American Oil and Gas Reporter - November 2015 - 27

MARKETMATTERS
Mixed Signals
Leave Crude Oil Prices
Seeking Direction
Crude oil price bulls are frustrated by weakness that has throttled any significant recovery in the price of West Texas Intermediate. WTI reached $50.92 a barrel in early October. This
brought the price above the late-August rally that lifted prices from
$37.75-the low of the entire sell-off since June 2014, when prices
topped at $107.73.
Bullish observers point to futures price statistics that are showing a flat to only modestly bearish price curve. In their view, a
worldwide glut of oil would show a more pronounced price carry. As of mid-October, the one-year carry between November 2015
and October 2016 WTI futures was $5.27-less than $1.00 a month.
On the other side, the "lower for longer" crude oil price thesis is carrying the day, at least for now. The bears argue that lower prices will reduce supply, allowing for a price recovery sometime in 2016.
Supply data do not yet indicate erosion of the domestic inventory position. At around 2 billion barrels, total petroleum stocks
are at record highs. On the U.S. Gulf Coast, stocks of crude oil
are in excess of 240 million barrels.
The supply glut is a global phenomenon as well. The International Energy Agency expects demand growth to slow from a
five-year high, and that major OPEC members will produce near
record amounts going into next year. IEA anticipates global demand to grow 1.2 million barrels a day in 2016. This is a significant gain, but less than that projected by the Organization of Petroleum Exporting Countries and the U.S. Energy Information Administration.
IEA is looking for a drop in non-OPEC production of about
500,000 barrels a day. The largest part of that decline is in the United States.
OPEC is producing more than 31.0 MMbbl/d. This is greater
than IEA's estimate of demand for OPEC oil, and lifting sanctions against Iran will only add to crude oil availability in 2016.
There have been some signs of willingness to discuss OPEC's
policy of defending market share at the expense of price, but no
action has resulted yet. Taken together with geopolitical tensions
in the region, and uncertainty rules the outlook.
Some producers-notably Venezuela-have expressed interest
in instituting a "price band." This would establish a range of prices
between $70 and $100. Production cuts would be initiated and then
lifted progressively as prices rose. But Gulf State OPEC producers
are reluctant to concede market share needed to make such a system work.
Divergent interests among producers remain a barrier to agreement. Moreover, higher prices would have the effect of encouraging more U.S. shale oil production, effectively capping crude
oil prices.
We are reminded regularly that the best cure for low oil prices
is low oil prices. Presumably, enough low prices have occurred
to contribute to the rally just experienced in WTI prices. Now,
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.

"A market-determined price band may be
the result, selling into higher prices and

cutting output at lower levels.

the opposite side of the coin may be in play. The rally was an invitation to lock in future crude oil prices above $50 for the first
time since mid-July. WTI futures contracts for December 2016
experienced a doubling of volume in the week ended Oct. 9, compared with the average of the previous four weeks. December 2016
prices ended the week at $54.14. This was "the biggest wave of
hedging since August," according to industry executives.
Notwithstanding this hedging activity, one analysis estimates North American exploration and production companies have
protected only 11 percent of their 2016 oil and natural gas production. Many producers apparently are holding off, hoping for
even higher prices to initiate their hedges. The balance of 2015
reportedly is hedged at 28 percent of output.
Press reports noted that the one-year carry had fallen to only
$4 a barrel, compared with $7 two months before (A shrinking
carry is bullish). The rapid hedging response to an attractive price
indicates the financial challenges being faced by producers with
credit conditions tightening. Companies did not respond to previous price rallies so rapidly.
Ironically, a hedged driller can produce oil even in a low price
environment, adding to supply. A rally invites hedging. Hedging invites less-price-sensitive production. A market-determined price band may be the result, selling into higher prices and
cutting output at lower levels.
Efficiency gains add to the bull's problems. One estimate puts
the break-even oil price near $50; a year ago, break-even was said
to be $70.
❒

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.
NOVEMBER 2015 27

American Oil and Gas Reporter - November 2015

Table of Contents for the Digital Edition of American Oil and Gas Reporter - November 2015