Mr. Market Or Mother Nature, Who Rocks Oil First?

| About: The United (USO)

Summary

Was the Oil price manipulated to hurt Russia?

Chicken & Egg – Oil Storage or Price.

The EIA's phantom oil storage.

Earth quakes on the rise at Oklahoma oil hub.

One of Oklahoma's oil storage facilities.

Click to enlarge

Was the Oil (NYSEARCA:USO) price manipulated to hurt Russia?

Many readers will find this topic very controversial and some may think it is too far out there, but consider how abnormally the stars aligned, and if true - the implications in the near future could be enormous.

While the Oil price crashed I speculated on a few occasions that this could all be a ploy to hurt Russia. There is no doubt that U.S and Russian relations have been in decline the last several years.

Oil is the lifeblood of the Russian economy.

Interesting that the EIA published a chart in July 2014 showing how dependent Russian's economy is on oil and gas. EIA estimated 68% of Russian export revenues are derived from oil&gas. The data came in the context of new sanctions imposed by the U.S., and Europe, for Russian muscle-flexing in Ukraine. July 2014 was also the beginning of the Oil price decline or what I called 'a crash'.

When Russia moved in Crimea in 2014 it caused a big stir in Europe and the U.S., but neither was in a position to do anything militarily so sanctions were imposed to try and cripple Russia economically.

While not a prevalent revelation in the main stream media, sanctions were specifically targeted at Russian Banking and it's Oil Industry confirmed by numerous trade experts, such as Paul Hastings.

If the U.S. aimed sanctions at Russia Oil - why not aim the price down to further the pain and to the benefit of a stumbling U.S economy?

Is the timing of a charge by the Saudi cavalry a co- incidence ?

Subsequently in 2014 U.S. ally Saudi Arabia who has no love for Russia began opening up their Oil taps and pumping out more supply at the same time U.S Oil production was around record highs last seen in 1970.

In January 2015 Saudi revealed they had already increased production to 9.8 million barrels. The main stream media was pushing the story that Saudi was trying to win back market share from U.S. shale production.

As prices fell, Saudi Arabia kept increasing supply and recent numbers show they are pumping about 10.2 million barrels/day and Oil Minister Ali al-Naimi warned in September they could increase to 12.5 million barrels.

Another factor with lower Oil. It is widely believed that a drop or low energy prices is a big boost for the U.S. economy, but at the time I doubted this and thought the damage done to the U.S. Oil industry would be about the same as economic gain or maybe more so.

This has proven to be true and probably no better highlighted earlier this year by Former US Treasury secretary Larry Summers calling it one of the biggest economic puzzles of our time.

The lower oil price hurts Russia, the U.S. and European economies benefit from low energy prices and for the Saudi playing along they gain market share and probably a behind doors deal that Wall Street will ensure the Saudi Aramco IPO goes well and at a good price.

Down goes Oil and all is good!

In 2015 there were frets that the world's Oil storage would fill up as tankers (floating storage) began to climb.

This is where the chicken and the egg comes into play.

Did oil storage climb from over supply or did the price drop cause oil storage to climb?

A lot of Oil goes into floating storage, strictly because oil traders can make a profit. They do not care about supply and demand as long as the contango (spread between current prices and future price) is high enough.

Large contango is indicative of market bottoms. During the 2008-09 crude oil crash, the oil market witnessed a super-contango, when the price difference between the first month and the seventh month contract had reached up to $10 per barrel.

Similarly, during the current crisis, the contango reached $8 per barrel twice, once in February of 2015 and again in February of 2016, as shown in the chart below, after which, the markets bottomed out and both cases headed higher.

Oil Contango

An article in the Globe and Mail this past February highlights the increased interest in floating storage by Oil Traders.

Yes a lot of floating storage is because of excess supply but a lot is also from Oil traders taking advantage of the high contango. This Oil is already sold in the market so is really not excess supply.

Therefore a considerable amount of storage is because of the price contango and not just over supply.

The EIA's phantom oil storage

Perhaps the strangest event is the big distortion or adjustments with the EIA's oil storage numbers. The market is focused on what you see on this chart, notably the increase from about 340 million barrels the end of 2014 to over 500 million

US oil stocks

The EIA, determines changes to the amount of oil in storage with a pretty straight forward calculation.

