Prior to the Iran-Iraq War, OPEC oil production peaked in July 1979 at 30.5 mbpd. (Bear in mind it is only 35.3 mbpd today.) Oil production started falling precipitously from January 1980, and by August of that year -- a month before the start of the Iran-Iraq War -- was already down 5 mbpd. Of this, the lion's share came from Iran and Kuwait. With the start of the war in late September 1980, oil production fell another 1.3 mbpd and another 1.5 mbpd the following month. By the end of October 1980, OPEC oil production had fallen almost 9 mbpd below in July 1979 peak.
To this point, the Saudis had not changed production materially, either up or down. The Saudis did, however, increase production by 600 kbpd from Oct. 1980 to August 1981.
In September '81, however, the Saudis cut production by 900 kbpd to prevent oil prices from falling below $30. These cuts accelerated, such that 18 months later the Saudis were producing an astounding 6.9 mbpd below their Nov. '80 level of 10.4 mbpd. At this time, OPEC production was almost 17 mbpd below its July 1979 peak. It is almost incredible to write this today.
The Saudis eased these cuts through 1984, but then resumed a restrictive policy, with production falling 7.5 mbpd below the 1979 peak in September 1985. This held oil prices around $24 / barrel, but was clearly unsustainable. Over the next several months, the Saudis would ease the cuts. A year later, oil prices had fallen by 60% and the Great Moderation was underway.
The Saudis did not participate in the oil price spike which occurred in the Aug. 1979 - Aug. 1981 period, the first of those two recessions during the period.
However, the Saudis were the principal drivers of high oil prices from Sept. 1981 through year-end 1985, after which the oil price cratered.
Oil rigs in total were up sharply, +12 to 886
Horizontal oil rigs gained more modestly, +3 at 778
Lots of movement this week
Permian saw +3 horizontal oil rigs, but the total was essentially unchanged in nearly three months
Cana Woodford was crushed, -9, bringing the count there to the lowest level since March
‘Other US’ has not only held earlier gains, but added an additional 9 rigs this week, reaching its highest count for the cycle. Has someone learned new tricks in the minor plays?
Vertical rigs saw a big jump, +6 to 64, the highest level in over a year. Vertical rigs are sometimes used to drill the top portion of horizontal wells, and thus may represent a precursor to subsequent horizontal oil rig activity
The model forecasts just this, notable horizontal oil rig gains in the next three weeks or so (followed by a crash heading into 2019)
Frac spreads rose by 5 to 474, about 9 below their normalized level, suggesting spread counts may continue to rise
Oil rigs were up marginally this week, +2 to 875
Horizontal oil rigs gained, +1 at 773
The 4 wma change for horizontal oil rigs fell to +1.25 / week
Frac spreads rose 2 to 472
In another two weeks or so, frac spreads should have returned to their normalized ratio with horizontal oil rigs, that is, frac spreads should continue to increase by 2-4 / week, with horizontal oil rigs gaining 0-2 / week through mid-November.
Overall, the underlying takeaway is unchanged: Under $70 / barrel WTI, the US horizontal oil rig count is unlikely to materially increase
Therefore, if shales under-perform – as the EIA weekly data (below) suggest is possible – oil prices will have to seek a higher level, say $80+ / barrel WTI by mid-year 2019, to revive rig additions and stimulate production growth.
Oil rigs declined, -3 to 863
Horizontal oil rigs rose, +2 to 769
The 4 wma change for horizontal oil rigs rose to +0.75 / week
Horizontal oil rig gains look better than the underlying reality because the Cana Woodford recovered from last week, +7 after -6 last week. Thus, the underlying trend is probably marginally negative.
The breakeven oil price to add horizontal oil rigs remains $70 WTI, allowing for the one-off nature of Cana Woodford gains
Frac spreads recovered strongly this week, +10 to 464. The spread ratio is returning to more normal levels and at the current pace should recover completely in the next two weeks.
The Midland – WTI spread is closing rapidly, suggesting that bottlenecks are easing in the Permian. (Slide 7.)
