This week is primarily about the demand side of the equation, coupled with some production concerns. Brexit continues to weigh on investors’ minds as concerns over a global economic slow down in the wake of the historic vote cause concerns over future demand. Additionally, the dollar has continued to strengthen against the British pound, thereby making oil more expensive to holders of other currencies.
Some supply volatility remains. Libya has announced a potential agreement to consolidate different operating entities into one, thereby raising the possibility of increased production from Libya. Supply outages from Nigeria and Canada are abating and production is ramping up. Couple these factors with an increased U.S. rig count, and markets are skittish.
However, I personally believe these factors are of limited importance over the long run. Brexit will work out. The EU has little real incentive to punish Britain for its decision, and every incentive to work with them. The deterrence factor of punishing them is by far outweighed by the EU’s incentive to continue free trade with Britain. Over time, cooler heads will likely prevail and an agreement will be reached. Moreover, markets tend to overreact to change. But that is the nature of the beast. Despite many economists prediction to the contrary, I believe we will look back and says “where’s the beef?”
Similarly, supply disruptions will continue in our unstable world. Increasing violence in the middle east (several attacks occurred within Saudia itself over the past week), remind us that we are one lunatic away from production loss somewhere. Whether a result of terrorism or worker strikes (as is currently possible in Norway), some portion of production will go down. The only question is where and when.
Overall, I think we will see a move towards a continuing balance despite an increasing rig count with substantial volatility along the way. US crude production averaged 8.933 MMBOPD in April, down 220 MBOPD from 9.155 MMBOPD in March (www.eia.gov/petroleum/production/). Total U.S. production is down 7.9% from April of last year, with the vast majority coming from onshore in the Lower 48. Despite the increasing efficiency of shale plays, this is consistent with frack wells quickly losing their ability to produce.
When you consider the production change, the likelihood of continued production decline from existing wells, and even a modicum of demand increase, I suspect we will see a continued convergence of supply and demand.
Couple these considerations with statements from key executives at Halliburton and Schlumberger that oil has or is close to bottoming, as well as comments from the Saudi oil minister basically declaring a cease fire on Saudi Arabia’s war against American shale (as discussed in another article in this weeks Five Star Standard), and I think we will, overtime, see increasing prices and increasing drilling. Its just going to be a wild ride getting there.