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Sunday, March 8, 2015

The coming oil bust

Cushing, Oklahoma, population 7, 826, has an over sized footprint in American energy production and soon in energy price. The town is home to the world's largest tank farm. If as the ancients said "All roads lead to Rome" then Cushing can boast that all pipelines lead to it. It is the price settlement point for West Texas Intermediate (WTI) crude. The town once boasted of 2 refineries but as local oil production declined its storage capacity became a convenient place to store crude in a soft market while waiting for the price to rise. From then, like Topsy, it just grew up. Today 12 pipelines bring oil into Cushing and two move it out. It has the capacity to hold about 70 million barrels of crude and soon, sometime between mid April and mid May, it will be full. No one knows what will happen. Definitely gasoline prices will drop again. A few producers will lose their shirts, congressmen will bitch that no one told them this would happen and Obama will read about it in the Washington Post. If history repeats itself you will probably learn just as much by seeking counsel from Dionne Warwick and Shirley MacLaine than listening to the talking heads on Fox Business or CNBC. Politicians and industry insiders always seem to be the last to know.

There is historical precedent for an oil bust. Following the OPEC embargo of 1973 and the "oil shock" of 1979 new production was brought on stream in the North Sea, Alaska's Northern Slope the Caspian Sea and Siberia resulting in declining oil prices throughout the 80's. The downward trend continued another decade culminating in a low of about $17 per barrel in early 1999. In just 9 short years it spiked at $142. per barrel bringing on a stock market crash, a bank liquidity crisis, and Barack Obama, a trifecta of bad happenstances.
No one can read the minds of the Saudi monarchy but it is apparent they have eschewed their traditional market strategy of defending price to maximizing sales. Some view it as a war on US fracking. Others say it's aimed at Iran and still others say it's the Russians they are out to get. In any case once the tanks at Cushing are full it will, barring the disappearance of a major producing country, take years to work off the glut. RBN has posited 3 scenarios going forward. They are rather broad brushed and by necessity highly speculative but probably as good at least as anything MacLaine is apt to dream up.
Scenario One; If by chance Obama, Yellen, and their EU partners could get their acts together and robust global economic growth would resume instead of an endless series of Summers of Economic Recovery and 2% GDP growth we are looking at WTI crude in the $80 range by 2017. If you are inclined to bet the farm on the good works and sound judgments of Obama and Super Mario Draghi this is the deal for you.
Scenario Two; They call it the cutback scenario. Obama and Yellen run to form and GDP growth remains tepid. Oil production remains flat in most basins but a few increase production by drilling only the sweet spots. This gets the WTI to $70 by 2020.
Scenario Three; The contraction scenario. GDP growth remains anemic and oil production peaks in 2015 and declines to 2014 levels. This keeps the WTI price in the $50 to $60 range through 2020.
While the WTI is a convenient focal point it is only a reflection of world market prices.The glut is worldwide. Crude is being stored in tankers anchored in Singapore. China’s coastline storage facilities ran out of space as the country filled up strategic oil reserves last year. Put off installing solar panel for a decade and take your dad's old 409 Chevy on vacation next summer.
So what about the Utica? By now it's apparent it's a gas play. Yes, it produces some oil but gas is what pays the bills and the price of natural is still well above its break even point. This is especially true where the Marcellus and Utica formations overlap. Magnum Hunter Resources is drilling 18 wells on its Stadler Pad in Monroe County; 10 in the Marcellus and 8 in the Utica. It can walk the rig from well to well with no need to disassemble. Drilling equipment such as the Schramm T500XD have cut drilling times by as much as two thirds since the inception of horizontal drilling.

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