18th September, 2017
Oil in deficit
Looking at the recent monthly reports of OPEC and IEA, one comes to the distinct conclusion that the oil market is in deficit. And the total US production according to the EIA 914 report has barely changed since February 2017. So, why is WTI still below $50?
There are many amusing arguments made by the bears:
- EVs are going to take over the world
- Demand for oil is dying
- The OPEC cuts are ineffective
- Shale oil has breakeven at $50
- US shale production can be increased and decreased at will, it is basically like opening a tap to get water from the water tank
EVs are going to take over the world eventually, when they find cost effective battery solutions and most of the world has no more electricity grid problems. Most third world countries where most of the oil demand is coming from have regular outages of electricity. So, the people who live there don't have enough electricity to power their TVs and refrigerators continuously, let alone an EV. And most EVs have a higher starting price than their counterpart ICE vehicles.
According the latest IEA OMR, oil demand is up by 1.6 MBPD year on year for 2017. This hardly seems like demand is dying for oil. In fact most forecasts put that oil demand in 2018 will break the 100 MBPD barrier for the first time in history. It seems very interesting that oil bears have lost totally their critical thinking when it comes to this point. If oil demand is dying, there should be a drastic reduction on demand for oil, or at least there should be no demand growth. Looks like the oil bears can't even figure out basic arithmetic. I will simplify it for them. When the demand is increasing, it is growing. When the demand is decreasing, it is dying.
Another argument which bears like to point out is that OPEC cuts are ineffective in that whatever production is cut by OPEC, is in fact filled by US shale. Nothing could be farther than the truth. While OPEC and NOPEC cut together 1.8 MBPD since January this year, US production has increased by only about 300KBPD. Granted that Libya and Nigeria have seen recent increases in production of about 700KBD, that still leaves 800KBPD in production cuts. This argument shows really how illogical oil bears are. A production cut, takes oil out of the market. So, in fact, the cuts made since January have made the situation for oil much better than say if OPEC and NOPEC were still pumping more oil.
There have been many arguments and publications saying that most of the shale oil production breakeven is below $50 or $40 or even $30. Apparently some of these shale companies have higher margins than Apple. This is laughable. No commodity product can have such high margins. Unless, there is a distinct shortage of the product or if there is very high demand. This again contradicts the assumption of the bears that demand is dying and there is a surplus of supply. If the demand is dying, why are shale producers having such huge margins. Why is offshore drilling for oil still alive? Some of the ludicrous arguments I have heard from the bears is that shale is totally going to replace offshore drilling which produces about 30MBPD+ oil per day. This is beyond laughable.
If shale has such low breakevens, it must be reflected in their income statements and balance sheets. Most of the shale companies are heavily indebted and were in loss even when oil was trading at $50 in 2Q2017. So, the magical breakevens touted by the oil bears are non-existent.
There has been a rumour going along online in numerous trading forums that shale oil, especially DUC wells can be turned on or off at will. It's like turning on or off a tap attached to a really big water tanker. Shale extraction of crude oil is a complex and highly technical process. Comparing this extraction process to turning on or off of a water tap is highly insulting to the technological innovation that made shale extraction possible. While oil bears constantly use shale production in their arguments, they fail to understand the extraction process and technological complexity of the shale extraction process. So, it is definitely not like a water tap which can be turned on or off at will.
To summarise, most of the arguments made by oil bears are superficial and lack consistency or even a mediocre depth in analytical or critical thinking. The constant bearishness in news by the media about crude oil and the resultant negative price action has further bolstered the oil bears' thinking. Sooner, rather than later, the bears are going to be proved wrong and by then, they'll have lost a lot of money on their bets.