North Dakota drilled, but not in production.
It is problematic whether the U.S. industry can adjust to changing prices rapidly enough to stabilize prices. It is one thing for a government such as Saudi Arabia-a single decision maker-to determine
national output. It is quite another for the highly diverse set of producers that comprise the American producing industry to adapt their
businesses to a single goal, or even to agree what that goal might be.
The increase in production and crude oil in storage has been
remarkable. Markets absorbed another 4.5 million barrels of crude
during the week ending March 6. This confirms the significantFIGURE 1
Days of U.S. Crude Supply
(Excluding SPR)
40

Number of Days

30

20

10

0
1985

1990

1995

2000

2005

2010

2015

Weekly U.S. Days of Supply of Crude Oil excluding SPR

Transactions in securities futures, commodity and index futures, and options carry a degree of risk. Past
performance may not be indicative of future results. This column is for informational purposes only. It does
not represent an investment offer, solicitation or recommendation.

"We are in slightly unexplored territory.
It's a big, big experiment."
ly oversupplied crude oil market that has been building since 200203, when crude oil supply bottomed slightly above 18 days of inventory. As of March 6, there were 29 days of crude oil in storage, a number not seen since March 1986 (Figure 1).
Refineries are operating at reduced turnaround levels and demand has been treading water slightly below 20 million barrels
daily since 2008, despite lower product prices.
So much crude oil supply, at best tepid demand, and important strictures on crude oil exports should translate to significantly
lower crude oil prices. Prices fell from $107.73 on June 20, 2014,
to $43.58 on Jan. 29, 2015. The industry has added another 35.8
million barrels to supply since then. Prices, meanwhile, ended their
downswing, trading between $47 and $54.
Industry press is replete with stories of swollen inventories,
an observation at odds with the reality of narrow range trading
for crude oil. One analyst wrote, "WTI could take another leg
down. If there is enough distress, if imports don't budge, which
they won't, if exports don't rise quickly enough, which is a wild
card, then producers need to shut in pipelines or run at low utilization so it doesn't come to Cushing."
It is hard to explain why, in the face of so much bearish information, crude oil prices have not reached $40 (as of March 17),
or even a price in the $20s, as predicted by one analyst. One possibility is the expectation that, as spring advances, demand will
pick up and eat into the crude oil overhang.
Geopolitics may be at work, too. Negotiations with Iran over
its nuclear program may not succeed, and the prospect of Iranian crude oil adding to supply may come up short. Moreover, the
situation in Libya is very unstable. Loss of that supply could be
supporting prices as well.
Meanwhile, the Energy Information Administration's ShortTerm Energy Outlook confirms continuing high levels of natural gas production. Despite declining prices and rig counts, marketed production reached 78.8 billion cubic feet a day in December.
EIA chalks up the anomaly to improving rig efficiency. Natural
gas output rose 6.1 percent for all of 2014, which was the strongest
growth since 2011.
Ì

ALAN H. LEVINE is chairman
and chief executive officer of
Powerhouse, a registered affiliate
of Coquest Inc., and a commodities
brokerage offering hedging services to the energy industries.
Levine has more than four
decades of experience as a petroleum specialist. He may be
reached at alan@powerhouseTL.com or 202-333-5380.
APRIL 2015 37



American Oil and Gas Reporter - April 2015

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Contents
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