Oil prices got routed in the aftermath of the OPEC meeting as the cartel pretense of restraint of production went away. In reality the decision will not really add more oil to the market. The perception of more supply in an oversupplied market was enough to cause the market to tank. The market is also not being helped by unseasonably warm temperatures that have reduced the normal winter demand and potential production restraints that winter can bring.
Oil prices are trying to stabilize after the drop, even after weak Chinese export data. One of the reasons is that there seems to be a disconnect between the Chinese slowdown and their demand for oil. Dow Jones reported, “November imports of crude oil into China were 450,000 barrels a day higher than in October and 471,000 b/d higher than a year ago, according to Olivier Jakob from the Swiss-based Petromatrix, citing data from the General Administration of Customs. The figures, equating to 6.65 million b/d, reflect booming demand in the world's second largest oil importer, with the crude being used in refineries as well as to top up the country's burgeoning strategic petroleum reserve. China has been taking advantage of cheap crude prices to create the reserve and analysts believe purchases could double in 2016 as more tank space becomes available.”
The other reason oil prices have been resilient is U.S. oil output from U.S. shale producers but that may change. The Energy Information Administration reported that U.S. crude oil production in January from seven major U.S. shale production areas is expected to drop 116,000 barrels per day to 4.86 million barrels per day in its “Drilling Productivity Report (DPR).” The EIA said last month that we would see a 118,000 barrels a day decline.
Yet CIBC World Markets says the, “EIA’s data on the changes in 'legacy' production - a measure on the decline rate of existing wells - suggests that if no new rigs were drilled, production would drop by a million barrels per day every quarter." U.S. production is now forecast to decline by 500,000 barrels per day over the next six months, a reason to expect at least some price recovery in 2016."
They go on to say,
“increasingly productive new rigs are behind the resilience of U.S. production, but this comes at a cost. Higher initial production also implies upward pressure on decline rates for these new wells. All else equal, the ability to take more oil out of the ground more expediently reduces the life span of a single well. Increasingly productive new rigs are behind the resilience of U.S. production, but this comes at a cost. Higher initial production also implies upward pressure on decline rates for these new wells. All else equal, the ability to take more oil out of the ground more expediently reduces the life span of a single well. Tight oil projects like shale have much swifter decline rates than conventional plays. The price of 12-month West Texas Intermediate futures contracts and shale drillers' access to capital remain integral variables that will inform when the supply-demand imbalance in the oil market is resolved.”
In other words, despite OPEC killing the market in the front end of the curve, the long term damage to future output is being underestimated. The bust end of the cycle is ugly but we still believe in history. And history suggests that we are creating the environment for much higher prices in the future. Look to buy long-dated futures and option strategies.
Triple AAA reports the positive point of this story and that is low gas prices. AAA says that the national average is less than a penny higher than the 2015 low (January 26), and should soon fall below the $2.00 per gallon mark for the first time since 2009. Pump prices have fallen for 29 of the past 31 days and bringing yesterday’s national average down to $2.03.