Oil back in the headlines…

Oil back in the headlines…

It’s been almost six months since some of the world’s major oil producers, led by Saudi Arabia, agreed to restrict their future oil production.

This was done in an effort to stabilise, and indeed raise the price of this most sought-after of commodities.

Of course, that production cut agreement resulted from the failed attempt to the let the Oil price fall – with the aim of squeezing US shale production and producers out of the market.

This year-long experiment (or game of chicken, some might say) is rumoured to have cost Saudi Arabia more than US$200 billion in lost revenues alone.

Money that it could not really afford to forgo, given the long term social and economic issues the country faces.

Whilst US production of shale oil and gas was undoubtedly hurt by the sharp fall in oil prices – which touched as low as US $26.05 per barrel (of West Texas Intermediate crude) in February 2016…

The very flexibility and mobility of shale production allowed it to weather the storm and, more importantly, bounce back as oil prices began to rise once more.

The rebound in the US Oil and Gas sector can clearly be seen in the widely followed Baker Hughes ‘Rig Count’ data. This is a weekly survey that records the number of active drilling rigs operating in the USA.

Click image to enlarge.

The chart above plots this weekly count and we can clearly see a sharp decline in the number of rotary drilling rigs deployed in the US throughout late 2015 and 2016.

However, as is evident from the spike on the right hand side of the chart, the number of active rigs deployed has been rising steadily throughout 2017.

In fact, the Baker Hughes data shows us that there are 462 more rigs active in the USA, as of May 5th 2017, than there were a year early. That’s a significant pickup in activity in anyone’s language.

Indeed, US bank Morgan Stanley has calculated that this is the strongest rebound in rig activity over a 52 week period seen at any time in the last 30 years.

The Baker Hughes data itself however, does not specifically say anything about outright production levels of crude oil in the United States – much of which comes from well-established traditional wells that do not need the services of drilling rigs.

Rather, the rig count data serves as a sentiment indicator for, and barometer of, potential future growth in the US oil industry.

That said, US oil production has been increasing and perhaps more importantly, oil traders are more inclined to believe that this increase in production can provide a counterweight to the Saudi-led production cuts.

Indeed, Crude oil prices have been drifting lower since reports in early April indicated that a continuing build up in US Crude supplies and inventory was plausible.

We can clearly see in the chart below that the price of US crude Oil (WTI) started to deteriorate and then fall away quite sharply across the month of April.

Prices look to have bottomed in early May, as US oil inventory data showed a larger than expected drawdown of supply and, as such, drew a short-term line underneath the price slide.

Click image to enlarge.

US Growth has got the Saudis spooked…

Whilst many people are familiar with the idea that Saudi Arabia is the world’s largest producer and exporter of crude oil…

What is less well known is that Russia and the USA are the second and third largest oil producers, respectively, on a global stage.

US production has grown substantially over the last decade and the US is now well on its way towards energy self-sufficiency.

Historically, US oil production had been restricted to the domestic market only. However the regulatory barriers that have prevented US producers exporting overseas are being removed…

The Trump presidency has the former CEO of Exxonmobil, Rex Tillerson, as its Secretary of State and, as such, there are expectations that further oil exports will be encouraged and made possible under the new administration.

The chart below (from the US EIA) clearly illustrates the sharp rise in US crude exports since the emergence of shale supplies in the early 2000’s:

Click image to enlarge.

It’s this sharp incline that has got Saudi Arabia and its OPEC partners worried. You see, many of them face similar long-term concerns…

These are economies which have been, and largely remain, dependent on oil revenues. They are also economies which face many demands on the money raised through those crude oil sales.

For example, many Saudis have become used to a state subsidised lifestyle, sheltered from the vicissitudes of the wider global economy.

The new Saudi leadership is well aware though that the kingdom can no longer afford to do this. And that its oil, whilst still plentiful, is going to run out – whilst, at the same time, the prices and revenues it receives from that oil can no longer be guaranteed.

If ever there was a case of having all your eggs in one basket then this is it.

To complicate matters further, both Iraq and Iran are trying to make up for lost time…

Their production and oil revenues have been greatly diminished by a combination of wars and western sanctions and both would really like to pump as much crude as possible, to help revive their domestic economies and, in the case of Iraq, to rebuild infrastructure devastated by more than a decade of conflict.

Lastly, Saudi Arabia wants to float the world’s largest oil business, Saudi Aramco, on global stock exchanges in the near future – to kickstart its economic diversification plans.

When you think of all that, you get a sense of the very high stakes that are being played for when OPEC members convene in Vienna for a meeting on the 25th May.

Crude Oil prices are moveable of course, but it’s interesting to note that futures prices show the markets are not currently expecting any dramatic re-bound in the price of a barrel of Oil, with deliveries of WTI for December 2018 trading at $48.56 (below the psychological $50.00 per barrel).

A disparity that will be causing some sleepless nights in Riyadh I imagine…