We expect rig counts flat to down for the next few weeks with recovering frac spreads.
If the Midland – WTI spread closes as the futures curve suggests, Permian rig counts could start to rise again, perhaps from mid-to-late October.
Oil rigs declined, -1 to 866
Horizontal oil rigs fell, -3 to 766
The 4 wma change for horizontal oil rigs fell to 0.0 / week
Horizontal oil rigs have gone exactly nowhere in the last 14 weeks
The Permian added 3 rigs, the Cana Woodford was hammered with a loss of 6 rigs
The breakeven oil price to add horizontal oil rigs is now $70 WTI, about the same as WTI
The model suggests horizontal oil rig counts will decline again next week
Frac spreads once again saw a very strong recovery, up 9 to 454
While the frac spread ratio remains below normal, it is rebalancing, both by spread adds and rig reductions
Equities, still look cheap
NY Fed: 2.3% (+0.1%)
Atlanta Fed: 4.4% (+0.0%)
- Oil rigs declined, -2 to 860
- Horizontal oil rigs gained, +1 to 766
- The 4 wma change for horizontal oil rigs fell to -1.0 / week
- Horizontal oil rigs have gone exactly nowhere in the last 12 weeks
- Frac spreads finally saw some life, up 9.
- The frac spread ratio is still very low at 57.3%, versus an normal value around 61.7%. This implies further build in DUCs and potentially more downward pressure on oil rig counts.
- The breakeven oil price to add horizontal oil rigs continues to creep up, now around $74 WTI. This is a good bit higher than the current price around $67.
- Equities, now suffering from Permian bottlenecks, look cheap.
- This week marks a psychological turning point in the oil cycle
- Total oil rigs rose, +2 to 862
- But horizontal oil rigs declined, -1 to 765
- The 4 wma change for horizontal oil rigs rose to +2.25 / week due to technical factors. Next week will likely see a decline on a 4 wma basis.
- Horizontal oil rigs have gone exactly nowhere in the last 11 weeks at WTI averaging above $68 / barrel.
- Under $68 WTI, the horizontal oil rig count is unlikely to rise further (although oil production will continue to increase at current rig numbers).
- This week again saw a material pullback in frac spread counts, -7 to 433. Since June 15th, frac spreads have fallen by 47 (-10%). This appears to be linked principally to transportation bottlenecks in the Permian. Operators are struggling to get the oil to market and are therefore reducing well completion activity.
- Aligning rig to frac spread counts would require a reduction in the horizontal oil rig count by 65 to 700. While such a steep fall does not look likely at this point, it seems quite likely that the rig count will roll off, and perhaps materially.
- Investors are beginning to appreciate that reviving rig count growth will involve moving to the next level of oil prices, and the back end of the futures curve is swinging up accordingly.
- It is not yet the beginning of the end, but to appearances, shales have reached the end of the beginning.
Bethany McLean, writing in The New York Times this morning (The Next Financial Crisis Lurks Underground), took a grim view of shale's prospects.
Some of fracking’s biggest skeptics are on Wall Street. They argue that the industry’s financial foundation is unstable: Frackers haven’t proven that they can make money.
Fracking is such a fragile industry that it is not hard to make it go bust. Saudi Arabia almost succeeded in doing so in 2014.It’s all a bit reminiscent of the dot-com bubble of the late 1990s, when internet companies were valued on the number of eyeballs they attracted, not on the profits they were likely to make. As long as investors were willing to believe that profits were coming, it all worked — until it didn’t.
These days, the rhetoric of “energy independence,” meaning an America that no longer depends on anyone else for its oil, not even Saudi Arabia or OPEC, is in perfect harmony with “Make America Great Again.” But rhetoric doesn’t produce profits, and most things that are economically unsustainable, from money-losing dot-coms to subprime mortgages, eventually come to a bitter end.
