Is Oil’s New Normal A State Of Permanent Price Instability?

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Goldman Sachs says it won’t be `hoodwinked’ on commodities again as it recommends investors buy into this year’s comeback story in oil, despite last year’s spectacular collapse. Saudi Energy Minister Khalid al-Falih, meanwhile, does his best to drive the bullish charge in oil, vowing to cut hundreds of thousands of barrels per day in supply.

On the other hand, Bloomberg Intelligence Commodity Strategist Mike McGlone says U.S. West Texas Intermediate crude may find itself in a “$50-per-barrel cage” for an extended period, in spite of higher prices sought by bulls. JPMorgan also says that while output cuts by the OPEC+ producer club should help prices, heightened global macro risk anxiety posed by China and its slowing growth will limit any support from supply-side corrections.

Meanwhile, JBC Energy warns of another spike in U.S. output that could neuter the Saudi cuts, predicting that shale oil production could reach new record highs “significantly above 12 million bpd” this month.

The truth, according to New York-based Energy Intelligence, could be somewhere between all these.

Oil Companies Face An Unwelcome Reality In 2019

In a wide-ranging analysis on the vagaries of energy production, trading and consumption, the publisher of Petroleum Intelligence Weekly said multiple structural changes within oil have made it nearly impossible to forecast trends or prices with reliability. Energy Intelligence adds:

“After reeling from the sudden near-40 percent collapse in oil prices late last year, oil companies face an unwelcome reality moving into 2019.”

“Instead of predictable prices or slow, linear changes, firms face the prospect of ongoing gyrations in shorter, faster cycles—a reality that will force them to remain conservative in spending and treat each price recovery as a welcome, but likely temporary, relief.”

Is Oil's New Normal A State Of Permanent Price Instability?

WTI Weekly Chart

Calling the phenomenon “a new state of permanent instability,” the consultancy said crude prices seem caught in a wide $50-$80 per barrel range over a trading year. While multiple factors are behind these huge fluctuations, the primary blame appears to fall on U.S. shale, which has upended the industry’s ability to forecast supply and gauge investment needs.

Says Energy Intelligence:

“Shale routinely brings more oil to market than expected, has put a ceiling on oil prices and has made it exceptionally difficult for OPEC to act as a stabilizing force. But if the resource suddenly starts underperforming and the industry has not made sufficient investments in alternate supplies, prices could spike and saddle producers with the different challenge of trying to address supply shortfalls with resources that require longer investment horizons.”

International oil producers hoped last year that investor demands for capital discipline among U.S. oil companies would give them a respite from the onslaught of barrels that shale has continuously brought to market.

Will Shale Production Slow This Year?

But no such reprieve came, with U.S. oil output instead surging in the second half of the year, thus raising the question: is capital discipline an irrelevant cap on shale?

Adds Energy Intelligence:

“Although publicly-traded U.S. producers routinely shelled out big sums to buy back shares rather than plow every extra dollar into higher growth, many still allowed their budgets to creep up during the year, and used the run-up in oil prices in the back half of 2018 to cover the difference.

“The true test will come this year should U.S. oil prices remain close to their current $50 level. Truly aligning spending with cash flows culled at $50 oil would mean giving up aspirations of significant growth for most producers.”

It says, so far, oil exploration and production firms were talking the talk, with Diamondback Energy (NASDAQ:FANG), Parsley Energy (NYSE:PE) and Centennial Resource Development (NASDAQ:CDEV)—all big players in the flagship Permian shale basin—indicating they would slow activity this year.

But even if capital discipline sticks, it may not be as much of a limiting factor as some think, says Energy Intelligence, noting that some of 2019’s production growth was already paid for by operators in 2018.

Citing numbers from IHS Markit, another consultancy, Energy Intelligence says:

“Industry-wide, the number of drilled but uncompleted wells (DUCs) in the Permian has set new records month after month, with the cost to complete those wells expected to either remain flat or fall as competition among service companies puts downward pressure on prices for sand and fracking services. What’s more, it will take a year or more just to complete the more than 4,000 DUCs the industry is sitting on in the play.”

From ‘Peak Oil’ To ‘Algos’, Challenges Continue

Then there is the on-again, off-again risk of “peak-oil” theory, where both the need and output of fossil energy sources will be replaced by renewables; the ticking “time-bomb” of Venezuela and Libya, two one time, rock-solid OPEC producers now in perpetual crisis mode; and fears of a slowdown, even a recession, in China this year, that could severely jeopardize global energy demand, given the country’s standing as the world’s largest oil consumer.

Finally, overarching all these considerations is the “financialization” of oil, Energy Intelligence says, where the influence of “black box” algorithmic trading houses and non-specialized energy traders expose positions in crude to broader investment agendas or sentiments that are disconnected from the physical fundamentals of oil.

The research agency noted that the average number of open contracts in the three main crude futures contracts—ICE Brent, NYMEX WTI and ICE WTI—has risen 40 percent over the past five years and 127 percent over the past decade.

But shifts in these positions themselves do not bring about earth-shaking price movements, revealing another twist. Says Energy Intelligence:

“The same number of long contracts was shed between May and August last year and October and December, but prices fell by $6 and $35 (instead), respectively. The big difference was that the late 2018 exit coincided with several other drivers, including weaker enforcement of Iran sanctions and broader macroeconomic concerns.”

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