Has The Oil Rally Stalled Or Is A New Oil Glut Emerging?

|
Includes: BNO, CLR, DBO, DNO, DTO, OIL, OILK, OILX, OLEM, OLO, SCO, SZO, UCO, USL, USO
by: Caiman Valores

Summary

Oil has plummeted in recent days as fears of growing production gain momentum.

U.S. shale continues to ramp up activity despite promised of restraint.

Geopolitical supply risks remain but are not enough to significantly constrain supplies.

Oil has fluctuated wildly recent weeks as investors grapple with turmoil in financial markets and economic as well as supply and demand fundamentals creating a confusing picture. The sharp correction across global financial markets last week sparked concerns over the health of the global economy and the sustainability of the global economic upswing that is currently underway.

While demand growth is expanding and supply risks remain, the belief that U.S. shale oil will grow at a rapid rate is weighing heavily on oil prices. Both West Texas Intermediate or WTI (USO) and Brent (BNO) have plunged by about 11% in less than two weeks, and there are signs of further carnage to come.

U.S. shale is getting ready to massively boost production

The fear is that U.S. shale oil producers are gearing up to launch another tremendous surge in activity that will see production soar, which according to the International Energy Agency or IEA will be reminiscent of the first wave of U.S. production growth in 2014. The Agency went as far as to say in its latest oil market report:

in 2018, fast rising production in non-OPEC countries, led by the US, is likely to grow by more than demand.

That outlook is confirmed by data emerging from the U.S.

The latest rig count spiked by 29 rigs compared to a week earlier to be at its highest point since April 2015. It is being unreasonable to expect that such a significant increase in the rig count to trigger a massive expansion in production. According to EIA estimates the last time the volume of operational rigs grew at such a rapid clip it added almost 600,000 barrels daily to U.S. oil output.

This is all flying in the face of the shale oil industry claiming that this time around it would act with greater restraint.

It is difficult to see an industry that has struggled through one of the longest and deepest oil slumps of modern times not jumping at the chance to open the spigots and generate much needed with WTI trading at close to $60 per barrel - even more so when many drillers such as Continental Resources (CLR) have slashed costs to the point where cash costs per barrel produced are less than $40 and in many cases those drillers are cash flow neutral at $40 to $50 per barrel.

Then you have the massive 1.9 million barrel inventory build reported by the EIA for the week ending 2 February 2018, which spooked markets, mostly because the likelihood of another significant spike is high because of the rig count rising at such a rapid clip.

Growing U.S. exports aligns with Trump’s plans for energy independence

Meanwhile, growing U.S. oil exports are threatening to loosen Russia and OPEC’s grip on international oil markets. The EIA even went as far as to state that the U.S. would become a net oil and gas exporter by 2022, which aligns with Trump’s energy policy aimed at growing U.S. oil production to such a level so as achieve energy independence.

This accords with his plans to bolster U.S. independence and sovereignty, giving Washington a far freer hand when it comes to pursuing the national interest and enacting foreign policy. Trump has regularly hailed the successes of the shale oil industry, its growing efficiency and the potential it holds to significantly boost U.S. oil reserves and production.

OPEC is capable of maintaining production despite supply threats

The only factors that could really help to bolster crude in the near future is if a perfect storm of geopolitical crises were to emerge, notably in the Middle East and Africa and take a considerable volume of production primarily from OPEC offline. The likelihood of this occurring is slim, and a number of signatories to the OPEC deal are in a position to open the spigots and bolster output should countries such as Venezuela, Libya or Nigeria experience outages. That is evident from OPEC’s January 2018 Monthly Oil Market Report, where despite Venezuela’s December 2017 output declining by 4.5% compared to November overall OPEC production, numbers remained stable.

Final thoughts

Both at the macro-policy and industry levels there are considerable incentives for U.S. drillers to substantially ramp up the tempo of operations. That can mean only one thing that U.S. oil production will grow sharply in coming months unless oil prices plummet once again to below $50, which is where most industry insiders and analysts believe that shale oil companies breakeven. While the considerable uptick in the volume of rigs has caused drilling costs to rise, there is little sign of any major constraints emerging that will restrain the U.S. shale oil industry from massively boosting production. This means that the surge in oil witnessed earlier this year that saw WTI briefly break through $66 per barrel could very well have come to an end.

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.