Crude Observations

Alright, now what?

It’s all well and good to admit defeat on my oil price prediction for 2017 as I did last week. But to then avoid any substantive discussion about the implications of that conclusion is actually a bit of a disservice to readers. So I will try in here to correct that.


But before I do that, I must first digress into a random discussion about forecasts generally. I mean seriously, does anyone, anywhere, ever expect to have their forecast be correct?


The more I think about forecasting and what a mug’s game it actually is, I am reminded of a term I coined many years ago when I was doing financial modelling for clients and forward looking valuations of businesses. This of course was infamous “POOMA” forecast. It’s a very official sounding term and I would often discuss forward looking information framed by the POOMA forecast – for example


“This free cash flow model shows an IRR of 27.5% using a WACC of 16.7%.”


“Where did you get your numbers?”


“The forward is based on the POOMA forecast.”


“Did that come from the client?”




In case you haven’t figured it out, POOMA is an acronym for Pulled Out Of My A**. Which should tell you all you need to know about forecasts. In hindsight, I may have had some of the best POOMA forecasts ever. And let’s face it, that’s the best many of us can do when it comes to crystal balling the future because at the end of the day there are too many variables to consider when doing a forecast.


Coming back to the present, the reason I bring this up is because last week I was lamenting oil prices adrift in a sea of shale, self-indulgently whining about the many conflicting signals that rendered my original shot in the dark useless. So I pulled out the “dart board” and metaphorically picked $56 as my new year end POOMA forecast for the price of oil. But all is not lost, for in any decent POOMA forecast, there needs to be a dose of reality and that reality is that prices aren’t going up anywhere near as fast as people had been hoping and that we were now back in that dreaded “lower longer” scenario.


So we have identified the trend, but if we are right about the trend, what does it actually mean for the market and industry? So here, without further ado, some genuine reality-based POOMA implications of range bound prices in the $45-$55 range.


First, let’s lead off by saying that in the context of the last few years, there is actually nothing wrong with oil in the $45 to $55 range. There is lots of opportunity to invest, make money and stay reasonably busy at this level. So let’s be constructive and not push any panic buttons.


One of the key things that should happen with prices stuck at this level is a gradual slowdown in the growth of activity levels in the United States and Canada. While many tight oil players boast of breakevens lower than $30, the reality is that current prices are pretty much where the marginal barrel is at when you factor in all the costs. There was in fact a recently published survey by the Dallas Fed that showed all-in break evens starting on average at $46 and rising. There is a big difference between breaking even on a production basis and breaking even on a land acquisition, finance, drill and complete basis and it seems to me, as an observer, that there are some shell games going on in how some companies talk about their breakeven prices to the market.


The land based oil-directed rig count in the United States should plateau around the 800 level, taking some of the froth and hype out of the market. This should be marginally constructive for prices and production, as it represents a lower level of sustained activity than many were forecasting, but offsetting that is a large backlog of DUCs (drilled and uncompleted wells) that has recently spiked due to industry ramp-up issues so the production growth will continue. This should pull up productivity levels that, according to the EIA, appeared to have stalled in recent months but which may have just been a victim of a lack of capacity to complete.


In Canada, expect a gradual increase in activity levels to just under 50% utilization heading into the new year and peak winter drilling season. Outside of Saskatchewan, Western Canada activity levels will be less impacted by the stagnant oil price because the mix of product is much different in areas like the Duvernay, Deep Basin and Montney. That said, Alberta and Saskatchewan are major producers of conventional and non-conventional oil so anything that shifts activity into neutral in the US will also affect us North of the border.


The obvious downside to a slowdown in activity levels would be a further delay in the return of pricing power to the energy services industry. Industry participants who were hoping for a high utilization driven rapid recovery in prices to pre-downturn levels likely need to resign themselves to a more gradual re-inflation. Good for the producers because they will still get to brag about lower breakevens, but not so good for some of the more marginal service providers, especially those who were still living on the edge with their lenders.


This is not to say that price increases won’t be available to service companies – they will, particularly in areas where the activity levels are going to be concentrated or in services where demand is strong and the asset base has been cannibalized. 50% utilization in Canada and the United States is nothing to sneeze at – there will still be a lot of money changing hands, crews and equipment still need to be hired and brought on-line, it’s just going to be a longer rampup.


Another, perhaps overlooked, issue this pause in price growth will cause for service companies is going to be in relation to their lenders. With a relatively strong winter Q1 and Q2 under their belts, many companies have pulled themselves back from the brink and the value of their assets have recovered. So the business may now be stable but suddenly their lenders are looking at a much longer recovery and may be inclined at this point, perversely, to cut their losses and call their loans. Layer on top of that rising interest costs as both the US Fed and Canada’s Central Bank turn hawkish on rates and the prospects for the over-levered service companies are maybe not the best. A longer recovery that ironically leads to more bankruptcies. Oh joy.


On the subject of leverage and higher interest costs, it is no secret that E&P companies utilize large amounts of debt to fund their capex as do many of the private equity players who have stepped in to fund them. Rising interest costs in a range-bound price environment bring a number of things to the party. First and foremost, the increase in costs and higher breakevens should serve to reduce the amount of capital available, which (in the real world) will act as a check on activity. Second, and perhaps more important or interesting, is that a higher rate environment means that other investments will start to look more appealing for capital providers searching for yield and thus return expectations for E&P companies will need to go up as well, but the returns won’t be there if prices are stuck in a rut and productivity improvements have by and large run their course. Ultimately, what this will lead to is a sectoral rotation out of oil patch into less risky yield investments. Ultimately, risk capital and lenders are fickle and some of it will go elsewhere, which will also help slow down the growth in activity.