Legendary oil fund manager Andy Hall was unimpressed. In an email this morning, he notes:
I think this article is light weight. It focuses on Chesapeake Energy which is the AOL of frackers (if we want to stick with the author’s dotcom analogy) and ignores companies like EOG and, perhaps even more importantly, Exxon and Chevron, who certainly are not going to run out of cash. While aggregate free cash flow in the industry has been poor, that is true of many other transformative businesses (commercial aviation, Amazon) which not only survived but thrived. With land acquisition costs behind them and a growing inventory of producing wells, the industry’s cash flow profile is inexorably improving. Finally, the heavy reliance on quotations from Chanos and Einhorn and breathy talk of high well decline rates does not suggest an original, profound or independent analysis. The writer is an editor for Vanity Fair...
Let me add a few points:
McLean is confusing free cash flow with profits. These are not the same. Companies growing production quickly will often be free cash flow negative, because they are using cash from operations and debt to maintain the pace of expansion. By contrast, accounting profits, which match current period revenues to current period expenses, are actually quite good for some operators. For example, we estimate underlying after-tax net income / sales at 14% for Pioneer Resources, after adjusting for one-time gains and costs. Pioneer's underlying breakeven continues to fall, now $51.50 / barrel realized price. If we include discounts resulting from Permian pipeline constraints, the company's net breakeven rises to around $58 WTI. Still, nothing wrong with that when WTI is just about $70.
Oil prices are set by US shales. Since 2005, US shales have contributed 63% of total global supply growth. By contrast, OPEC has added 20% of total supply, barely enough to cover losses from countries whose production has been declining. Shales are not the tail, they are the dog. Put another way, if shales were producing less, oil prices would be higher. If they were not producing much at all, then oil prices would be well over $100 / barrel, as was the case before the shale revolution.
At any given time, shale companies may or may not be a good equity investment, depending on how hyped the shares are at the moment. Nevertheless, the economic reality is this: The global economy cannot continue to expand at a normal pace without a commensurate increase in the oil supply. Right now and for the foreseeable future, that means shales. Shales are not a nice-to-have, a pets.com, or a fad. They are the lifeblood of the global economy and absolutely essential to the world's prosperity.
- This report was neutral to mildly bearish in its fundamentals. The market took the opposite view again, with WTI up nearly $2 / barrel
- Total inventories, in absolute terms, fell 0.4 mbpd.
- However, compared to long term averages, total excess inventories rose a stiff 7.7 mbpd
- By turnover days, excess crude inventories declined again, to 1.9 days above long-term averages.
- Excess crude and key products (CGD) rose a hefty 5.3 mb to 58 mb by turnover days
- Refinery runs were just off last week’s all-time record
- Net crude imports returned to more typical ranges, even as the Brent spread has expanded to near $7 / barrel
- Net product exports were range-bound
- Product supplied hit a record for this week of the year at 21.5 mbpd; gasoline demand continues to languish
- US production was up 1.5 mbpd yoy, 1.4 mbpd / year on a 3 mma basis
- The single weakness in this report was the large rise in product inventories, whether measured by long-term averages or normalized turnover days. Notwithstanding, refineries continue to run very hard, suggesting optimism about either domestic or export demand, or perhaps reflecting precautionary inventory in the event of a hurricane strike as we saw last year. A wide Brent spread suggests net crude imports will be low.
Over at Econbrowser, Harvard economics Professor Jeffrey Frankel argues that real interest rates are inversely correlated with oil prices.
Our analysis suggests this is true, but the correlation is weak, with an R-squared only around 0.08. Changes in real interest rates don't tell us much about the direction of oil prices.
What's more, nominal oil prices are positively correlated with nominal interest rates, but again, very weakly.
For this reason, traders will usually key not on interest rates, but on exchange rate movements, which transmit directly into oil prices virtually real time. Interest rates are, of course, a key determinant of short term exchange rate movements, but their impact on oil trading is more indirect via exchange rates.
- Oil rigs let off again this week
- Total oil rigs fell, -9 to 860
- Horizontal oil rigs declined, -2 to 766
- The 4 wma change for horizontal oil rigs came in at +1.0 / week
- Frac spreads came in very low, at a ratio to rig counts the lowest since early 2017.
- Frac spreads and visual inspection of rig trends suggests that rigs continue to roll off from here for the next several weeks.
