Oil markets have looked pretty dull for a couple of months now.  In November and Dec, the markets were biding time to see whether OPEC would actually cut the 1.2 MMBD promised and how winter weather would shape up.

The answers came in and we had a sharp reaction once the holiday hangovers cleared (not to mention the year end books closed and bonus' were set).  January has been painful for the oil market longs so far and good for price conscious consumers.

So  bit of 20-20 hindsight from the world of capitalist running dogs follows below:

The oil markets have been range bound the last 30-40 days so this won't be much.  On weak days we see $57ish.  On max hype days, $60-61 ( front month WTI contracts).

Downside risks are still there but OPEC has done an OK job of stopping the downward slide due to their overproduction in 3Q.

I doubt we see WTI with a $4X.XX before the end of the year.  More likely we just keep chopping around this price --$60 ish-- in the near term.

It's been about a month since the last of these.  At that time I laid out a case for how we could get into the $50's on crude oil.  And like the stopped clock, I got one right.

Where are we overall now?

Just a brief diary to point out that the entry of hedge funds into the commodity speculation game isn't a one way street where they take average Joe's money.

Check this out. It shows that the conjecture I've been making that big time speculators are making the oil markets more volatile and that when they snap, they are a big cause of the washouts we've seen in natgas and gasoline.

Enormous losses at one of the nation's largest hedge funds resurrected worries yesterday that major bets by these secretive, unregulated investment partnerships could create widespread financial disruptions.

The hedge fund, Amaranth Advisors, based in Greenwich, Conn., made an estimated $1 billion on rising energy prices last year. Yesterday, the fund told its investors that it had lost more than $3 billion in the recent downturn in natural gas and that it was working with its lenders and selling its holdings "to protect our investors."

from the diaries with minor edits. - Jerome

As always with apologies to Jerome for teasing him with the title.

And with the agreement up front that $100 is only matter of time.  The question I'm asking is what will the path look like over the next 3 months.

World Oil markets are piling up bearish news in the last few days and prices are dropping pretty hard.  The true tin hatters out there see collusion designed to help Republicans, but I'm not buying it. http://www.eurotrib.com/comments/2006/9/6/213625/6185/4#4

So what could make oil drop into the $50's in the next few weeks?

Before you flame me

1.  I fully believe the era of cheap energy is mostly over (I think $3/mogas is pretty cheap on a historical basis).
   
2.  Barring the invention of a magic bullet, energy prices will be significantly higher in 10 years than today

Then why the diary?

I offer the following just so people understand that there will not be a straight line path from here to there and why the "market" may not agree with "peak oiler" visions.  We all need to stay nimble as orthodoxy of any sort can prove to be expensive.  Prices could well be much lower or much higher this time next year.

Natural Gas

US Natural Gas was $15/MMSCF ($90/bbl equivalent) this fall/winter past.  The late summer hurricanes shredded production capability as we all know.  Typical speculation/panic buying drove prices of both oil and gas to very high levels.  Predictions of gas piercing the $100 oil equivalent price were common.

We got lucky with a mild winter, aggressive restoration of supply and price led demand reduction.  As a result, nat gas prices have collapsed back to $6.5/MMSCF ($39/bbl equivalent) even while crude prices remain near the highs.  The key difference is nat gas is much more a local mkt insulated from international political problems.

A WAPO article outlines the current nat gas situation:

At the end of last week, natural gas in storage amounted to 2.4 trillion cubic feet, up 23 percent from a year earlier and 38 percent higher than the five-year average,

that's huge.  As Jerome has shown, natgas production curves decline more steeply than oil fields so drilling rates are a key indicator of near term supply.  The EIA has a data series showing proven reserves and another showing Prices.

The data show a real drop off in proven reserves from the early/mid 80's when prices were relatively high to the 1990's when prices were much lower.  From 2000, when electricity markets really began to lean heavily on natgas and prices responded, reserves have been growing.  Lots of holes are being poked.

By OGJ editors
HOUSTON, June 9 -- US drilling activity continued its slow growth with 1,661 rotary rigs working this week, 4 more than the previous week and up from 1,339 during the same period last year, said Baker Hughes Inc.

The bulk of the increase was in land operations, up by 9 rigs to 1,539 working. Activity in inland waters gained 1 rig to 25 drilling. Offshore drilling declined by 6 rigs to 97 in US waters, including the decrease of 4 to 92 in the Gulf of Mexico

[Source]

Rig data from Baker Hughes (large PDF!)

