Oil: Fasten Your Seatbelts

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Includes: BNO, DBO, DNO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU
by: ValueAnalyst
Summary

Oil prices plunged by 43 percent.

Oil rig count is starting to plunge.

Has this happened before? Yes, it has.

After halving in less than three months, oil prices seem to have stabilized:

Chart Data by YCharts

The sudden reversal in the last month, I believe, is the prelude to another and larger upward move for the reasons I discuss in this article.

Inventories Are High, But...

The key reason why oil prices plunged by 43 percent is illustrated in the following graph:

Chart Data by YCharts

From mid-July through September of 2018, the total U.S. Crude Oil and Petroleum Products Stocks increased rapidly by 70 million barrels, or by one million barrels per day.

This increase in total oil inventories was, in large part, driven by the jump in OPEC's production output by, you guessed it, one million barrels a day in July.

...Declines To Resume

In December of 2018, OPEC agreed to a bigger-than-expected production cut, which is now starting to reflect in shipments to the United States:

The above table from the EIA's most recent Weekly Petroleum Status Report shows that Net Imports (Including SPR) dropped by 1.0 million barrels per day from the prior week, specifically because of lower imports, whereas exports from the United States have remained relatively stable in recent periods.

As a result, total U.S. oil stocks dropped by 4.8 million barrels last week:

Weekly Oil Inventories

Because production cuts only just started to bite, I expect the rate at which oil inventories decline to increase in the coming weeks and months, but this is not the only reason why oil prices will resume their multi-year upward trend.

Related image

U.S. Oil Production Growth To Halt

The following graph superimposes Brent crude oil prices on top of the recent trend in US oil rig count in the last 12 months:

Chart Data by YCharts

As a result of the rapid drop in oil prices from October through December of last year, I expect the U.S. oil rig count to continue to decline through the first quarter of 2019.

Specifically, I expect the U.S. oil rig count to decline from its recent high of 888 rigs in November to less than 800 by the end of March of 2019. This is a significant drop of nearly 100 rigs, unmatched in recent years.

What Does This Mean?

A significant drop in U.S. oil rig count is important for oil and energy sector investors, including those who invest in the acceleration of sustainable energy through Tesla (TSLA), because a large drop of nearly 100 oil rigs will likely translate to a stall in the U.S. oil production growth, accompanied by a larger-than-expected increase in oil prices, as happened in the second half of 2017:

Chart Data by YCharts

I note that the decline in U.S. oil rig count from August through October of 2017 was less than 50, or one-half of the drop of nearly 100 rigs that I am forecasting for the first quarter of 2019.

As a corollary, I expect the U.S. crude oil production, which had accelerated throughout 2018, to stall and flatline through the first half of 2019 at its current level of close to 12.0 million barrels per day:

Chart Data by YCharts

Bottom Line

It's going to be a hot summer.

Disclosure: I am/we are long TSLA. 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.