Category
Oil
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In Search of the Next Bakken Shale Oil Field
Fracking technology has reshaped the U.S. energy industry by opening up vast shale oil and gas fields that were previously uneconomical to exploit.
Now, following half a decade of rapid growth, so-called unconventional oil accounts for about 2 million barrels per day of production in 2012.
So much oil is being produced domestically, in fact, that six companies including the world's largest oil trader Vitol and Royal Dutch Shell PLC (NYSE ADR: RDS.A) have applied to the U.S. government for energy export licenses. If approved, it will be the first such exports to occur in decades.
It is expected that, by 2020, unconventional oil production will be at the 4.5 million barrel per day level.
This is a familiar story to energy investors. The names of the best known shale oil fields such as Bakken, Eagle Ford and Utica are very recognizable to these investors.
But some other names are less well-known and are worth investigating.
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Why Oil Prices Can't (and Won't) Collapse
The markets opened again yesterday after the tragic storm across the East Coast.
In a world ravaged by storms, geopolitical tensions, rising demand, supply concerns, and increasing costs, it's important to know what's really driving oil prices moving forward.
The most important thing you can know is that increased market volatility is not going away. The challenge, of course, is to harness these volatile forces in order to come out ahead in the future.
That's the subject today. First I need to set the picture of where we are today.
There has been persistent talk from the usual sources that the price of oil will collapse, along with a range of field support and midstream service providers.
There is just one problem with this argument.
It's just not going to happen.
Don't get me wrong. I am not suggesting that the accelerating volatility in oil prices will point only in one direction, or that the trajectory is straight up. This is not going to be the first half of 2008 revisited.
Rather, we will continue to experience intense movements over shorter intervals. This is what statisticians call kurtosis – greater amounts of volatility occurring in shorter cycles.
Despite the overall upward trend demanded by indicators, these more compact movements will occasionally go in either direction.
That means we can experience downward spikes restraining oil prices over shorter durations. Nonetheless, the overall medium-term dynamic continues to move up. This is producing what I call a "ratcheting" effect: The market prices will undergo downward pressures within a basic upward tendency.
So where are oil prices going?
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Oil Prices: As the WTI-Brent Spread Widens, Refineries Are Set to Advance
Brent and WTI crude oil prices have been on a downward trajectory. Recently Brent had declined for seven consecutive trading sessions while WTI had been down for five.
Given the importance these benchmarks have in pricing crude worldwide, it is useful to review what they are before talking about their widening spreads.
Brent and WTI (West Texas Intermediate) are the two principal crude oil price benchmarks of global trade. Brent is set in London, WTI on the NYMEX in New York.
As I have observed in Money Morning on a number of occasions, neither benchmark actually reflects the quality of the oil traded worldwide.
On average, 85% of the oil in the international market on any given day is more sour (having a higher sulfur content) than either of these benchmarks. That means the actual trades are done at a discount to the price of one or the other of these standards.
Both are denominated in dollars, the currency in which virtually all oil consignments internationally are priced. That certainly is one primary reason for their continued use.
In addition, the daily liquidity of futures contracts traded in the world's two largest investment locations is yet a reason for their use.
Finally, with more than 200 benchmark rates for crude existing throughout the world, most having insufficient volume to constitute a basis for oil prices, there needs to be yardsticks to determine pricing differentials and swaps.
Those common yardsticks should be the most liquid and highest volume trading contracts available.
Brent and WTI fit the bill in all of these aspects, despite the fact they don't reflect the lower quality of most oil traded.
Oil Prices: Global Markets Favor Brent Crude
Still, the most interesting development since mid-August 2010 has been the following: despite representing lower quality oil, Brent has been trading at a premium to WTI.
Of the two, Brent has more sulfur content. That should result in a lower price rather than higher comparative price.
Actual trading conditions prompt a spread in favor of Brent for several reasons.
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Iran's Currency Collapse Has All the Markings of a Full-Blown Crisis
Matters are beginning to come to a head in Iran.
So far, the impact of Western sanctions – an EU embargo of oil purchases, European and U.S. restrictions on Tehran's access to international banking, and a new move to intensify the trading restrictions even further – have had a devastating impact.
Iran's currency, the rial, has collapsed.
Riots have begun. Its government has rapidly lost its authority. And the Iranian economy is unraveling.
