The True Edge
A Navarik Market Update
In the oil market, nothing lasts forever. In OPEC’s case, that was surely the hope for the ongoing period of low global oil prices, even if in time the wider market almost began to believe that this period of “lower for longer” was a new normal. But there are growing signs that OPEC’s patience may have paid off, although not due to any action of their own, but paradoxically due to Shale Oil’s own successes.
Consider that US production’s continued viability has been thus far reliant on two trends: growing oil demand (particularly in Asia-Pacific), and low input prices (such as third party oil field services and wages). Both of these are on relatively uncertain terms as we enter Q4 2017. Navarik Data delegates to the Asia-Pacific Petroleum Conference recently returned and noted, as surely did many who attended, that the talk of the town was the breadth of producers angling to send their barrels to strategic petroleum reserve tanks in China. The recent expansion of the quasi-governmental Saudi Aramco storage tanks in Japan have also provided some off-take in the region above and beyond the normal intake demands of the region’s refineries. The competition for crude to fill these tanks has been such that West Texas Intermediate, one of the key grades being exported to China, averaged a spread of about $5-$7 under Brent during the month of September, as opposed to as little as $1-$2 under for the rest of Q3. This is not sustainable, as WTI is such a gasoline-heavy crude slate that if the barrels were being exported to be refined and consumed as normal, it should command a premium over heavier and more sour slates. We should not expect that West Texas producers will be willing to send such a benchmark product to market at such a discount over the longer term, including once SPR tanks are for all intents and purposes full and the relative purpose of Chinese/Asian oil imports shift towards normal refining feedstocks.
Moreover, the capacity of WTI to compete at this price level is also under question. To a not insignificant degree, shale drillers profited from the sticky post-recession wages in much of the United States, at least initially. Even if much of their workers were skilled and high-wage, their wages were held at that level rather than increase during the shale boom by the fact that the goods and services they in turn consumed with their pay stayed low. In effect, this increased the purchasing power of their wages even if the sticker price they were paid for their work did not increase. However, in a perfect storm of economic factors, this appears to no longer be the case. The general economic situation has improved, and classic boom town conditions have taken hold in some Texas oil towns such as Midland, so that oil field workers don’t have the same purchasing power if their wages were to stay flat. Likewise, the number of wells being drilled has been such that producers and services companies often find themselves short enough workers, handing negotiating power to workers who are in turn able to demand higher wages.
Put together, then, these two trends show strong headwinds for the supposed OPEC-killer. From their underside, the cost of doing business is increasing, while from above, they face ongoing competition that is suppressing their revenues. But OPEC shouldn’t pronounce victory just yet; unlike OPEC, US shale drillers have recourse to the self-correcting mechanism of prices. If shale’s worst fears come true, and input prices rise fast and Asian imports flatline at precisely the same time, some projects will fail. This will reduce input prices once more, and reduce production, increasing global oil prices again. The ones that survive (through consolidation, renegotiation, etc.) will therefore be on stronger footing. How this plays out, if it plays out at all, will have ramifications for all producers, not just shale and not just OPEC.
- https://www.ft.com/content/0e7e748c-6f92-11e7-93ff-99f383b09ff9 (FT, July 23 2017)
- http://www.businessinsider.com/biggest-strategic-petroleum-reserves-countries-2017-3 (Business Insider, April 1 2017)
- https://www.bloomberg.com/news/features/2017-09-25/in-world-s-hottest-oil-patch-jitters-mount-that-a-bust-is-near (Bloomberg, September 25 2017)
- https://www.wsj.com/articles/u-s-shale-juggernaut-shows-signs-of-fatigue-1507195802 (Wall Street Journal, Oct 5 2017)
Colin McCann is an Oil & Gas analyst with Navarik Corporation. The Navarik Data Products team analyzes Navarik's proprietary data sets and external sources to provide insights into the oil & gas shipping market. The resulting analysis enables physical and paper traders to see ship movements across the barrel before anyone else in the market.
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