- Q3 GDP
- NY Fed: 2.0% (-0.4%)
- Atlanta Fed: 4.5% (+0.2%)
- Oil rigs took a breather, consolidating last week’s gains
- Total rigs were flat at 869
- Horizontal oil rigs declined, -2 to 768
- The 4 wma change for horizontal oil rigs came in at +1.5 / week on the back of last week’s strong numbers
- Horizontal oil rig counts stand at the level of ten weeks ago in both the Permian and other plays
- Frac spreads declined by 6 to 444, compared to a 2 horizontal oil rig decline. Unlike rigs last week, however, the frac spread count has been declining steadily for two months
- At 58%, the frac spread ratio is the lowest since January 2017, suggesting that we may see rig counts start to roll off once again
- This month’s DPR shows US shale oil production was up 150 kbpd in July to 7.2 mbpd.
- Year on year growth in the Permian came in a 0.92 mbpd – almost one million barrels per day of annual growth from just one play!
- Total year on year production growth reached 1.6 mbpd
- On a more recent basis, 3 mma production growth, annualized, is coming in at 1.3 mbpd
- Q3 GDP
- NY Fed: 2.4% (-0.2%)
- Atlanta Fed: 4.3% (+0.0%)
- This report was bullish in its fundamentals. Like last week, the market hated it.
- Total inventories, in absolute terms, rose 2.5 mbpd, the biggest weekly gain in our series.
- However, by turnover days, excess crude inventories declined to 2.1 days above long-term averages, with a clear peak showing, as we anticipated.
- Excess crude and key products (CGD) rose 3 mb to 53 mb by turnover days, moderately bearish
- Refinery runs set a new all-time record just below 18 mbpd.
- Net crude imports were very high, probably due to timing of off-loadings. Note, however, that despite net crude imports running more than 1 mbpd over recent averages, excess crude inventories by days declined. This is very bullish, as it suggests US refiners anticipate strong refined product demand, either domestically or via exports, even as their crude inventories are running quite tight. With the Brent spread moving up to $6 / barrel, this is markedly bullish.
- Crude exports were notably soft. Next week should be better.
- Net product exports were strong, but not unprecedented.
- Product supplied was weak and gasoline supplied was very weak. More and more, the data suggest that the US consumer has hit a tolerance limit around $65 / barrel WTI.
- US production was up 1.4 mbpd yoy, 1.1 mbpd / year on a 3 mma basis
- This report does not underpin oil price weakness visible in the last ten days or so. Such weakness is more likely related to global demand, as Trump administration tariffs may be precipitating an economic crisis in the emerging economies. More in the body of the report.
- A shockingly bad week for rig counts, notwithstanding that is was expected
- Total oil rigs fell, -2 to 859
- Horizontal oil rigs collapsed, -6 to 756
- The 4 wma change for horizontal oil rigs came in at -3.75 / week, the worst performance since last November. The model says this number continues to deteriorate, with declines through Labor Day.
- The Cana Woodford was pounded, down 3. Horizontal rigs were not much changed by play otherwise.
- The number of frac spreads fell by 5, now 25 (-5.3%) below their June peak. Problems in the shale patch extend to fracking, and not just drilling.
- The apparent breakeven to add horizontal oil rigs came in around $75 / barrel WTI (front month, 4 wma basis)
- Vertical oil rigs are at their highest level since last November – is that a precursor to rising horizontal rigs a few weeks later?
- There is a discrepancy between Baker Hughes and Drilling Info in terms of horizontal rig count trends.
- Last week, we said the Williston Fund (ICPAX), which we track as a metric of equities to oil prices, looked undervalued. It is up 3% since then. We expect oil-related equities to run hard until the next sell-off in the market, probably in late October.
- Q3 GDP – Another hot quarter coming up?
- NY Fed: 2.6%; Atlanta Fed: 4.4%
- A clear local peak in oil rig counts
- Total oil rigs rose, +3 to 861
- Horizontal oil rigs were flat at 762
- The 4 wma change for horizontal oil rigs came in at -0.75 / week. Expect this number to deteriorate next week.
