I think I will stick with $17.00 but push my timeline from 14 days to 28 days.
Crude Oil Tsunami Headed This Way: Oil May Have Farther To Fall
Mar. 24, 2020
Includes: AOIL, BNO, DBO, DTO, DWT, NRGD, NRGO, NRGU, NRGZ, OIH, OIL, OILD, OILK, OILU, OILX, OLEM, SCO, UCO, USAI, USL, USO, USOI, UWT, WTID, WTIU, YGRN
By Fluidsdoc
The Daily Drilling Report
Seeking Alpha
Summary
Massive amounts of crude oil are headed our shores.
Enough that our ability to store it all is questionable.
The Law of Diminishing Marginal Utility could take oil to multi-decade lows.
Good news is closer now than it was the week before. We explain.
Introduction
The oil market appears to be seriously over-supplied currently, giving prices in this commodity only one direction to travel, down. We are seeing indications of a historically over-supplied market right now, so we expect continued weakness on the commodity front. The impact of this reality will be felt across the value stream for crude and refined products until demand begins to pick up. If you're a driver of a giant pick-up truck, you're in for some of the happiest times of your life over the next few months.
Over the short run, crude, as these foreign barrels reach our shores, will follow the law of diminishing marginal utility where early consumption is advantaged over later consumption of a good. Here is an example -
That first bite of triple sausage and pepperoni pizza is just amazing. If you're like me, the first slice disappears in the first 30 seconds. Even as you reach for the second slice, your stomach is starting to flash warnings to central command, "slow down just a hair." By the time you reach for the third slice, you're chewing slower and taking more time between bites. The utility gained from tossing more pizza down is reaching near-zero for the time being.
The example above is not a perfect analogy, but that's essentially the situation that appears to be developing post-Vienna for oil.
"Storage facilities around the world are brimming with cheap oil and could run out of space within months, traders and analysts say, a predicament that could drive down crude prices to unprecedented single-digit dollar amounts."
Demand is collapsing
This edition of the EIA-STEO gives us a first look at the effect of the Coronavirus on global oil demand. This report was delayed for a day to take into account the events of March 9th when crude dropped 30% in a single day.
This analysis shouldn't come as a great surprise to anyone, and actually it may be a little optimistic (forecasts usually hit one extreme or another depending on the bias of the forecaster). Daily we see some of the major consumers of refined products slashing their schedules.
Airline schedules - down 50-70%
Cruise lines - down nearly 100%
Automobile traffic - no metrics available but we're using less gas, as shelter in place orders in New York, California, and a number of other states reduce demand for gasoline, etc.
These actions are beginning to have an impact on crude and refined products.
Goldman Sachs (GS) has also put out an analysis, giving us a stereoscopic view of the market. These two analysis largely agree with each other, with Goldman calling for a decline of 8-mm bod from previous forecasts.
This all suggests we have farther to fall in terms of the crude price. Graphs show demand beginning to rise again in late April. I think the reality of that depends on the perception about the virus. If new cases are declining by then, as they should be if the China experience is any guide, then this will likely bear out.
Interestingly, both curves show a sharp increase as the activity levels start to pick up, a couple of months hence.
Floating storage
It hasn't made a lot of news, but tankers have started being booked up a couple of weeks ago. The Saudis put the ball in play with the almost immediate chartering of 31 VLCCs, each with a capacity of 2-mm bbl, following the breakdown of the Vienna talks. About a dozen of these will be headed toward the U.S. Folks, that's about 24 mm bbl of oil arriving in about 6 weeks. Shell (RDS.A) (RDS.B) has also taken this step, chartering several VLCCs to store oil at sea.
It should be noted that this is an expensive step with tanker chartering rates increasing 10-fold this month.
Refinery storage capacity
Storage is available in refineries now with current utilization of capacity at ~63%. Concerns abound going forward, though, as to spare capacity being rapidly filled with cheap oil as demand suffers.
“We believe we have not seen the worst of the price rout yet, as the market will soon come to realize that it may be facing one of the largest supply surpluses in modern oil market history in April,” said Rystad Energy’s Head of Oil Markets Bjornar Tonhaguen.
Remember what I said about the last marginal barrel. It's worth far less than earlier barrels, meaning the price could continue to drop.
New sources of supply coming online
Rystad
Finally, Rystad shows us just who's leveling their oil cannons at the globe with short-term production increases. We've sort of forgotten about Libya in recent times. Rystad suggests that today, while this country is producing less than 100K BOPD, a cease-fire could bring another couple of million barrels into the market in April.
Bjørnar Tonhaugen, Rystad Energy’s Head of Oil Markets, comments:
“Any large political power sometimes needs to remind its adversaries and competitors of its might. We believe Saudi Arabia seeks to teach the market a lesson." There is a risk of production shut-ins as the world’s oil storage capabilities will be put to the test, with oil’s spot price subsequently collapsing, in which case countries with higher break-even prices will be the first to be affected."
Rystad
"Higher breakeven prices" is code for U.S. shale, the short-term fate of which we will discuss in a separate article later this week.
One way to play this decline in oil
The carnage in the service and supply sector has been well noted in recent days. The VanEck Vectors Oil Services ETF (OIH) is one way to play this if you think this is overdone. It is comprised of some of the key companies that service the needs of oil E&Ps as they develop, transport and produce energy.
One way of comparing the depth of this decline with prior declines is the market perception for this ETF. In February of 2016, oil fell to the mid-$20s, while the OIH maintained a relatively lofty $27.14.
The pricing today clearly depicts an industry that's been left for dead by the smart money. It is comprised of names you know if you follow this industry. Names that you probably own at higher levels on an individual basis.
The Thesis for the OIH
Buying into OIH is a good way to make a bet on the recovery of this industry, while avoiding the single-stock risk that some carry. These companies all supply essential services to the development of new oil fields around the world. The industry simply cannot do its work without them.
One thing that will drive business when life resumes some semblance of normality is the neglect fields onshore and offshore are experiencing now. Wells that need to be drilled in shale plays to maximize field recovery aren't being drilled right now. Wells and fields in deep water plays have lagged for years as the industry focused capital on U.S. shale. Work on broken wells is also being deferred as companies hoard cash formerly destined for capex.
Once this maelstrom calms, the industry will return to work, likely in a price scenario almost immediately double today's crude price in the low $20s. No one is making money in the E&P business at present prices, and you are going to see near-hibernation out of them, until they can.
Risk
A bet on the OSX is obviously a bet that there will be a recovery. While we think this will happen, and indeed, must happen, it could be longer than we expect. In that case, you might face a dead money scenario.
Your takeaway
Oil is going to be subject to additional downside volatility as this crush of crude arrives at our shores from their disparate origins. For investors with some extra money to put to work, great companies are selling for multi-decade lows, creating an opportunity in the OIH.
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