By Stephen Bennett
Fuel inventories are plentiful going into this heating season. What does that signify for this final quarter of 2016 and the first four months of 2017?
Fuel Oil News interviewed three experts for their thoughts: Philip J. Baratz, president of Angus Energy, a firm that helps companies manage fuel price volatility, and offers business consulting services and data analysis; Richard M. Larkin, president of Hedge Solutions, an energy consulting firm that provides businesses with strategies for procurement, marketing, and risk management; and Alan H. Levine, CEO and chairman of Powerhouse, a group of energy experts and broker professionals. A petroleum specialist for more than 40 years, Levine is an internationally recognized expert in pricing and business practices in the energy industry, and an authority on the relationship of energy futures to cash petroleum markets. Fuel Oil News conducted the interviews with Baratz, Larkin and Levine around Sept. 1.
An online extra, “Heating Season Fuels Outlook—Part II,” with additional commentary by Sprague Energy’s managing director, David P. Daoust, and Sprague’s natural gas supply manager, Shaun Kennedy, appears here. Daoust and Kennedy’s comments were received on Sept. 9 via email.
All of those commenting emphasized that, the market being unpredictable, their remarks should not be used as a guide to making purchasing and hedging decisions.
“I think this season is going to be very uncertain because there are a variety of factors that are working into the potential for oil pricing,” said Levine. “One of them, of course, is the fact that we’re sitting on very large quantities of crude oil and distillate fuels. That in itself will put something of a natural limit on the upside.” Levine said, “I’d be very surprised if we could move much above fifty dollars a barrel.”
The abundance of inventory is due to the fact that the U.S. has been producing very large quantities of crude oil, Levine said. Even though U.S. crude oil production has fallen by roughly one million barrels a day, “we’re still producing a huge amount of supply,” Levine said. Further, “demand has been very strong, encouraging refiners to continue to create more product,” Levine said.
These circumstances are resulting in production of “a lot of two oil and that’s a serious concern for the outlook going forward, especially in view of the fact that last winter was as warm as it was, leaving us with very large excess supply going into [this] season,” Levine said. “The effect is to put a damper on where prices might go.”
A battle for market share between OPEC and the U.S. hydraulic fracturing industry continues with unabated intensity, the experts agreed. The OPEC strategy “of trying to produce us out of business” has had some effect, Levine said, “but I want to point out that eight and a half million barrels a day production is still a lot of production.”
Levine added, “The Saudis have sent somewhat mixed signals in recent months. It would seem that they’re a little bit more willing to have a conversation about freezing production.” At least, Levine noted, “That’s something they said in June [at] the last OPEC meeting.”
The term of art the Saudis use for agreeing to reduced production is “stabilizing prices,” Levine said. “It’s the first time they’ve said that since they started this campaign to essentially kill the American oil industry. But at the same time they produced more in July than ever before. So we’re getting a very confused picture on the production side with respect to the Saudis.”
Meanwhile, Iran is producing more as well, though it has not returned to pre-sanction production levels, Levine noted.
Larkin, the president of Hedge Solutions, noted too that Iran has been “consistently upping” its production numbers. Before sanctions were imposed, Iran produced roughly five million to five-and-a-half million barrels a day, Larkin said. Iran now is approaching four million barrels a day, he said.
For its part, the U.S. over the past spring and summer seemed to cement its role as “the new swing producer,” Larkin said. There was some uncertainty regarding how nimble the fracking industry could be in reacting to market changes, Larkin said. The unknown factor was how fast the fracking industry could return idled wells to production “if the price gets to a level that’s economical for them,” Larkin said. “What is that number?” Larkin asked. According to published predictions and analyses, Larkin noted, “some think it’s $45, some think it’s $50, some think it’s closer to $60.”
A rally in May and June was telling, even though it didn’t hold. Forward months were trading in the mid $50s per barrel, Larkin noted. “You look at how the rig counts recovered over the last ten to twelve weeks and there’s clearly an indication that if the price gets to around $50 the fracking industry will bring [idled] production back on line,” Larkin said. Companies can restart fracking wells “fairly quickly,” Larkin said. “The only question is how quick they can bring the workers back.”
Baratz differed, viewing the fracking industry as somewhat encumbered in reacting to market changes. “It’s not as if one day there’s this piece of land in Oklahoma and then the next day it’s kicking out fifty thousand barrels a day,” Baratz said. “It’s a process. It’s very, very expensive.” The cost of building a well and the per-barrel cost of extraction once a well is producing are determining factors, Baratz said. A well might have been built with an expectation of getting “eighty dollars a barrel forever,” Baratz said. If instead a barrel is at $40, the cost for the working well to extract crude becomes more significant, Baratz noted. “If it only costs twenty-seven dollars to pull it out of the ground you’ll still keep producing at forty dollars a barrel,” he said.
But with U.S. production becoming less profitable “easy access to money to go out and find new places to drill dried up very, very quickly because those aren’t great investments anymore,” Baratz said. Oil companies and firms are buying up land leases and oil production leases in the Gulf of Mexico—“buying cheap,” Baratz said. “There are fire sales going on.”
Those with the lowest oil production costs—Saudi Arabia, Iran, Iraq—are “game to fight it out in this context,” Baratz said, while Venezuela spirals into a dire state. “That’s become a very dangerous place to live or to try to do business because the petrodollars aren’t there to support everything,” Baratz observed.
Amid a supply glut, “there is no doubt that the market is looking for a rebalancing,” Baratz said. When that might happen is uncertain, Baratz said, though many analysts and authors of research reports are forecasting that it is six to 18 months away.
The Energy Information Administration said in its Sept. 7 Short-Term Energy Outlook, “Although the pace of inventory builds is slowing, continuing builds and high inventory levels will likely contribute to Brent prices maintaining the recent $40/b to $50/b trading range during the next two quarters.” The EIA forecasts Brent prices to average $45/b during the fourth quarter of 2016 and first quarter of 2017, while “acknowledging that global economic developments and geopolitical events in the coming months have the potential to push oil prices near the top or bottom of the $40/b to $50/b range.”
Average West Texas Intermediate crude oil prices are forecast to be $1/b lower than Brent prices in 2016 and 2017, according to the Outlook. “The slight price discount of WTI to Brent in the forecast is based on the assumption of competition between the two crudes in the U.S. Gulf Coast refinery market,” the EIA said.
Stocks of propane are approaching the highest level they’ve been in the last five years, noted Levine. A drawdown—and the extent of a drawdown—will depend largely on weather, including “the possibility of a La Nina event” that would bring cold temperatures, Levine said.
“It is weather-dependent,” Baratz said of the propane market. But he added that even if the winter turns out mild, residential uses of propane for heating water, drying clothes and for cooking create a base level of demand.