For the past month, the price of oil has soared by a 50% on no fundamental catalyst; in fact, the “fundamental” situation has gotten progressively worse with the record oil inventory glut increasing by the day even as US crude oil production posted a modest rebound in the past week after two months of declines, while the much touted OPEC/non-OPEC oil production freeze has yet to be discussed, let alone implemented.
With or without a valid catalyst, however, the short squeeze price action has drastically changed not only investor psychology, but that of the IEA as well, which on Friday announced that oil may have bottomed (if the agency’s predictive track record is any indication, oil is about to crash).
But while traders, algos and CNBC guest “commodity experts” may be certain that oil will never drop to $27 again, someone else is not at all convinced that oil prices will not drop again: oil producers themselves.
We first noted this earlier this week,since January, the spread between Brent for delivery on the 2020 end of the curve and crude for prompt supply has dropped by nearly $8 to around $10.71 a barrel. “Brent’s flattening contango since January comes as many producers want to cash in immediately on recent price rises. They’ve been heavily selling 2017/2018 and beyond, and it shows that they don’t quite trust the higher spot prices yet,” said one crude futures trader.
“This means that even the producers don’t really expect a strong price rally until well into 2017 or later,” he said. The companies that explore for oil and pump it out of the ground have been locking in price gains by selling off future output as a financial hedge, pulling down prices for those contracts, said sources with some of the producers and traders who had been counterparty to deals.
And now, courtesy of Credit Suisse James Wicklund’s wonderful “Things We’ve Learned This Week” summary of key events in the oil space in the last 7 days, is an explanation of just this:
Locking It In. Since January, the spread between spot Brent prices and 2020 Brent prices has dropped nearly $8.00 to $10.71 per barrel, indicating selling in 2017, 2018, and 2019 futures contracts. According to Reuters, the majority of selling has come from E&Ps looking to lock in prices to hedge against a repeat of last year’s second half commodity price route. At the same time, the hedges indicate a lack of confidence that the current commodity rally will continue.
However, as long as the momentum-cashing algos are bidding oil up, the majors will be delighted to hedge at ever higher prices; which incidentally means that Saudi Arabia’s plan to put as many marginal producers out of business in the fastest possible time, has just been delayed by another 9-12 months. Whether this means that Saudi plans for a production “freeze” have also just been swept away, remains to be seen as soon as that so overhyped OPEC meeting takes place, if ever.
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As a bonus, here are several of Wicklund’s other key event highlights from the past week:
- Near Record. Despite significantly reduced activity in North America, 2015 was the second-largest year in terms of total proppant volumes supplied as frac sand, ceramic proppant, and resin-coated proppant producers supplied 55mm tons to the oil and gas industry. Frac sand accounted for over 92% of the 2015 market, whereas ceramic proppant and resin-coated proppant volumes fell to their lowest levels since 2010. The resilience of proppant volumes was the result of increased proppant intensity per well. Unfortunately for proppant producers, prices fell off a cliff in 2015 due to excess market supply.
- Talking Politics. During Sunday’s Democratic Presidential debate, fracking was a hot topic between Sen. Bernie Sanders and Sec. Hillary Clinton. Clinton has, in general, historically supported fracking. Clinton changed her stance noting, “[b]y the time we get through all of my conditions, I do not think there will be many places in America where fracking will continue to take place.” Sanders took a more adamant stance, calling for an all-out ban against fracking on federal lands.
- North Sea Production Holding Firm. North Sea crude supply is expected to average 2.22mm boe/d during April, up from March’s 2.17 mm boe/d and its highest level in four years. If April’s estimate is met, crude oil supply out of the North Sea will have exceeded 2 mm boe/d for 8 consecutive months.
- Flood Gates Opening? In late 2015, the National Iranian Oil Company (NIOC) unveiled 49 development projects to be offered to local and foreign investors under the new Iran Petroleum Contract (IPC). The 29 oil and 20 gas projects offer a wide array of development opportunities, ranging from brownfield projects on mature onshore and offshore fields, recently developed fields, to very large greenfield projects. Government officials project that the removal of sanctions on Iran may trigger at least $50B a year in foreign investment to finance a rebound in an economy hit by the oil slump.
- Infusion. We have been paying close attention to E&P equity raises over the past few weeks, looking specifically at the size and proceeds of the deals. So far in 2016, NAM E&Ps have raised $9.3B in equity, down from $16.0B for full-year 2015. Proceeds are similar to 2015 as E&Ps proceeds are going to pay down debt and, in some cases, fund capex.
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