The Global Oil Picture Looks Worse Than It Did A Month Ago

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Daniel Jones

Summary

In this piece, I looked back at aggregated data associated with U.S. production, as well as international data, to figure out what the picture should look like moving forward.

What I discovered is that while U.S. output should fall meaningfully, it's unlikely to be enough to balance the market out by itself this year.

To me, this signifies a greater chance of OPEC cutting, but investors should be aware of these risks for the moment.

Last month, after finishing up a series of analyses of the Permian, Eagle Ford, Bakken, Niobrara, Utica, Haynesville, and Marcellus regions, the seven largest onshore oil-producing regions within the U.S., I wrote an article looking at the overall global oil picture. In it, I concluded that some glut would likely persist throughout the U.S. and the world through this year, but that it would set 2017 up for some meaningful drop in crude inventories. Now that I've written fresh pieces on the subject, I've decided to revisit the situation and concluded that although the picture for the oil market is showing signs of improvement, the situation isn't quite as favorable as data indicated last month.

A look back at my original analysis

In my last piece, I provided a comprehensive analysis of the global oil industry using the data I collected from the EIA's (Energy Information Administration) seven regions that are recorded in the organization's Drilling Productivity Report as well as from its Short-Term Energy Outlook. What I discovered was that, if my estimates are correct moving forward, oil production across these areas should fall to about 4.24 million barrels per day under the conservative forecast I provided.

This represents a fall of 810,759 barrels per day from the 5.05 million barrels per day the organization reported for December 2015. This drop could reach as high as 1.97 million barrels per day under the liberal forecast I provided (though investors should be cautious about assuming this to be the case). To be accurate, however, it's important to keep in mind that just because oil production should fall by a great amount by year-end, it doesn't mean that investors should use that number for the entire year. In the table below, you can see what the picture looks like by using the average production throughout 2016.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report and from the Short-Term Energy Outlook.

However, this does not account for other factors estimated by the EIA. In the table above, you can see other factors, such as Iran's increase in oil production, global demand changes, increases in production in the Gulf of Mexico, and other fluctuations projected elsewhere in the world. The table also includes an estimate of 1.5 million barrels per day in excess production (many analysts think the number ranges between 1 million and 2 million barrels per day, so I picked a reasonable mid-point).

But times change

Unfortunately, this trend now looks obsolete. For starters, changes in my core analysis makes the supply side of the equation in the U.S. look far more appealing under both the conservative and moderate scenarios, but less favorable under the liberal scenario due largely to a downward revision by the EIA regarding decline rates. My core assumption regarding Iran has remained unchanged, because the number is what the government of Iran believes to be possible this year (500,000 barrels per day in extra production almost immediately, and another 500,000 barrels per day six months in).

However, some other categories have changed, and this has been mostly for the worse. While the EIA had forecasted global oil demand to grow by 1.41 million barrels per day this year, they now believe the number will most likely be around 1.24 million barrels per day. Total production outside of the U.S. and OPEC was forecasted to fall by 210,000 barrels per day, but that number has been moved to a decline of only 60,000 barrels per day. The only good revision (other than my own findings) relates to the Gulf of Mexico, which is now forecasted to increase production by 90,000 barrels per day as opposed to the 130,000 barrels per day the EIA had forecasted last month for this year.

By factoring these changes in, you can see the table below, which shows a more bearish tone than what I expected to take place a month ago. Under the conservative scenario, oil stocks are expected to increase by 473,878 barrels per day. Meanwhile, that number is forecasted to be a gain of 310,451 barrels per day under the moderate assumption, and the liberal assumption even assumes an increase of 158,139 barrels per day.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report and from the Short-Term Energy Outlook.

It should be mentioned, though, that this is all based on so many factors, any one of which can change materially. In the case of Iran, I think it's highly probable that their government cannot increase production by as much as they say they can. According to data provided by the EIA, they expect output in the country to rise by just 300,000 barrels per day (on average) this year to 3.1 million barrels. This does, admittedly, have a margin of error of 250,000 barrels per day. I honestly do not think the number could be any lower than what the EIA has forecasted, but it is possible to see an increase above what they think is likely.

To adjust for this, I looked at the supply/demand situation under a base case (where Iran's oil production increases by the 300,000 barrels per day the EIA thinks it will) and under a high case (where they increase it by 550,000 barrels per day, accounting for the upper end of that margin of error). What I found is that, if the EIA is correct, the conservative case will result in stocks climbing by 23,878 barrels per day, while the moderate case will see stocks fall by 139,549 barrels per day. The liberal case, which I believe is improbable, would see a decline of 291,861 barrels per day. Under the high case, these numbers will be for an increase of 273,878 barrels per day, 110,451 barrels per day, and for a decrease of 41,861 barrels per day, respectively.

Takeaway

Right now, I'd say this data suggests that the oil supply/demand picture is less favorable than it looked a month ago. Despite benefiting from generally more appealing forecasts regarding production declines in the U.S., changes abroad (mostly relating to demand) more than offset this. Of course, these results can vary meaningfully and probably will, most likely due to what happens to Iran. If the EIA's base case is correct, we will probably see some drawdown this year, but there is no promise of that happening.

This also doesn't factor in two very important things - one being a fact if my analysis is correct, and the other being a possibility. The possibility is that OPEC seems to be nearing some sort of action, and that could change the picture for the better very quickly. The fact, however, is that oil production in the U.S. will (if I'm correct) be much lower at the start of next year compared to the average change posted in my analysis.

Even if Iran can increase production by another 500,000 barrels next year, this drop in output, combined with a demand increase of between 1.2 million and 1.5 million barrels per day will still create a powerful force that will, absent additional supply coming on, help to correct the glut very quickly. My low-end estimate here would imply a decrease in oil stocks each day of 812,900 barrels per day, which would help the drawdown of excess oil production materially even if output in the U.S. remains flat.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.