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"Drillers Are In Denial" Brynjolfsson Warns Crude Bounce Is "One More Head-Fake"

Via Armored Wolf's Jon Brynolfsson,

The last day of January saw a substantial rally in Crude. Ostensibly, the trigger for this was a notable drop in the Baker Hughes rig count.

I don’t buy it. I think Fridays 3% uptick in crude prices will be one more head-fake, a false breakout.

 

 

 

and as we noted earlier, rig count and production are quite different...

 

Keep in mind, oil drilling rigs and oil wells are not the same thing. Drilling rigs are used to increase the number of wells. So with 1243 drilling rigs in operation, and “rightward turning” (which means drilling downward), more wells are coming on line. The old wells will remain in operation, supply will continue to exceed demand (which economist will say is an impossibility, unless one excludes from demand, as I do, inventory builds represented by oil put into storage.)

To be fair, while the old wells will remain in operation, they will suffer from their decline curves, and the decline curves for shale oil wells are VERY steep (estimated to be between 60% and 70% per annum.) Also to be fair, low prices may engender increase demand, demand from vacationers, increased air travel (triggered by lower ticket prices), and perhaps some industrial cross over demand. Eventually, I guarantee it, supply will equal demand, and inventories will stop building.

However, analyst estimate that the reduction in US Energy Capex is insufficient to turn the supply picture around, it will merely DECREASE THE RATE OF GROWTH IN US PRODUCTION. Because globally, supply currently exceeds demand by 1 million barrels a day, and supply is increasing, inventories will continue to build. The supply demand realities, are clearly trumping the geopolitical tensions.

I expect global inventories to continue to build until at least June.

 

They’re already at record levels, most onshore tank farms are filled to capacity, and energy arbitrageurs are already leasing the limited fl eet of crude tankers to use as fl oating storage. Drillers seem to be in denial, they fail to acknowledge that as long as inventories are building toward untenable levels, there will be extreme pressure on spot crude prices.

To give you an idea of the magnitude of this denial, Capex in the energy industry has been $200 billion per annum in recent years, with 80% of that devoted to drilling and well completion. At this point, past investment is a sunk cost, and any new investment, including that represented by the Baker Hughes rig count, is putting good money after bad. Analysts are rapidly reducing their estimates of 2015 capex, from 15% last month, to murmurs of 50% reductions more recently. There is more wood to chop.

Global political tensions are high and will be rising as oil revenues in exporting countries collapse. Analysts speak of a “break even” price for oil across various nations including social costs. What they don’t seem to realize is that absent a universal suppliers’ cartel (which OPEC clearly is not, because its members are autonomous, and many of the largest producers, including Norway, Russia, and US are not even members), high social break even prices incentivize individual producers to pump more, not less, oil at low prices! Frankly, one need not apply any “game theory” or strategic analysis to oil price determination; the massive size, fragmentation, and liquidity of the oil markets makes it a perfect study in competitively determined equilibrium pricing.