On the tail end of the last few weeks’ relief rally in the price of oil, it sure feels like some of the panic and urgency is out of the market, at least from the perspective of investing as companies use the respite from bad news to continue to tap the equity markets for capital to shore up their balance sheets (close to $13 billion in North America).

 

A key question is how sustainable this rally is given some of the forecasts. I suppose a lot depends on continued happy words from Russia and Saudi Arabia about the production freeze and the results of the end of March meeting of the large producing countries who have proposed or signed on to the freeze, but with each passing week, the reductions in capex grab tighter hold and the confluence of events needing to happen to reduce oversupply gets closer so this rally appears to be stickier than others. Will volatility return and prices drop again? Absolutely, I wouldn’t be surprised at all to see sub $30 before the year is out, but perhaps not as drastically or for as long.

 

Notwithstanding the price recovery, in the upstream operational (or real world), the headwinds and pain continue to be felt, as activity levels fall, capex is cut across the board and rig counts decline.

 

So a glass half full in the pricing world but half empty in the upstream world.

 

Some of the things that support the half empty thesis:

In Canada, the rig count is at generational lows and although the comparison from earlier periods to now is a little more difficult given the mix of oil v gas rigs and what was once all vertical to what is now all horizontal, the reality is the psychological effect of such low numbers is pretty significant.

 

In the United States, the rig count for oil is entering historic lows, with the current count being the lowest since Baker Hughes started tracking it. Again the vertical vs horizontal comparability of data is relevant, but given that the peak of the rig count came during the tight oil boom, the severity of the downturn is remarkable.

 

Capex in the upstream energy space in Canada is projected to decline in 2016 by another 40-50%, on top of 2015’s declines. This from a high of $80 billion down to about $30 billion in the low price scenario.

 

Capex upstream US is expected to decline by a similar, or even greater, percentage amount.

 

What this means is that companies are being forced to maintain production out of cash flow and there will be limited investment in production growth at least until prices recover somewhat and budgets get set at the tail end of Q3 2016.

 

Politically, no one in Canada can seem to get out of their own way or stay out of trouble when it comes to energy infrastructure projects, whether it is Energy East grandstanding, LNG fumbling, hydro projects with no customers, concrete plants with no environmental reviews – the list is astounding and ever-growing.

 

Unemployment is rising in Alberta and if Petronas follows through on an a rumoured threat to write off $12 billion in LNG prep work, you may as well turn off the lights in NE BC, because those rigs will be silenced.

 

Break-up is early this year due to an exceptionally warm winter which served to further dampen activity.

 

Auctions at Ritchie Bros for oilfield equipment are bigger, longer and more frequent.

 

Metal recycling companies are the busiest they have ever been.

 

But there is good news – maybe the glass is half full!

The rally in the price of oil indicates a light at the end of the tunnel and it came at the right time as the sentiment had definitely hit rock bottom.

 

Additional countries are buying into the “production freeze” and production is starting to get shut in around the world.

 

Iran’s mythical incremental production is proving to be elusive as expected, which may explain why they are declining to participate in the production freeze. So far only about 130,000 bpd have been added to Iranian output.

 

American tight oil production is coming off and the pace of declines is likely to accelerate.

 

Most of the projects in the Gulf of Mexico that have been holding production numbers up are now complete so there will be less additions to supply from them.

 

Refinery turnaround season is almost done and we are getting closer to the “driving season” when all those brand new gas guzzling SUV’s can hit the road and help work down the pervasive storage numbers.

 

Many of the worst case forecasts have been scenario tested at $30 average oil prices (worst case) and $40 average (best worst case?). With any luck we can surprise to the upside.

 

It now appears that the big brains around the world think the US will avoid a recession (where did that even come from?) and that global growth, while unspectacular, will be stable.

 

It’s a mess, but there is good amongst the bad. So, is the glass half full or half empty for the upstream oil and gas sector?

 

Arguably, neither. As any self-respecting engineer will tell you, the real answer is that the glass was too big to begin with.

 

The industry had over-built itself for high-pricing perfection in terms of equipment, manpower, pricing and wages and the current contraction is in many ways the tail end of one of the largest industrial resets in recent memory.

 

All of this excess capacity has to be dealt with somehow and the only way to do that is to park it, dispose of it or sell it. What we are witnessing is the hollowing out of the energy services sector and a measure of destruction that will take years to recover from. One can only hope that the pendulum doesn’t swing too far in the capacity reduction so we aren’t caught unawares in the other direction.

 

While many inefficient, over-levered or over-invested players may find themselves left by the wayside, the industry carries on. From a Canadian perspective, ironically Canada’s overall production is actually expected to grow marginally over the next years as oil sands projects come to fruition so this means that investment in replacing production is going to continue, especially given that the demand for fossil fuels is still growing and that Canada’s market share will, ironically, increase during the downturn.

 

In that context, the survivors are leaner, meaner and more efficient. And with the massive cuts in capex and the above referenced shelving of excess service company capacity, the industry feels way smaller, even if the actual output of that industry hasn’t gotten smaller.

 

So we find ourselves neither half full nor half empty, instead we have a smaller glass.

 

The question is, when the rally hits, as it will, how much will it overflow?

 

Guess Who’s Coming to Dinner

If you are Canadian and have been awake for the last 48 hours, you are by now aware that the over-hyped Trudeau visit to Washington and Thursday’s State Dinner is thankfully behind us (honestly, how many summits, conventions and boondoggles can a new PM handle!)

