September 29, 2022 at 5:00 AM
VOT Research Desk
Key Insights and Analysis
The energy market has been challenging these past few weeks. As potential investors in energy companies, we are disappointed to see the week ending especially. That is the year’s understatement. This week saw the occurrence of nearly every negative sentiment, including the recession, Fed tightening, strengthening the dollar, China demand, inventory increases, and what amounts to the entire Closet of Anxieties regarding the oil price. Oil-WTI fell below $80 for the first time since January 11th, closing below its 200-day moving average of $89.00 on Friday. This puts WTI close to a crucial psychological level in the lower $70s, above which producers will drastically reduce capex in an effort to raise prices.
We will argue in this article that the selling is excessive and ignores a fundamental fact about the oil market. Only the SPR releases have been concealing the fact that it is lacking in supply. An energy catastrophe is imminent and will begin to manifest in the coming months. The era of energy insecurity will begin in 2023 as global economic growth picks up. The most important thing to remember is that nothing can stop this “train from barreling into the station.”Simply put, “That’s because there’s just no additional supply out there today at all,” read a recent NY Times article.
The Saudis and Emiratis have very little extra supply that they can sell. That’s all there is. We have used the strategic petroleum reserve, which will expire in a few months. The oil market simply lacks any additional cushion right now.
The short answer is that producers have been discouraged from exploring or approving the mega-project that was the mainstay of the 2000-2013 period since 2014.
We believe that as the SPR releases that had put excess oil on the market come to an end, oil prices will rise in the long run, probably toward the end of the year. The story told by the graph above, which was compiled by SP Global and Worldometer, is compelling. Every year, approximately 80 million new people join the nearly 7.9 billion already present, all of whom require energy to sustain their lives (though not always do).Between 2014 and 2020, spending on new upstream sources decreased by 55%, while the global population increased by 8%.The math is wrong.
The oil market is undersupplied. Stockpiles have increased by approximately 15mm barrels since the government announced the SPR releases in March to lower domestic gas prices. Taking into account the 172 mm barrels that were removed from the SPR during this time, inventories would have decreased to less than 248 mm barrels. That may seem like a lot, but with our 19 mm BOD habit, it only lasts 13 days, fewer than two weeks!
Not only are SPR releases artificially increasing inventories, but the EIA-Drilling Productivity Report also indicates that new well productivity is decreasing. Since it simply takes active rigs at a given point and divides them into new well production as reported by various sources—typically state regulatory agencies—this is admittedly a simplistic measure.
The fact that the yardstick is constructed using fourth-grade arithmetic without elaborate modeling does not negate its educational value. It does reveal an undeniable pattern in the production of new goods. Despite a steady increase in the number of rigs for the majority of this year, there is a significant decline across all key basins, with the exception of the North Dakota and New Mexico basins.
If you carefully read it, you can argue that the Drilled but Uncompleted well-DUC count withdrawal from mid-2021 to January of this year was largely responsible for the gains in production that have been recorded thus far this year. Well performance in the shale basins began to decline as DUCs decreased, and this is clearly observable.
This is true regardless of the underlying cause, which I have speculated could be the depletion of premium drilling stock. In recent times, this has been documented multiple times in well-read publications like the Wall Street Journal.
