On the Source of the Oil Glut…

…and the Coming Irrelevance of Saudi Arabia.

Certainly an interesting take on the last sixteen months:

This week, Saudi Oil Minister Ali Al-Naimi will for the first time face the victims of his decision to keep oil pumps flowing despite a global glut: U.S. shale oil producers struggling to survive the worst price crash in years.

While soaring U.S. shale output brought on by the hydraulic fracturing revolution contributed to oversupply, many blame the 70-percent price collapse in the past 20 months primarily on Naimi, seen as the oil market’s most influential policymaker.

We’re going to disabuse you of this notion.

It will be Naimi’s first public appearance in the United States since Saudi Arabia led the Organization of Petroleum Exporting Countries’ shock decision in November 2014 to keep heavily pumping oil even though mounting oversupply was already sending prices into free-fall.

Wrong.  The free-fall began in November 2014:

U.S. Landed Costs of Saudi Arabian Light Crude Oil (Dollars per Barrel)

2009	38.70	44.30	51.68	56.21	61.88	67.89	66.06	68.92	73.06	74.91	74.15	72.38
2010	77.79	77.07	77.83	80.94	77.90	76.29	75.82	76.63	76.59	82.66	85.07	91.44
2011	98.70	104.49	110.02	117.81	112.23	110.36	112.08	109.85	112.01	108.09	109.48	108.16
2012	110.94	116.39	120.54	115.43	107.10	97.79	100.30	107.18	108.35	106.24	108.14	107.18
2013	110.26	108.62	108.65	102.74	101.92	100.57	105.48	106.16	104.08	99.83	95.40	100.61
2014	101.94	104.36	103.81	102.53	102.92	106.38	105.51	100.24	94.71	83.36	77.88	59.88
2015	50.32	52.02	54.29	60.45	64.06	59.88	52.08	45.49	45.63	43.65	41.81

The press is in the habit of saying the price of oil collapsed during the summer of 2014, but while Brent had peaked in June 2014…

Europe Brent Spot Price FOB (Dollars per Barrel)

2009	43.44	43.32	46.54	50.18	57.30	68.61	64.44	72.51	67.65	72.77	76.66	74.46
2010	76.17	73.75	78.83	84.82	75.95	74.76	75.58	77.04	77.84	82.67	85.28	91.45
2011	96.52	103.72	114.64	123.26	114.99	113.83	116.97	110.22	112.83	109.55	110.77	107.87
2012	110.69	119.33	125.45	119.75	110.34	95.16	102.62	113.36	112.86	111.71	109.06	109.49
2013	112.96	116.05	108.47	102.25	102.56	102.92	107.93	111.28	111.60	109.08	107.79	110.76
2014	108.12	108.90	107.48	107.76	109.54	111.80	106.77	101.61	97.09	87.43	79.44	62.34
2015	47.76	58.10	55.89	59.52	64.08	61.48	56.56	46.52	47.62	48.43	44.27	38.01
2016	30.70

…the precipice wasn’t reached until the turn of the following year.

Pipelines

One of the better oil industry analysts out there is Daniel Jones, who in trying to lay to rest the idea that Cushing running out of storage will trigger a WTI “bloodbath…“

[It] should be mentioned that this doesn’t mean WTI prices won’t drop if tanks reach their peak sometime soon. Back in 2011, when tanks nearly peaked, the price of WTI fell in relation to the price of Brent, with the spread between the two climbing significantly and staying that way for years. However, in June of 2012, in response to this arbitrage opportunity, the Seaway Pipeline elected to reverse the flow of crude toward the Gulf region so that it could benefit from this disparity. Given the large pipeline network that exists today within the U.S., it wouldn’t be unthinkable for operators to also reverse flow, which would help to alleviate these concerns.

…should have noticed that Seaway triggered the worldwide price crash at the end of 2014:

The opening up in December last year (2014) of the Enterprise/Enbridge joint venture 450 Mb/d Seaway Twin pipeline from Cushing to Freeport, TX in conjunction with the Enbridge 585 Mb/d Flanagan South line from Pontiac, IL to Cushing has enabled significant pipeline flows of heavy Canadian crude to reach the Texas Gulf Coast. According to our friends at Genscape, average daily flows on Flanagan South since December 19, 2014 have been 389 Mb/d and average flows on the Seaway Twin have been 240 Mb/d. As we described last year the two new pipelines are part of an extensive expansion project by Enbridge of their Western Gulf Access system, that delivers Western Canadian heavy oil sands crude as well as Canadian conventional crude and shale crude from the northern portions of the Williston Basin into the U.S. Midwest (see ”The Promised Land? Flanagan South and the Seaway Twin”).

