More Evidence This Is Not An Oil Production Problem -- It's A Refining Problem And Inflation Problem -- June 12, 2022

Updates

June 13, 2022: WTI adjusted for inflation.

Original Post

Are we back to counting DUCs? Of fifteen wells coming off the confidential list this next week only two -- both Zavanna wells -- 13% -- report production data. Link here.

• one can debate the reason for the high price of oil and yet we are seeing more oil than necessary
• I used to suggest it was a refining problem; that remains true to some extent;
• a bigger problem is inflation (to include transportation inflation);
• but it appears the big problem is spare capacity

For the reader concerned about dates: Yergin noted this in March, 2022.

Spare capacity:

• although it was called something different years ago, we noted this on the blog maybe a decade ago;
• a lot of folks call it under-investment, and that's been a recurrent theme over on twitter;
• I was never concerned about under-investment, but I was wrong; I never anticipated Russia's suicidal ideation;
  
• Josh Young started talking about this a year ago (?); perhaps  too much of a new face to have been taken seriously, and he concentrated on Canadian oil;
• but the guy who wrote the bible on oil, made it clear, back in March, 2022; archived.
  
• when did Brent / WTI really start to surge
• 70-year chart here;
• but let's look at 10-year chart:
• there was the anomaly, February, 2020 - April, 2020
• recovered to baseline February, 2021; the baseline extended back to late 2014, when oil plunged from $120 to $60
• after February, 2021, steady increase but not clear what might happen, through October, 2021
• but by January, 2022, the chart seemed to reflect what others were starting to notice: a question about spare capacity
• from November, 2021, to June, 2022, it's been pretty much a straight line from $70 to $120
• in March, 2022, when CNBC posted Yergin's analysis, oil was trading below $100 and just ready to break out
• of course, March, 2022, was the month Russia invaded Ukraine

Thoughts:

• so, let's put some numbers to this:
• baseline, when global supply / demand (oil) balanced: $60
• inflation: add 20% since March, and that's being very, very liberal; probably closer to 10% but let's say 20%, which adds $12 = $72
• demand change from 2019 / 2020 anomaly (pandemic), it's almost looking like a wash at the moment; it certainly appears global oil supply is more than meeting global oil demand (global oil demand held back by continued on-again/off-again Covid lock downs in China); with that, I can't see adding anything to the $72-price point based on supply/demand now
  
• going forward, inflation, add another 10% -- no one is suggesting that; that is way too high but let's put that in as a place holder, $72 + $7 = $80 in round numbers
• spare capacity / under-investment: call it what you want but the market is looking ahead three months (height of driving season in US) and six months out (China continuing to open up) and analysts see a spare capacity / under-investment premium of $40 currently and as much as $80 if one accepts the analysis of Goldman Sachs, JPM, and others
• remember: it's the price of that last bbl of oil that determines the price of oil.
  

Spare capacity / under-investment

• under-investment? why? Oil sector pretty good at anticipating demand and responding in kind
• so why the under-investment?
• politicians suggest oil sector under-invested over the past twenty years for greedy reasons
• to cut to the chase, under-investment wasn't for greedy reasons; under-investment was due 1000% due to "keystoning" of America; oil sector was not allowed to invest in America in the past ten years, perhaps twenty years if one considers when plans for the Keystone X were first being drawn up;
• any doubt: "leave it in the ground" -- policy statement from our current SecEnergy.
  
• it will be impossible for the US to make up for that under-investment in any meaningful time frame; it's just not going to happen, and again, mostly due to continuing "keystoning of America";
• Plan A: America's production would meet global demand; can't happen in current environment
• Plan B: global demand will need to be met by OPEC (B1) and Russia (B2)
• oil at $120 suggests analysts feel Plan B will fail
• maybe, without Ukraine, Plan B would have held together for another year or so
• Ukraine simply compressed in time the whole spare capacity issue
• again, global oil supply more than meets demand now; price is forward-looking
  
• analysts suggest Ukraine changed everything

What does this mean going forward:

• WTI: in fairly narrow trading range right now -- $118 - $122
• any signs of "truce talk" between Ukraine - Russia: skittish oil traders will take profits, get out quickly, resulting in quick drop in oil price to well under $100
• if Russian sanctions aren't quickly lifted after truce, oil will gradually move higher again; the volatility in the price of oil after a truce is announced will ebb and flow in line with political comments coming out of the EU
• OPEC will get a lot of ink but overall production cannot make up for shortfall in Russian production; we'll know more after Biden's visit to Saudi Arabia in July