As it regards governments, particularly in Canada (where we are), range bound prices have a number of implications. First off, it makes the ultimate POOMA forecast (a government budget) simpler because the price deck range is easier to find. However, and more importantly, the Alberta fiscal budget was based on a $55 average WTI price for the fiscal period, which now doesn’t appear likely. Lower prices will lead to a larger than expected deficit, exacerbated by now increasing interest rates. Alberta’s fiscal situation isn’t going to materially improve then until prices go up. This will in turn crank up the heat on the pipeline discussion as the province and its producers seek higher prices outside our captive market. In British Columbia and Saskatchewan, stalled out growth in their energy sectors will affect their finances as well, delaying full recoveries and making the soon to be rocky marriage of the NDP and Greens in BC even more fraught with uncertainty.


Of course while we think we have it bad, other countries around the world will be affected in different ways. While $45 a barrel is an improvement on 2016, it may not be enough to save Venezuela. But it will be enough to improve the finances of other OPEC countries. In the case of the US and other consuming nations, they will be insulated by their diversity.


The winner of these range bound prices is of course the consumer and I think it is important not to lose sight of that as low oil prices will keep inflation in check and should lead to increased demand. It is quite possible that lower prices will result in much higher consumption and that, of course, will help with inventories and lay the foundation for higher prices going forward, particularly in the context of the lack of global upstream investment outside of North America that we discussed last week.


So, range bound prices mean a gradual slowdown in the rate of growth of the industry in North America, less inflation in the service sector, a kick in the teeth to government finances and the prospect of increased consumer demand from lower prices. Which should all theoretically lead to higher prices in the medium to long term.


And amidst all the thrashing about in North America, OPEC/NOPEC continues to make money. Well except Venezuela. Makes you wonder if this wasn’t the plan all along. Or is that another POOMA?


Prices as at June 16, 2017 (June 9, 2017)

  • The price of oil continued to fall during the week as the market lost confidence in OPEC cuts.
    • Storage posted a decrease
    • Production was up marginally
    • The rig count in the US continues to grow
  • Natural gas fell marginally
  • WTI Crude: $44.71 ($45.89)
  • Nymex Gas: $3.027 ($3.040)
  • US/Canadian Dollar: $0.7565 ($ 0.7425)


  • As at June 9, 2017, US crude oil supplies were at 511.5 million barrels, an decrease of 1.7 million barrels from the previous week and 10.6 million barrels ahead of last year.
    • The number of days oil supply in storage was 29.5, behind last year’s 32.6.
    • Production was up for the week by 12,000 barrels a day at 9.330 million barrels per day. Production last year at the same time was 8.716 million barrels per day. The change in production this week came from a decrease in Alaska deliveries and increased Lower 48 production.
    • Imports fell from 8.341 million barrels a day to 8.025, compared to 7.622 million barrels per day last year.
    • Refinery inputs were up during the week at 17.256 million barrels a day
  • As at June 9, 2017, US natural gas in storage was 2.709 billion cubic feet (Bcf), which is 9% above the 5-year average and about 11% less than last year’s level, following an implied net injection of 78 Bcf during the report week.
    • Overall U.S. natural gas consumption was up 3% during the week – as a large increase in power offset declines in retail, industrial and commercial demand
    • Production for the week was flat and imports from Canada were up 1% compared to the week before. Exports to Mexico were up 13%.
  • As of June 5, the Canadian rig count was 143 (23% utilization), 86 Alberta (20%), 23 BC (32%), 32 Saskatchewan (28%), 1 Manitoba (7%)). Utilization for the same period last year was just above 10%.
  • US Onshore Oil rig count at June 16 was at 747, up 6 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States was up 1 at 186.
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was flat at 21
    • Offshore rig count at January 1, 2015 was 55
  • US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 56%/44%


  • A judge in US circuit court ruled that the US Government through the Army COrps of Engineers was lax in its assessment of the Dakota Access Pipeline and ordered it to redo its environmental review. The ruling is being appealed and the pipeline will continue to operate. It is expected that this ruling will be struck down on appeal.
  • GE and Baker Hughes have received clearance for their merger from the Department of Justice.
  • The CQ Energy Canada Partnership (“CQ”), the Canadian E&P joint venture in which Centrica plc owns a 60% interest, is to be sold to a consortium comprising MIE Holdings Corporation (“MIE”), The Can-China Global Resource Fund and Mercuria for a purchase price of C$722 million.
  • Trump Watch:
    • Attorney General Jeff Sessions had his turn at the enquiry this week. I don’t know about you, but if I am nominating people for senior roles in government, I would hope they have good memories, because there was a whole bunch of “I don’t recalls” happening. Seriously dude? Didn’t you take notes when you met with the Russians? Pretty sure Comey would have… In other news, Trump has elected to roll back Obama executive orders normalizing relations with Cuba. I am assuming that once he runs out of orders to roll back there is a legislative agenda to pass. Right?
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