Is this Finally the End? What Does it All Mean?

So the past week has been, how shall we say, a bit of a challenge for the oil patch. Thanks to the wonders of cartels and not so free markets, we have seen the price of our favourite commodities – oil and natural gas, drop to precipitous levels that have not been seen since at least 2009 for oil and 2012 for gas.

It begs the question – are we done? Can it really be over? Is it time to pack up Calgary and just admit defeat? Will OPEC suddenly produce all the oil we will ever need? Are pipelines done?

The answer of course is no.

But it is worthwhile nonetheless to take a look at some of what has happened over the last week and see if it is possible to parse through the noise, because there is a LOT of it!

OPEC – Cap? What Cap?

In their semi-annual meeting last week, everyone’s favourite cartel elected to remove their “cap” on production, effectively acknowledging that they had been over the cap through a combination of member cheating and not giving a toss about a cap for pretty much the last two years. In reality, OPEC has very little control over member production so in many ways, the cap is more of a friendly suggestion than a real target.

The meeting has been variously described as acrimonious, confrontational and volatile and stretched to some seven hours as opposed to the usual four, meaning that most of the OPEC representatives would have missed their lunch reservations at Walter Bauer (look it up).

This of course prompted the usual proclamations that the age of OPEC is over, their influence done, the door is wide open for out of control production and that the position of the U.S. is effectively cemented as the swing producer for global oil.

Forgive me for calling BS on this.

Last time I checked, OPEC had some 31.5 million barrels a day of production, controlled by National Oil Companies owned by mostly autocratic (and for good measure, corrupt!) governments.

The U.S. in the meantime produces about 9 million barrels a day of oil, about 4 million (+/-) of which is from tight oil, the balance from mature fields and offshore. So this extra 4 million barrels of tight oil is produced by hundreds of independently owned oil and gas exploration and production companies each operating in their own economic self-interests with nothing even remotely approaching a coherent industry organization, let alone a cartel. The reality is that the tight oil players exist to produce as much as they can as cheaply as they can to make profits for their shareholders. They are price-takers pure and simple. When the price is high, they drill, when it falls, they slash costs and cut back. They are answerable to no one except their bank and their shareholders.

OPEC singular national producers on the other hand, act in the economic self-interests of their governments and states. Their national incomes and budgets rely disproportionately on oil revenues. It is impossible to separate the interests of the largest players in OPEC from the interests of their governments.

The largest member by far is Saudi Arabia, which has the largest economically accessible reserves, the largest spare capacity, arguably the most stable government and thus the highest ability to set or control prices through concerted action whether it is expanding or restraining production.

It is fairly clear who the swing producer is in this environment.

So what is happening at OPEC?

There have been lots of opinions thrown around, but one that I think deserves some consideration is the following.

OPEC nations have been producing at or near capacity for quite a while. Saudi Arabia knows this. Singapore recently rejoined the crew, and Iran will come to the table in the new year with their new capacity and will demand a fair share of the quota.

But the reality is that no one really knows what that “capacity” actually is. Can Iran really bring 500,000 barrels a day of production on stream immediately, growing to 1 million in short order? Will Venezuela and Nigeria ever stop cheating, let alone report their actual numbers?

But when all the dust settles, assuming everyone is producing all they can (which they are), a thought emerges.

If you assume Iran adds 750,000 barrels, and Singapore adds 900,000, that’s a big difference from the previous cap of 30 million, which clearly wasn’t going to be agreed to with these new influences. If you set the cap now higher at 31.5 million barrels, you just set the stage for more cheating, uncertainty and more market angst as these other countries add to the mix.

But, if you take the cap away altogether and let each country legitimately maximize production without a cap, you quickly establish what the upper bound of each parties’ productive capacity is and you can then re-allocate pro-rata quota based on actual full-pin production. Then, in June, when you meet again, assuming the oil market is still mired in the muck, you have a platform on which to establish a sensible and enforceable quota reduction.

The added benefit?

Another six months of soul-crushing low prices for Canada, the Unites States, Russia and the rest of the non-OPEC world. And a major win for the Saudis, precisely because now in addition to calling out the non-OPEC rivals, they have been able to flush out their in-cartel competition and cement themselves firmly in the driver’s seat as the, wait for it, actual SWING PRODUCER!

