2) The Oil market is getting tighter heading into the winter heating oil demand season - key is distillate demand in Q4 2017:


At the start of the year, the market was wondering what it would take for Oil price to continue its rally given OPEC had agreed to take out 1.8 mln bpd out of the market as announced last November 2016, only to see the price fall back below that level over the Summer. What happened? In one simple answer: Shale! Well it certainly did not help that Iran and Iraq boosted their production just as OPEC was cutting production during the year. OPEC was blind sided by the fact that Shale just needed $45/bbl. WTI plus to keep pumping given their hedges in place and raising debt and equity to survive, hence taking market share away from Saudi and OPEC members.


Push forward to July 2017 this year. Saudi Arabia announced that it would start exporting less crude to US as investors focused on the US weekly DOE numbers, they were hoping to manipulate the aesthetics of the market to help rally the prices. Bold effort as it may be but something else has been at work in the background.


Since the outages post Hurricane Harvey, product demand has held up with gasoline demand averaging around 9.2 mln bpd and distillate demand averaging 3.9 mln bpd. Refineries are pumping at maximum to produce as much product as they can, given margins are very lucrative right now. As Summer driving season draws to a close, gasoline stocks in the US are not a problem (as seen in Chart 6 below), showing gasoline inventories as of 20 October 2017. They have been drawing slowly into the Summer but are still trailing towards the higher end of the 5-year range.


Distillate inventories as of 20 October 2017 plotted on Chart 7 below shows a different situation altogether. They have been drawing quite aggressively over the last four months ~ since July. (Let’s not be too hasty in congratulating the Saudis for playing with the aesthetics just yet).


It is interesting that when most people quote Oil prices and demand / supply, no-one mentions product demand, namely gasoline and distillate. People tend to forget that Oil is a seasonal market and that its use is dictated by the products it is used to make. In the Summer, gasoline is the main driver. Over the Winter, it is heating oil demand, namely distillate. As we approach the Winter heating demand season, we are already starting it with relatively lower distillate inventories which does not bode well if we actually do have a cold snap!


But what about US Shale and its “endless supply” as WTI prices breach $50/bbl.?


Since US shale came back with a vengeance at the start of the year catching people by surprise, most expect them to keep pumping as prices are only higher now! US shale certainly is the swing producer currently. But even US shale is reaching its capacity limits as their efficiency improvements are running out of speed. Cost inflation is back as evidenced by the Q3 conference calls, making it harder to pump more. It is naive to extrapolate the same level of growth from earlier this year into 2H of this year. To get more out, prices need to be alot higher to incentivise further capex and investment spend.


To put it in perspective, global oil demand is very strong and is expected to be ~ 1.7 mln bpd in 2017 (higher than the 1.1 mln bpd long term average). This is driven by China and increased distillate demand due to industrial production being better in developed market economies even in Europe.


According to a recent FT article dated 18 October 2017, it explains how rig productivity has generally stopped rising this past year across Permian, Eagle Ford and other basins, as production from new wells per active rig have been falling. In addition, the US E&P companies have been burning cash over the past five years, unable to cover their drilling costs from their incomes. Growing production will not be as easy as the market assumes and the companies may also start being a lot more disciplined to protect their shareholder interests.


36 | ADMISI - The Ghost In The Machine | November/December 2017


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