Stock Change = Domestic Production + Net Imports - Crude Oil Input to Refineries

However the data never matches up accurately with the data from underground and tanker storage, the EIA assumes the problem comes from the less accurate production, import, or refinery data, and "adjusts" the numbers accordingly. In the past, this adjustment has been minimal around 10% to 15% so can be safely ignored.

But over the last several years, the differences have often represented as much as 60% and more of the total number and has really widened more so since 2014.

At least on paper, there's a lot of oil in U.S. storage - but as this chart shows in July more than 400 million barrels- that doesn't appear to come from either domestic production or from imports.

This is a lot of phantom oil derived from EIA adjustments. It would be hard to imagine that 400 million barrels are really not there in storage, but I bet the real storage may be closer to the 300 - 350 million barrel number than most believe.

Click to enlarge

Another point of interest is storage utilization. It was pretty steady around or just over 60% until the end of 2014, then it moved up to 70% or just over. This is roughly only a 10% increase in utilization and is considering the EIA's phantom storage. If we were so much awash in oil would not this be higher?

Summary

What if oil storage is far less than the markets believe?

And at the same time production feel significantly because of less drilling.

It would mean the market could come back to balance very quickly.

We know that Saudi Arabia has a policy to maintain a spare output capacity between 1.5 to 2 million barrels and is currently pumping oil at a rate near a 32 year high. There is not much increase left in Saudi output.

I pointed out in my Oct 24th Gold and Oil update how drilling rigs have plummeted around the world - outside the middle east and this will lead to lower production.

This has already begun and the production decline will pick up speed.

The latest EIA weekly report shows that U.S production is already down - 6.1% from a year ago.

China's oil output dropped 11.3% from the same time a year ago to 16.1 million tons, according to the National Bureau of Statistics. The daily average was 3.8 MMBOPD, the lowest since May 2009, and down from 3.9 MMBOPD in September.

In Norway average production in September was: 1,375,000 barrels of oil, about 11% below the oil production in September last year.

Offshore Oil production now counts for 30% of total production and it is about to take a big hit. Infill drilling is used to arrest the natural decline in an offshore oil field.

This chart shows the decline in infill drilling due to previous drops in the price of oil. The data is from the Gulf of Mexico, Southeast Asia and Brazil. The decline in infill drilling in 2009 was the largest… until now. The first half of 2015 saw the largest decline in offshore infill drilling in history.

Based on this trend, Rystad Energy estimates that global offshore oil production in mature field will decline next year by 1.5 million barrels per day (bpd), or 10 percent, to 13.5 million bpd from 15 million bpd in 2015.

The UK North Sea may fare worse with the collapse of investment in new projects. Oil&Gas UK reports that this year the upstream industry is expected to approve less than £1 billion to spend on new projects, compared to a typical £8 billion per year in the last five years - sparking fears for the long term future of the industry.

If there is no demand shock to the market, the supply erosion from less drilling will bring the market back to balance in the next year and perhaps even amount to a supply deficit. Especially if storage levels are not what we are led to believe.

Oklahoma earth quakes could cause supply shock.

However there is growing potential of a supply shock in the U.S. The Oklahoma oil hub is the most important in the U.S. and sets the West Texas Intermediate oil price. Ironically drilling for oil and fracking may bring on it's own demise.

Bloomberg reports that several producers, as well as the U.S. Environmental Protection Agency, are facing lawsuits because of seismic activity allegedly linked to oilfield wastewater disposal in Oklahoma and other states. The region, previously not known for intense seismic activity, began having a significant number of earthquakes in 2009, the same year area oil companies began using fracking to shatter deep rock layers to extract oil and gas.

In fact since 2011, the number and size of these quakes has grown immensely and it is just a matter of time before one does severe damage to the oil hubs, storage and pipelines. Note the number and dates of the 10 largest quakes in Oklahoma. Seven of the largest quakes have occurred since 2011.

  • Sept. 3, 2016 - 5.8

  • Nov. 5, 2011 - 5.7

  • Apr. 1952 - 5.5

  • Nov. 6, 2016 - 5.0

  • Oct. 1882 - 4.9

  • Nov. 9, 2011 - 4.8

  • Nov. 5, 2011 - 4.8

  • March 2014 - 4.5

  • Dec. 2013 - 4.5

  • 1974 - 4.5

Perhaps Mother Nature will disrupt supply before the lack of drilling.

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.