US Rig Count Decline Augurs $20 bbl WTI Crude Oil

Posted by: : Paul EbelingPosted on: February 18, 2015 US Rig Count Decline Augurs $20 bbl WTI Crude Oil

US Rig Count Decline Augurs $20 bbl WTI Crude Oil


At 50 bbl, US Crude Oil prices are down by more than 50% from their June 2014 high at 107. They may fall more, maybe as low as 20 bbl.

The Big Q: Why?

The Big A: US economic growth has averaged 2.3% a year since the recovery started in mid-2009. That’s about 50% the rate you might expect in a rebound from the deepest recession since the 1930s.

Also, growth in China is slowing, growth in the EU is minimal, and is negative in Japan. Now, add in the large increase in US vehicle gas mileage and other conservation measures and it becomes very clear why global Crude Oil demand is weak and may fall farther.

At the same time, Crude Oil output is climbing, thanks in large part to increased US production from hydraulic fracking and horizontal drilling. US output rose by 15% in the 12 months through November 2014 from a year earlier, based on the latest data, while imports declined 4%.

And like all cartels, the Organization of Petroleum Exporting Countries (OPEC) is designed to ensure stable and above- market Crude prices. But those high prices encourage cheating, as cartel members exceed their quotas. For the cartel to function, its leader, Saudi Arabia must accommodate the cheaters by cutting its own output to keep prices from falling. But the Saudis have seen their past cutbacks result in market-share losses.

So the Saudis, backed by other Persian Gulf Crude Oil producers with sizable financial resources, UAE, Kuwait, Qatar embarked on a head on assult with the cheaters. On 27 November, OPEC said that it would not cut output, sending global Crude Oil prices to a deep dive.

The Saudis figure they can withstand low prices for longer than their financially weaker competitors, who will have to cut production 1st as lifting becomes uneconomical.

Another Big Q: What is the price at which major producers chicken out and slash output?

The Big A: Whatever that price is, it is much lower than the 125 bbl Venezuela needs to support its mismanaged economy. The same goes for Ecuador, Algeria, Nigeria, Iraq, Iran and Angola.

Saudi Arabia has $726-B in foreign currency reserves and is betting it can survive for 2 yrs + with prices of less than $40 bbl.

The price when producers fade to black  is not necessarily the average cost of production, which for 80% of new US shale Oil production this year will be 50 to 69 bbl, according to the data. Instead, the fade to black point is the marginal cost of production, or the additional costs after the wells are drilled and the pipes are laid.

Think of it this way, the price at which cash flow for an additional barrel falls to Zero.

Last month, Wood Mackenzie, an energy research organization, found that of 2,222 oil fields surveyed worldwide, only 1.6% would have negative cash flow at 40 bbl. That suggests there will not be a lot of capping at 40 bbl. Keep in mind that the marginal cost for efficient US shale Oil producers is about 10 to 20 bbl in the Permian Basin (Texas) and less for Oil produced in the Persian Gulf.

Also consider the conundrum financially troubled countries such as Russia and Venezuela find themselves in, as they need the revenue from Crude Oil exports like O2 to service foreign debts and fund imports.

And, the lower the price, the more Crude Oil they need to produce and export to earn the same number of USDs, the Buck is used to price and trade Crude Oil.

With new discoveries, stability in parts of the Middle East and increasing drilling efficiency, global Crude Oil output will no doubt rise in the next several years, adding to pressure on prices.

US Crude Oil production is forecast to rise by 300,000 BPD during the next year from 9.1-M now.

The drilling rig count is falling, but it is the inefficient rigs that are being idled, not the horizontal rigs that are the backbone of the fracking industry. Consider also Iraq’s recent deal with the Kurds, meaning that another 550,000 BPD will enter the market.

While supply grows, demand weakens.

OPEC forecasts demand for its Crude Oil at a 14-yr low of 28.2-M BPD in Y 2017, 600,000 BPD less than its forecast a year ago and down from current output of 30.7-M BPD. It also cut its Y 2015 demand forecast to a 12-yr low of 29.12-M BPD.

The International Energy Agency (IEA) reduced its Y 2015 global demand forecast for the f4th time in 12 months by 230,000 BPD to 93.3 -M BPD and sees supply exceeding demand this year by 400,000 BPD.

Although the 40% decline in US gasoline prices since April 2014 has led consumers to buy more high powered SUVs and pick-up trucks, consumers during the past few years have bought the most efficient blend of cars and trucks ever.

At the same time, slowing growth in China and the shift away from energy-intensive manufactured exports and infrastructure to consumer services is depressing Oil demand. China accounted for 67% of the growth in demand for Crude Oil in the past 10 yrs.

That being the case Shayne and I look for deeper declines in Crude Oil and related energy prices.

HeffX-LTN Analysis for OIL: Overall Short Intermediate Long
Neutral (-0.11) Bullish (0.28) Neutral (-0.06) Very Bearish (-0.54)
HeffX-LTN Analysis for USO:  Overall Short Intermediate Long
Neutral (-0.00) Bullish (0.26) Neutral (0.02) Bearish (-0.29)
HefX-LTN Analysis for UGA: Overall Short Intermediate Long
Neutral (-0.06) Bullish (0.37) Neutral (-0.19) Bearish (-0.38)

Stay tuned…


Paul Ebeling

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Paul Ebeling

Pattern Recognition Analyst, equities, commodities, forex
Paul Ebeling is best known for his work as writer and publisher of “The Red Roadmaster’s Technical Report” on the US Major Market Indices™, a highly-regarded, weekly financial market letter, where he enjoys an international audience among opinion makers, business leaders, and respected organizations. Something of a pioneer in online stock market and commodities discussion and analysis, Ebeling has been online since 1994. He has studied and worked in the global financial and stock markets since 1984.

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