COP21

In other news the nations of the world and their Canadian cheerleaders have come to some form of agreement (yet to be released) regarding climate change and emissions that to my uninitiated eyes seems to rely on public shaming to achieve results (except in Alberta). Good luck with that I say.

I close with a quote from John Kerry, delivered in a speech to the COP21.

“… The fact is that even if every American citizen biked to work, carpooled to school, used only solar panels to power their homes, if we each planted a dozen trees, if we somehow eliminated all of our domestic greenhouse gas emissions, guess what – that still wouldn’t be enough to offset the carbon pollution coming from the rest of the world.

If all the industrial nations went down to zero emissions –- remember what I just said, all the industrial emissions went down to zero emissions -– it wouldn’t be enough, not when more than 65% of the world’s carbon pollution comes from the developing world.”

Um, what? I realize this is cherry-picking from what must have been a truly inspiring speech about the need for us all to make major sacrifices on the altar of climate change, but isn’t he also saying that it doesn’t actually make a difference?

Prices as at December 11, 2015 (December 4, 2015)

• The price of oil ended the week marginally up, after a strong midweek rally.
  • Storage posted a surpirse decrease
  • Production was down marginally
  • Markets are selling the storage story
  • The rig count decreased
  • OPEC
• Natural gas lost ground during the week as production declines continue to be offset by warm weather.

• WTI Crude: $35.58 ($40.08)
• Nymex Gas: $1.983 ($2.179) (Free!)
• US/Canadian Dollar: $0.7278 ($ 0.7479)

Highlights

• As at December 4, 2015, US crude oil supplies were at 485.9 million barrels, a decrease of 3.5 million barrels from the previous week and 105.1 million barrels ahead of last year. Another large increase in imports contributed to the inventory build.
• The number of days oil supply in storage was 29.5, ahead of last year’s 23.5.
• Production was down to 9.164 million barrels per day. Production last year at the same time was 9,071 million barrels per day. Based on the numbers, it is likely that by end of December year over year production growth in the U.S. will be negative. The marginal increase in production this week came from lower 48.
• As at December 4, 2015, US natural gas in storage was 3,880 billion cubic feet (Bcf), which is 6% above the 5-year average and about 15% higher than last year’s level, following an implied net withdrawal of 76 Bcf during the report week.
• Overall U.S. natural gas consumption decreased by 1.1% for the period led by residential consumption
• Oil rig count at December 11 was down to 524 from 545 the week prior.
• Natural gas rigs drilling in the United States were up to 185 from 192.
• As of December 7, the Canadian rig count was at 177 (23% utilization), 112 Alberta (21%), 29 BC (36%), 33 Saskatchewan (26%), 3 Manitoba (17%)). Utilization for the same week last year was 49%.
• US split of Oil vs Gas rigs is 74%/26%, in Canada the split is 42%/58%

Drillbits

• Alberta’s NDP government delayed the release of its Royalty Review until the new year, after a bruising few months of policy missteps. The oilpatch reaction amounted to a head shake and “whatever”
• Select capital budget updates
  • Cenovus – $1.4 to $1.6 billion, a decline of 19% from 2015
  • Conoco Philips – $7.7 billion, down 25% from 2015 in order to protect its dividend
  • Baytex – $325 to $400 million, 80% allocated to Eagle Ford, balance to Canada
  • Chevron – $26.6 billion, 24% lower than 2015
  • Gibson’s – $200 to $300 million
  • Husky – $2.9 to $3.1 billion
• The new year should see the disappearance of many billions of barrels of reserves as SEC accounting rules come into play with the new price average. Last year reserves were estimated at an average price of $95 per barrel, this year, that number if $51. Writedowns are expected to be extensive – in the range of 30% to 40%.
• Rystad Energy, a consultant, estimates that capex cuts globally will be in the range of $70 billion in 2016 after reaching $250 billion in 2015, the first back to back declines in global capex in decades
• Drumpf Watch – OK, this is devolving into theatre of the absurd. After a weekend statement that he would ban Muslims from entering the U.S., the presumptive frontrunner has been annihilated in the press and by responsible governments worldwide, his competition in the Replublican race, the Pentagon, the US government, business leaders and pretty much any person on the street. Yet his poll numbers are stubborn. It is frustrasting. Why won’t they fall?