Oil Price Rallies Ahead Of Fundamentals

Summary

• US oil production averaged ~10 mb/d in May.
• But production is set to return in June likely back to ~11 mb/d.
• We see US oil production recovering eventually back to ~11.5 mb/d but existing decline rates will eat into production after that.
• Oil prices are rallying ahead of fundamentals, which means it will be a choppy rebalancing if product storages don't start drawing soon.
• In order to avoid a choppy rebalancing, it needs to be demand led via lower product storages and higher refinery throughput.
• Looking for a helping hand in the market? Members of HFI Research get exclusive ideas and guidance to navigate any climate. Get started today »

Welcome to the ahead edition of Oil Markets Daily!

EIA reported a supportive crude storage figure today but the overall report was bearish as total liquids continue to build.

Source: EIA, HFI Research

US oil production finished May averaging ~10 mb/d with an overall drop of ~2 mb/d m-o-m. If we take into account adjustments, it has dropped ~3.2 mb/d since March.

Most of the production drop is shut-in barrels, so we expect this to start recovering in June. For the time being, we have June production recovering back to ~11 mb/d with July volume around ~11.5 mb/d.

The lack of well completions will eat into the base production rate as existing basin decline pushes overall production lower. August should see US oil production flatlining around 11.5 mb/d as well.

Obviously, these estimates will be subject to revisions, so we will keep a close eye on production figures going forward.

For the time being, we have not seen any meaningful recovery in associated gas production, which is a good tale that oil production has not rebounded meaningfully either.

Oil Price Rallies Ahead of Fundamentals

But the recent crude rally is going well beyond where fundamentals are today. Refining margins are starting to recover, but continue to lag the crude movement. While OPEC+ is set to agree on extending the ~10 mb/d cut for a month or two, the issue comes down to compliance. Global crude timespreads are starting to inch towards backwardation, but without solid fundamental support from higher refinery throughput, it will be very difficult for the timespreads to hold.

As a result, the pace of US oil production rebounding will play a big role in the next rebalancing phase for the oil market. If US shut-in production returns too fast, we may delay the recovery by another month or two. Refinery throughput needs to increase to support the increase in production, or else all those barrels will just be stored again.

So the forward drivers of the oil market will continue to be:

Demand > product storage moving lower > refinery throughput moving higher > margins moving up > crude rallies > timespreads move into backwardation > crude storage draw

If the order of the recovery is flipped in any way, it will be a choppy rebalance.

Analyst’s 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.

Comments

[User 13435622]

The dark side of Corporate America:

oilprice.com/...

[PT Larry]

@Westexr EOG paints rosie 2H 2020.

www.spglobal.com/...

[Westexr]

@PT Larry

Very encouraging. I am also optimistic.

[PT Larry]

@Westexr Great jobs report this morning. Economy coming back faster than expected, AND OIL.

@shaner1 @kimbillro

[shaner1]

WTI hit $39.54 pre-mkt after report, NASDAQ selling off a little, work from home theory taking a hit @PT Larry @Westexr @kimbillro

[PT Larry]

EOG Resources paints rosie 2H 2020 outlook for WTI.

www.spglobal.com/...

@shaner1 @WesTex @kimbillro @Brian C. Nelson @RS055 @twfry

[Sir V-i-val]

@PT Larry I would take everything that this Permian snake oil salesman says with a truckload of salt after he made a statement like.......As for EOG, they said, the company is focused on only drilling new wells if there's a 30% return with oil priced at $30/b....

[Brian C. Nelson]

HFIR - I am having a hard time with your 11.5 MMbo/d estimate in August 2020. It looks like it will be ~10.3 MMbo/d with $50+ oil and the rig/frac counts on a steep incline. By Dec 2020, I have the frack spread and rig counts at 300 and 636 respectively, which more or less implies $60 oil, and US production at ~10.7 MMbo/d. US production in 1Q21 should be ~11.1 MMbo/d with similar rig/frack spread counts that should balance the market through 2022.

Finally, I would not be surprised if March 2020 in the EIA 914 report has a significant downward revision (i.e., ~175k) at the end of June.

[shaner1]

@Brian C. Nelson - Appreciate the post. the 914 reports will provide some "head scratching" entertainment going foreword.

[twfry]

You have frack spreads back at 300 and that being enough for to increase supply.

[PT Larry]

@Brian C. Nelson Thanks for your bullish oil price comments.

My knowledge is limited but know that to overcome the current, severe decline rate, DUCs need to begin pumping and wells need to be completed.

This is what many seem not to grasp. Most think because shut-ins are returning, production will increase. Not true.

[damonhill]

There are between 210K and 746K undocumented orphan well sites in the U.S.
There is a "huge numbers of O&G companies going bankrupt in the coming months, leaving behind more orphan wells and costing a lot of workers their jobs"
www.spglobal.com/...

[PT Larry]

@damonhill Thanks for the link.

[Sir V-i-val]

@damonhill there is a very easy fix for orphan well...Force the O&G companies to pay for the capping of the orphan well first before they can drill a hole in the ground....but they can't afford to pay 19.000 dollars upfront.....if they can afford to pay 19.000 dollars they can't afford to invest 6.000.000 dollars needed for drilling and fracking a well...

[Lotsdawg]

An in depth article on refining margins would be in fact constructive as coal prices suddenly take a powerful bid at an exceptionally low price.

And of course interest rates while still at record lows show powerful carry in the yield curve.

Bank stocks are soaring suddenly.
I am amazed that Warren Buffet no less has completely missed this and indeed been exactly wrong.

Long $gd General Dynamics
Strong buy
Maybe the longs will take some of their vast riches off the table with Bill Ackman of Pershing Square at the top of the list.

Lord knows that kid has earned it.

[kimbillro]

Buffett has BAC @Lotsdawg .

[SilentRage]

Buffett's time has passed. He got burned so bad on airlines and OXY that he's become uncharacteristically gun shy. He's like Michael Jordan playing at age 40 on creaky knees for the Washington Wizards....a shell of his former self. Sad to watch. He should just hang it up.

[kimbillro]

Why would Buffet hang it up? He's only 89 and turns 90 on August 30, 2020 @SilentRage . Buffett is going to a buffet with Jimmy Buffett for his birthday.

[shaner1]

Many States finally started loosening up this week, massive riots during "shelter in place for fear of a virus" indicates plenty of pent up demand IMO. Thanks @HFIR

[PT Larry]

@shaner1 Cuomo comments this morning on Fox stated NY transit system will be fully operational as NYers return to work this month. I visualize NY business shifting-in employees such as, 8-4 shift, 9-5 shift, 10-6, 11-7, etc. Provides for less crowded transit sys. Wonder if this could work?

[shaner1]

That could work, i think people will avoid mass transit whenever possible.
@PT Larry

[PT Larry]

@shaner1 This all goes back to stuff @Andrew Butter wrote about. He demos an accurate vision.

The next idea is frac spreads coming back at a much higher cost. This will help keep the banks out. We'll see how things play out.

[nkvbradenton]

The pace of recovery in crude oil pricing is rather abrupt. Too much bullishness and it will be interesting to see how everything shakes out on the US production front. The shut in wells will come back online, now that pricing is in mid thirties. There are bound to be crosscurrents in oil market going forward as this article rightly suggests.

[cyrus trask]

Everything else is ahead of fundamentals, so why not oil too?

[kimbillro]

Oil included @cyrus trask .

[PT Larry]

Thanks for the article.

[allaboutbacon]

Well I guess potential USO investors are aware of your prediction. It has been creeping like a slow snail, and I'm still stuck from the split!