- Horizontal oil rigs are showing a clear local peak, similar to last July. By the time the count bottomed in November, horizontal oil rigs had fallen by 32. The difference is that oil prices were $20 / barrel lower then.
- Our model sees falling horizontal oil rig counts through Labor Day.
- Frac spreads have also peaked and are looking weak relative to rig counts.
- Animal spirits are flagging, even if production growth remains strong.
- Q2 GDP
- The BEA advance estimate for Q2 GDP came in at 4.1%
- NY Fed: 2.8% (+0.1% from last week)
- Atlanta Fed: 3.8% (-0.7% from last week)
- Overall, the Atlanta Fed seems to be the superior approach, but neither method is entirely satisfying
- This report was a bit to the bearish side, but nothing serious.
- By turnover days, excess crude inventories rose to 2.1 days turnover above long-term averages, but with the pace of increase slowing
- Excess crude and key products (CGD) rose 2.5 mb to 47 mb by turnover days
- Net crude imports fell to the third lowest level in the last twenty years on exceptional exports
- Refinery runs again came in at last year’s level, strong but not record-breaking
- Total product supplied and gasoline demand both posted solid weeks despite elevated pump prices
- WTI has moved up a bit from last week, and backwardation remains acute for the next month.
- However, backwardation overall has softened, but interestingly from a rise at the back end. That is, the market believes that breakeven production costs will be higher in the out years than earlier thought.
- Brent and WTI continue to go their own ways, with WTI in steep short-term backwardation, and Brent in soft contango through January.
- This EIA report gives little support to the notion that the Brent interpretation of the market is right in aggregate. None of LOOP futures, net crude imports or product exports speak to anything but a robust US market sending impressive volumes into the global marketplace.
- And as a random tidbit: June L48 production is 1.25 mbpd higher than the EIA forecast for the period a year ago. And yet Brent oil prices are $18 / barrel higher than the EIA forecast at that time. Forecasting is hard to do, especially about the future.
- A brutal week for rig counts
- Total oil rigs fell, -5 to 858
- Horizontal oil rig counts came in -7 to 762
- The 4 wma change for horizontal oil rigs fell to -0.7 / week
- ‘Other US’ was hard hit, down 7; not much movement otherwise
- A year ago, operators were adding rigs at $50 WTI; now they are withdrawing rigs at $70 WTI.
- All this begs the underlying economics of shale production after 500 horizontal oil rigs have been added in this cycle.
- Q2 GDP
- NY Fed: 2.7% (-0.1% from last week)
- Atlanta Fed: 4.5% (+0.7% from last week)
- Horizontal oil rig counts fell again this week, -2 to 769
- Total oil rigs were flat at 863
- The 4 wma for horizontal oil rig adds fell to +1.0 / week
- The breakeven to add rigs appears to have risen to $65 / barrel WTI, with an outright decline in rigs counts expected from August given recent oil prices.
- The July Drilling Productivity Report (DPR) continues to show excellent production gains from the major plays, with yoy growth at 1.6 mbpd, of which 0.9 mbpd (68%) comes from the Permian alone.
- Compared to May, the DPR sees June shale oil production up 124 kbpd, 68 kbpd (55%) of this from the Permian
- In short, the data suggest excellent production growth, but reluctance by operators to commit additional rigs, even at ostensibly favorable oil prices.
- Q2 GDP
- NY Fed: 2.8% (+0.0% from last week)
- Atlanta Fed: 4.5% (+0.7% from last week)
- Rig counts recovered after last week’s lousy numbers
- Total oil rigs are up, +5 to 863
- Horizontal oil rigs rebounded, +6 to 771
- The 4 wma for horizontal oil rig adds rose slightly to +2.0 / week, but the general pace of rig additions still seems downward
- The big movers this week were the Cana Woodford, -6; and Other US, +7. Expect some reversal of these numbers next week.
- Q2 GDP
- NY Fed: 2.8% (+0.0% from last week)
- Atlanta Fed: 3.8% (+0.0% from last week)