This has all the markings of a full-blown crisis.
It will have an uncertain impact on the region and the wider oil market. This could get very unpredictable and very nasty.
Let me explain…
Sanctions Paralyze Iran's Economy
Indications are emerging from several quarters that the current sanctions regime has dealt a major blow to the Iranian currency. The developments are prompting foreign initiatives to paralyze the regime in Tehran.
"The current perception is that the sanctions may have to be increased before Tehran will show clear signs of relenting," a source in the EU Energy Commissioner's office told me on October 6.
Still, it remains too early to determine how far EU members are prepared to go in strengthening anti-trade restrictions.
Nonetheless, several policy sources in Brussels, London, and Paris, confirmed last week that a rising consensus believes something additional is warranted.
A complete EU embargo of Iranian oil imports took effect on July 1. That action had widely been expected to put upward pressure on Brent prices in London. While some of that pressure has materialized, continuing demand concerns from the ongoing credit crisis and sluggish employment data have dampened the impact.
Still, a widening of the rift with Iran, coupled with the deteriorating situation on the Syrian-Turkish border, is certain to bring the problem to center stage.
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Why Oil Prices Are Entering a "New Normal"
One of the things I have learned from almost four decades of doing this is that oil and gas specialists know a great deal about what they do for a living.
However, few of these specialists really understand enough about what the person to the right or left of them does. This tends to breed tunnel vision.
And these days it has become a serious problem.
That's because what is now hitting the oil and gas markets requires a more expansive and integrative understanding of what is actually taking place.
The truth is energy markets are evolving.
We are entering a period in energy and oil prices that I have begun calling the "New Normal."
You see, a volatile, dynamically changing combination of factors now undermines the traditional way of viewing oil and gas markets.
And it is about to get a whole lot more unnerving for the average analyst who still insists on pushing square pegs into round holes.
Unfortunately, for the old school aficionado, we are rapidly moving into new territory. Here, market machinations are occurring that defy the "traditional" explanations.
Oil Prices and the Talking Heads
You know what I mean by "traditional."
The talking heads on television try to explain the latest spurt or dive in oil prices by relying on the same trite and tired lineage of explanations.
In just the last month, we've seen movements in energy prices justified solely on the following factors:
- A supply glut in Cushing, Okla.;
- Fluctuations in the euro-dollar exchange rate;
- The European credit crunch;
- The latest unemployment figures;
- Inflation;
- Manufacturing, housing, or production figures.
But it really doesn't work this way anymore. While such factors are not completely irrelevant, they are also not calling the shots.
There are several factors contributing to this New Normal, but I will be restricting my comments this morning to just three.
They are:
- The balance between conventional and unconventional production;
- Increased market volatility; and
- Global geopolitical matters.
So let's get started.
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There is Nothing the Shorts Can Do About Higher Oil Prices
After another pricing pull back of almost 10% earlier this week, crude oil prices rebounded on the back of an unlikely source.
A Spanish deputy prime minister presented a budget. The proposal was hardly earth shattering.
It detailed planned expenditure cuts but provided no details on the other shoe that has to fall – tax increases. Given that a main element in the Eurozone crisis continues to be on the fiscal side, tax increases will have to follow.
The difference cannot be made up only from program cuts. The budget announcement, therefore, appears simply to forestall the inevitable.
Nonetheless, a dry news conference in Madrid was the latest excuse for bulls to take over and drive the oil price (and the markets) higher.
This is merely the latest example of an immediate overreaction to developments.
Yes, it is important that Spain is positioning itself to benefit from the new paper buyout plans being orchestrated by the European Central Bank (ECB).
Unlike the basket case of Greece, the Spanish have made an effort to clean up their act prior to a bailout request.
Next up are the stress test results of Spanish banks. An independent audit show Spanish banks need $76.3 billion.
And while there is some question over whether the test is a valid indicator of overall banking sector weakness, there is no doubt what the government's objective is.
This will not be an across-the-board rescue of the banking sector because Madrid does not want a full-blown rescue from the EIB.
That would put the entire Spanish banking industry under pan-European oversight. Now it may ultimately come to that. But before officials capitulate, they will orchestrate a smaller number of comparatively healthier financial institutions (at least on paper).
This hardly ends the crisis.
But it does indicate that a strategy is taking shape. And that is all the bulls needed to charge forward.