 

While there were awesome pictures, and some really important Canadians were in attendance at the State Dinner (Mike Myers, Ryan Reynolds… I am guessing Celine Dion, Neil Young and Nickelback were busy?), as is typical of these events, not too much of substance was done. It is ironic that Trudeau spent so much time courting a lame-duck president whose party may not even be in power for the majority of the Prime Ministerial mandate instead of a centred effort to meet the Congressional and Senatorial leadership from both sides of the aisle, but what do I know. Besides, with Obama he gets to do all those manly bro-hugs and nod-nod, wink-wink grey hair jokes.

 

One announcement of note was the commitment to reduce methane emissions from the oil and gas sector by 45% from 2012 levels which seems on the face of it very onerous, but when one considers the scale of the growth in US tight oil drilling and associated gas production and flaring in that period compared to Canada, young Justin may have inadvertently done the patch a small favour especially if the US sees fit to actually enforce any proposed rules!

 

Prices as at March 11, 2016 (March 4, 2016)

• The price of oil ended the week up
  • Storage was up, finished product inventories declined more than expected
  • Production was basically flat
  • Markets traded up on production freeze and US dollar declines.
  • The rig count decreased
  • The market is anticipating eventual OPEC action
• Natural gas rose during the week.

• WTI Crude: $38.47 ($35.85)
• Nymex Gas: $1.811 ($1.674)
• US/Canadian Dollar: $0.7557 ($ 0.7398)

 

Highlights

• As at March 4, 2016, US crude oil supplies were at 521.9 million barrels, an increase of 3.9 million barrels from the previous week and 73.0 million barrels ahead of last year.
  • The number of days oil supply in storage was 33.0, ahead of last year’s 29.4.
  • Production was up slightly for the week at 9.078 million barrels per day. Production last year at the same time was 9.314 million barrels per day. The marginal increase in production this week came from the Lower 48.
  • Imports continued at elevated levels during the week exacerbating the storage issue
• As at March 4, 2016, US natural gas in storage was 2,479 billion cubic feet (Bcf), which is 42% above the 5-year average and about 58% higher than last year’s level, following an implied net withdrawal of 57 Bcf during the report week.
• Overall U.S. natural gas consumption fell by 11.4% for the period led by residential and power consumption
• It is hoped that a warmer summer and low gas prices will increade demand for power generation and draw down inventories in the summer months.
• Oil rig count at March 11 was down to 386 from 392 the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States was down to 94 from 97.
  • Rig count at January 1, 2015 was 328
• The continuing massive decline in U.S. rig counts continues to be a somewhat overlooked story given all of the OPEC related noise
• As of March 7, the Canadian rig count was at 99 (15% utilization), 61 Alberta (13%), 26 BC (32%), 12 Saskatchewan (10%), 0 Manitoba (0%)). Utilization for the same period last year was about 40%.
• Offshore rig count was at 26
  • Offshore rig count at January 1, 2015 was 55
• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 29%/71%

 

Drillbits

• Final results for Q4 and full year 2015 numbers continue to trickle in.
  • Athabasca Oil reported cash flow of ($54) million for Q4 and ($68) for 2015 compared to ($9) and $18 million in the same periods last year. Net loss for the quarter and year was $604 million and $697 million respectively. Capex for 2016 is expected to be $91 million
  • Pennwest delivered funds from operations of $7 million for Q4 and $180 million for the year compared to $180 and $935 million in the same periods last year. Net loss for the quarter and year was $1,606 million and $2,646 million respectively.
  • Seven Generations reported funds from operations of $106 million for Q4 and $414 million for the year compared to $101 and $328 million in the same periods last year. Net loss for the quarter and year was $29 million and $187 million respectively. Capex for 2016 is expected to be $900 to $950 million.
  • Crescent Point reported funds from operations of $497 million for Q4 and $1,938 million for the year compared to $573 and $2,408 million in the same periods last year. Net income for the quarter and year was ($382) million and ($870) million respectively. Capex for 2016 is expected to be $950 million.
  • Anadarko annouced job cuts of up to 1000
  • TransCanada confirmed it is in discussions with US-based pipeline operator
• Australia’s giant Gorgon project is preparing to ship its firtst cargos of LNG. The $54 billion project can ship 2.1 Bcf per day and is one of the largest natural gas projects in the world.
• The rumour mill suggested that Petronas had set a March 31 deadline for the Trudeau governent to approve its LNG development. Subsequent news reports denied this. The leak did however underscore the sensitivity this project holds.
• Imperial Oil announced it was filing regulatory applications with the Alberta Energy Regulator to seek approval of a new in-situ oil-sands project on its Cold Lake lease area. The new project would produce 50.000 bpd of bitumen. Well played Imperial.
• Imperial also announed announced that sale of 497 Canadian service stations for $2.8 billion to a variety of service station operators.
• Drumpf Watch – Won a couple of primaries, lookedlike a buffoon in last night’s debate. During a rally this week a 70 year old supporter sucker punched a protester. Meh. I suppose this is how people become desensitized – an old guy punches a yourg guy, whatever… Except, the old guy was an “angry, immigrants go home, kick out the muslims white guy” and the protestor was African American. Does that change it? No? What of the old guy was a regulator and the protestor was a banker? Not yet? What of the old guy was Donald Drumpf and the protestor was your kid? Ah, now we’re there.