Right, so if you were following along on Wednesday, you know that FGE Chairman Fereidun Fesharaki is about to have a nervous breakdown.
Specifically, Fesharaki thinks maybe US shale producers are on a suicide mission to destroy the global crude market.
US operators, Fesharaki said in a note dated earlier this week, are “effectively on a path to self-destruction” and they’re “taking the industry down with them.”
It is, Fesharaki says, “close to madness [as] production is rising mindlessly and no one considers the consequences.”
Well the “consequences” are lower oil prices. Or, more poignantly, a bear market, into which crude plunged last week and a bounce over the past several days notwithstanding, the outlook isn’t great.
The shorts are piling on in both WTI and Brent and the jounros are having a veritable field day writing bearish articles:
And so, every analyst who ever had anything bullish to say on this market is now scrambling around to explain what happened. Cue Goldman who just lowered their our 3-mo WTI forecast to $47.50/bbl from $55/bbl previously:
Spot WTI oil prices at $43/bbl are now back to November pre-OPEC deal levels, down from $52/bbl just a month ago and vs. our prior 3-mo $55/bbl forecast.
How did it go so wrong? The surprise over the past month was that two large US stock builds and the unexpected ramp-up in Libya and Nigeria reduced the confidence that inventories would normalize before the end of the OPEC deal. Concurrently, the steady increase in the US rig count and the six month drilling to production lag now imply that US production will be growing strongly by the end of the OPEC deal. This threatens to close the window of time for stocks to normalize before the OPEC cuts end and raises the concerns that OPEC will then ramp up production to defend market share.
No longer being able to dissociate between the 2017 draws and the concerns of a surplus in 2018, Dec-17 oil prices could no longer act as the anchor and pivot for the forward curve and left the whole curve to return into contango. In fact, trading of the distinct 2017 vs. 2018 balances through long Dec-17 vs. short Dec-18 timespread positions likely precipitated this unraveling by offering producers too strong a price signal to ramp-up production this year.
Right. So where, Goldman asks, “does this leave us?”
Simple: with everyone watching shale. To wit:
The new anchor is likely to be the price at which shale activity slows. The oil market is back to searching for an anchor and we believe that this will likely be for now the price at which shale activity slows. Until a month ago, the greater than seasonal March-May draws and the upcoming May OPEC meeting had helped rationalize the steady ramp up in US activity. Data since then has however shaken confidence that these draws were real and sustainable and the market must now address the shale response. Shale’s velocity is making it the marginal barrel today, pushing the burden of proof on determining once again at what price oil horizontal drilling activity will decline.
Where does this leave us? We believe that prices have reached a level near $45/bbl at which US producers should start to adjust their drilling activity. Further, strengthening near-dated timespreads suggest that the draws we expect have yet to unravel. The threat of Libya/Nigeria production, the uncertainty on when and at what price level shale activity will slow and the shrinking window of time for the draws to normalize inventories before OPEC is tempted to ramp up all leave us cautious of calling for a sharp bounce in prices here.
We believe that it will be evidence of such a drilling slowdown that will help stabilize deferred prices, with price upside front-end driven and coming from observable draws and near-term physical tightness. If our inventory path proves correct, this will drive the curve into backwardation later this year, although with 1-year forward prices still anchored near $45/bbl. In particular, upside in long-dated oil prices will need to remain limited to ensure the sustainability of lower inventories by curtailing producer’s ability to grow future production through forward sales.
Of course all of that assumes shale operators are some semblance of rational, and if you ask the above-mentioned Fereidun Fesharaki, that just isn’t the case.
We would caution that what very well may end up happening here is that US producers will simply continue on this bonanza up to and until wide open capital markets slam shut or, in other words, until Wall Street (and you, dear investor) take away the keys.
Either that, or prices will fall so low that the US is hit with a tsunami of bankruptcies and restructurings, at which point everyone who thought HY Energy spreads would eventually “mean revert” and trade reliably inside HY spreads as a whole will feel pretty goddamn stupid…