Oil Prices Poised To Rise As Cycle Comes To An End By Dan...

Oil Prices Poised To Rise As Cycle Comes To An End

By Dan Steffens - Apr 02, 2018, 6:00 PM CDT
Each month, I publish reports on ten to fifteen publicly traded upstream oil & gas companies. Part of each report is my estimation of what the company would sell for in a negotiated transaction. I’ve been doing this for almost twenty years and during that time there have been several oil price cycles. The one that started in mid-2014 includes one of the most severe declines in crude oil prices in the last century. It has lasted much longer than the average cycle, which is about two years.

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I have been working in the oil & gas industry for more than 40 years, so I have lived through several boom and bust periods for upstream companies. Here are a few observations:
• Oil price cycles tend to overshoot on both the upside and the downside. The price of oil never stays at the “Right Price” for very long because a small over-supply can push the price quite low and a small under-supply can cause a big price spike. During the early months of this cycle, crude oil prices dropped below $30/bbl.
• Once oil supply & demand get out of balance, there is no quick fix. This is an extremely capital intense business and it takes years to set up funding and mobilize the resources for major upstream projects.
• Since the Arab Oil Embargo in 1974 there has not been a prolonged period of stable oil prices and I doubt there ever will be again. We are in the 9th inning of this cycle and we are warming up for the next “boom” period of higher oil prices.
• The end of a down cycle is marked by an increase in M&A activity. I think we saw the first of several big mergers announced on March 28, 2018.
Let’s take a look at where we are on the price of crude oil first. Then I will look at the $9.5 Billion merger of Concho Resources (CXO)and RSP Permian (RSPP). I will try to explain how Concho arrived at the offer price and why the deal makes sense for both companies.
Oil Price
The price of West Texas Intermediate (WTI) crude oil was on a fairly steady uptrend from the end of June, 2017 through January, 2018. The price of oil dropped more than 10% in the first half of February and then began what turned into a classic wedge formation. Wedge patterns usually signal that a significant breakout is coming, up or down. With oil supply/demand clearly tightening, it was a good bet that the breakout would be to the upside. WTI began a push higher on March 16, 2018, testing the January high. Related: The Ultimate Renewable Energy Hybrid
In my opinion, the International Energy Agency’s monthly “Oil Market Report” (3/15/2018) was the catalyst for the breakout. You can find a summary of the IEA report here:

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90% of humans live in the Northern Hemisphere and more of them drive cars, trucks and SUVs each year.
Demand for oil is seasonal and April is the beginning of a big increase in global demand. The summer driving season is becoming more and more the “High Season” for oil demand. Fewer homes burn oil for space heating each year and there are more SUVs on the road each year. China and India are the primary sources of rising global demand for oil. Refiners do most of their annual maintenance projects in February and early March, so they can ramp up production of transportation fuels in the second quarter. Summer blends of gasoline also require more crude oil.
At the end of December, 2017 U.S. refinery utilization was up to 96.7%. In February, 2018 the utilization rate dipped below 88%, but it is now ramping back up. In last week’s EIA report the U.S. refinery utilization rate was 92.3% for the week ending March 23. By mid-April, the refinery utilization rate must be over 95% if summer demand for transportation fuels is to be met.
All of the major U.S. hydrocarbon liquids inventories are at historically low levels.The U.S. and all of the OECD countries, whose economies depend heavily on these commodities, should have at least 30 days of supply. EIA reported the following levels of liquid inventories in the U.S. as of March 23, 2018. All of them are lower than the previous week.
• Crude oil: 26.1 days of supply
• Gasoline: 25.6 days of supply
• Jet Fuel: 23.2 days of supply
• Distillates: 32.1 days of supply
• Propane: 24.8 days of supply
Refined products inventories have been low since Hurricane Harvey shut down more than 30 percent of U.S. refining capacity for over two months. The U.S. has struggled to get back to 30 days of supply for most of these critical refined products. The world’s largest economy is heading into the peak period of demand for transportation fuels with very little cushion.
Last year, global demand for products made primarily from oil increased by 2.3 million barrels per day from the first to the second quarter. A similar spike in demand is expected this year. In their March “Oil Market Report”, IEA said that global demand for oil will exceed supply within sixty days.

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