The map in Figure #1 shows the path of the Enbridge Mainline from Edmonton and Hardisty in Alberta to the Chicago area (purple dashed bracket) – with two sections known as the Enbridge system on the Canadian side (light blue line) and the Lakehead System on the U.S. side (darker blue line). The new Flanagan South pipeline runs parallel to the existing 193 Mb/d Spearhead pipeline between Flanagan and Cushing (green dashed bracket). The final Seaway Twin segment from Cushing to Houston (orange bracket) runs parallel to the existing Seaway pipeline that was reversed in June 2012 and expanded to 400 Mb/d in 2014 (see Seaway Reversal). Until the Seaway reversal in 2012 there was no pipeline capacity from the Midwest to the Gulf Coast at that time except for the 98 Mb/d ExxonMobil Pegasus pipeline (itself closed for most of 2013 and 2014 by a rupture). Although the original Seaway pipeline expanded to 400 Mb/d in 2014 and the southern section of the TransCanada Keystone XL TX opened up 700 Mb/d of capacity between Cushing and Nederland, TX in the same year, flows of crude from Canada along those routes to the Gulf Coast were still constrained by a lack of Canadian crude flowing into Cushing. The heavy crude that did flow from Canada into the Midwest (via Spearhead and the original Keystone pipeline) was primarily destined for regional refineries – many of which – like the 400 Mb/d BP Whiting refinery in Illinois had been specifically upgraded to process heavy Canadian crude.

PAR has noted several times before that TransCanada’s Keystone pipeline…

…increased crude production each time Phase I (Hardisty to Patoka), Phase II (Steele City to Cushing), and Phase IIIa (Cushing to Port Arthur refineries) opened in June 2010, February 2011 and January 2014 respectively; naturally TransCanada competitor Enbridge moved to counter:

Moreover, heavy crude from Western Canada (WCS) is driving the price of Brent and WTI in one direction–straight into the floor:

33.01 ▼ 1.27 (3.7%) BRENT USD/bbl

29.64 ▼ 1.13 (3.7%) WTI USD/bbl

16.89 ▼ 1.23 (6.8%) WCS USD/bbl

23.26 ▼ 1.66 (6.7%) WCS CAD/bbl

DAILY CHANGE FEB 19, 2016

When Will It Bottom Out?

Upon closing last Friday, WCS traded at a 48.8% discount against Brent.  Canada’s crude dropped below the $20 a barrel mark on 7 January 2016, and has remained below that threshold since.  The effect on Canadian exports…

Canadian crude oil exports to the United States reached its highest level ever of 3.4 million barrels per day in the first week of January, according to preliminary data from the U.S. Energy Information Administration.

“That’s the one piece of puzzle you don’t hear too much about — the market share Canada is gaining in the U.S.,” said Carl Evans, senior crude oil analyst at energy research firm Genscape.

The surge comes as U.S. crude oil production recedes on the back of a withering oil price environment, with the EIA expecting a 80,000 bpd decline in U.S. domestic output in December alone.

…has been dramatic.  Canadian oil exports to the U.S. have topped the 3.4 million barrel a day mark twice more since the Financial Post noted the first instance, and last week outstripped Saudi Arabian imports to American refineries by a four to one margin.

There is a bright side to this for energy bulls–heavy oil is finally starting to fall into the red:

Some of the most known South American blends, which normally trade at significant discounts to benchmark Brent that has tumbled to under $30 per barrel, are fast becoming a type of ‘negative oil’ in a global glut.

Red numbers have also affected Canadian grades and U.S. shale crude, a change that increases the pressure on producers to consider shutting wells rather than running at a loss.

Among the varieties already affected in South America are Venezuela’s Diluted Crude Oil (DCO), which is now selling around $15 a barrel and Colombia’s best seller Vasconia, offered at below $21 in spot deals LCO-VAS, sources from producing firms said.

South America’s fourth largest oil producer, Ecuador, is also under breakeven point, President Rafael Correa said, which is forcing the country into fiscal cuts.

“We have a crude price that is not even covering production costs, which are $24 per barrel,” Correa told journalist on Wednesday.

The latest figures from Venezuela’s state oil company PDVSA show the average production cost for all its crudes is $18 a barrel, while Toronto-listed Pacific Exploration & Production , Colombia’s largest private operator, said its production cost including diluents, transportation and taxes averaged $20 to $22 in the third quarter of 2015.

“Last week we were right at the breakeven point,” said a source from Pacific. “But we are currently below that line.”

However, heavy oil producers have uncommon staying power due to their significant advantages over conventional drilling:

Oil sands deposits, particularly Alberta’s, are often maligned for being the highest cost and most carbon-intensive oil barrels on Earth. But these deposits remain very attractive assets for oil majors like Exxon, even at these depressed prices. For one, there’s no exploration risk. no dry wells, little reservoir uncertainty. And oil sands deposits have very slow depletion rates, resulting in assets which can operate for several decades versus conventional wells which typically run dry after a few years. That’s long enough to ride out peaks and valleys in crude oil prices.

In short, oil sands almost do not have to contend with the EUR break-even issues that dog traditional oil production.  This allows the Albertans to lie in wait, as Canadian crude producers have been able to increase American market share with WCS prices below $20 a barrel while the rest of the world (save Colombia, Ecuador and Venezuela) cries about $30-35 oil; which doesn’t bode well for the Saudi gambit to run the table against American shale drillers.  Even if Canada doesn’t take up the slack in an American rout, Venezuela, which managed to outstrip Saudi oil imports last week, should be an indication of what American oil refiners are willing to buy. 

But why do refiners desire to buy heavy sour bitumen over light sweet crude?