By John Richardson
SURPRISED by the latest decline in crude prices following the US Energy Administration’s (EIA) report that more oil went in to storage last week than in any other week in 34 years?
You really shouldn’t be if you have taken note of another extraordinary data set from the EIA that shows the huge leaps in productivity achieved by the US shale-oil industry.
And whatever was really behind the preliminary decision by OPEC to cut production during the informal meeting in Algeria in September, all the signs immediately after the meeting were a.) The proposed cut wouldn’t be enough to result in a sustained rally of prices and b.) It would prove very hard to get a final agreement amongst all the members to make a final cut at all.
You could have therefore also foreseen a second reason why oil prices fell by 3% last week: More evidence that a final OPEC deal is proving very elusive:
- Having successfully raised $18bn in the bond market, Saudi Arabia is better positioned to withstand the loss of some revenue.
- Iraq, OPEC’s second-biggest producer, was the latest to plead for an exemption from a cut, citing its fight against Islamic State as a cause of hardship.
- Libya and Nigeria, two OPEC producers who have seen production curtailed by domestic conflicts, have together added 800,000 bbl/day of output a day since September. This figure exceeds the size of the planned OPEC cut.
As for Russia, which is of course in not in OPEC, its output has just hit a post-Soviet high. Goldman Sachs says that it believes Russian production will remain cash-flow positive at any prices above just $10/bbl. This explains why Russia continues to pump more and more oil, and why Goldman now expects Russian output to his 11.4m bbl/day in 2017. This was the number they hadn’t expected to be achieved until 2018.
OPEC and non-OPEC producers will in general want to pump as much oil as possible whilst they can, to avoid being forced to leave their most-valuable national assets in the ground for good. This is why I remain bearish on long-term oil prices. Producers everywhere will increasingly want to maximise production, and will do everything possible to further lower production costs, as they realise that we have gone beyond demand growth for crude because of economic and environmental reasons.
Back to here and now, though, and here is one of those ironies that you think will end all ironies, until another even-bigger irony comes along. This from the same Zero Hodge post which I’ve already linked to above:
A plunge in oil prices may be just what US shale producers are waiting for. The reason for that is that while OPEC has been busy desperately jawboning oil higher, US producers have been thinking of the inevitable next step, oil’s upcoming re-acquaintance with gravity. As a result, as the EIA reports, the amount of WTI short positions held by producers and merchants is just shy of a decade high.
According to a recent EIA report, short positions in West Texas Intermediate (WTI) crude oil futures contracts held by producers or merchants totalled more than 540,000 contracts as of October 11, 2016, the most since 2007.
The US industry is of course in pole position to understand exactly how much its production costs have fallen, and is thus set to make a lot of money from betting on its ability to innovate.
What happens next? Back to $30/bbl or below seems perfectly possible over the next few months, especially if there is an additional demand shock.
That shock could be delivered by the result of tomorrow’s US presidential election that spooks financial and commodity markets.
And/or there is China where a financial-sector crisis would have major implications for the global economy, as I discussed last week. The Global Financial Crisis was obviously led by US sub-prime. On this occasion, the next global crisis could well be led by China because of its alarming, renewed rise in debt.
Last week I discussed two dangerously complacent myths – China has enough foreign reserves and domestic household savings to avoid a major debt crisis.. Always start with the data. More and more data continues to emerge that should challenge this complacency. Take this, for example, from Charlene Chu of Autonomous Research, who is quoted as follows in this Barron’s article:
How much of the current $30 trillion in Chinese debt and other impaired financial assets in the financial system is non-productive, or yielding no net return?
Chu estimates that about 22% of this pile will be nonperforming by year end. And of this troubled paper, totalling $6.6 trillion, actual losses after recoveries are likely to weigh in at more than $4 trillion.
Chu, like all of us, doesn’t know whether the future holds a sudden global financial shock or long-term economic stagnation in China. In building your scenarios on crude-oil prices over the next six months, it is therefore important that you consider what follows:
- The government kicks the can down the road again and the real estate bubble continues, which provides further support to crude prices.
- We see a slight reduction in crude prices, chemicals prices and chemicals demand as the air is gradually taken out of the bubble.
- Crude prices, chemicals prices and chemicals demand collapse as a result of a financial-sector crisis in China.