This data shows just how much rig activity can vary.  When prices were this high in 1981, the USA had almost 4000 rigs in action 5000+ worldwide.  Today we have about 1650 (3000+ worldwide) and in 1998 when OPEC were fighting over price we were down around 800 (1800).

these rig counts are oil and gas combined, but gas is generally affected by both as about 1/4 of nat gas production is a byproduct of oil production.

The lesson here is like most commodity markets, gas is volatile.  And while the oil industry is slow to react, they do react eventually and usually over-react damaging their profitablity (back handed proof that if they collude, they don't do it very well).

Will gas spike this fall?  If the hurricane season spares the USG facilities, we could see the opposite.  Storage capacity could hit max, leaving producers nowhere to put the gas until winter comes.  After that, it's just weather.

Crude

Last fall's Katrina price spike has not really abated.  We're still sitting at $70/bbl.  But there are other reasons we're not seeing any relief.

1.  Venezuela lost 1 mmbd production when Chavez broke PDVSA's resistance to his rule.  They've never gotten back up to their prior production peak.
   
2.  Nigeria has roughly 800 MMBD off line due to internal unrest.  The locals are pissed that all the money is sent to Lagos (and then Switzerland) instead of staying in the production area.  They're killing folks to keep the production levels down.
   
3. Iraq is still bumping along well below their pre-war capacity.  Mr. Wolfowitz's 5 MMBD production levels turned out to be just an opium dream.
   
4. General world paranoia that the worst president ever will invade Iran and risk the entire PG production due to military action at the Straits of Hormuz.  ($150/bbl in a heartbeat)
   
5.  Hedge funds are actively investing money in longer dated futures shifting the price band upward.  It's a market.  More buyers, higher prices.

US crude stocks in commercial hands are about 342 million bbls.  That's high relative to the 5 yr average.  But when you look longer term, we've got less in tank than in the early 80's.  Moreover, when you consider days cover we've got 342/16 = 21 days of crude runs.  Back in 1982 we had roughly 350 MM bbls with just 12 mmbd crude runs or more like 30 days cover.

Why?  Oilcos got tired of tying up so much working capital in crude oil.  Especially as that capital was tied up in the refining end of the biz which was making little to no profit.  Consolidation of refiners and just-in-time inventory control both came to pass.  The number of refineries was reduced, tankage was bulldozed to keep line personnel from using it etc.

As you might expect, refiners are much more nervous about covering their needs and are forced to pay up for crude even with decent stock levels.  Prices do show that there is no prompt shortage as front month futures are below outers (contango)

See: NYMEX data (may have to go to the main page and click thru accepting the NYMEX's data delivery terms)

6/16 close:
July  $69.5
Aug  $69.93
Dec  $71.83

Where are we going on price?  Ask Bush.  If his broker tells you he's buying calls, watch out Iranians.  If he's flat, call the hurricane prediction centers.

One very contrary opinion comes from BP.  It's one we should all consider as they actually have thinking management unlike the rest of the majors. They're calling for a decent chance that we head back to $40 in the medium term.

Refining Capacity

Capacity continues to grow.  US capacity damaged last year is basically back up and running with mogas production back at last year's highs.

Still the spread (or crack) between mogas and crude is wide at $16/bbl.  People are still worried that we cannot cover demand which is not dropping off much despite the price increases.  Stocks are building back into the 5 year average range, but we've no great cushion forming.

Better slightly down than up, year on year, but so far the demand reduction I expected hasn't been seen.  The US consumer still has enough money in pocket to buy gas even though we all whine about it.

Longer term, there have been a bunch of new refinery projects announced.  The Saudis alone have announced 2 new 400 MBD refineries.

Each week the OGJ reports on the talk in the trade. In the latest:

Interesting that the Venezuela are considering 3 new ones at a total of 700 MBD.  If all these projects go, we'll repeat 1979-82.  Massive expansion followed by margin collapse due to overcapacity.

Conclusion -- who actually read this far?  I've no great insight other than the energy markets are far more complex than meets the eye.  Don't make any sucker bets.

Just to be upfront:

1.  I don't dispute that the era of cheap oil is over.
   
2.  The purpose of this info is just to provide some counterbalancing perspective to the idea that we're in deep caka this winter on petroleum supply.  And to explain why prices seem to go down despite predictions of doom from some quarters.
   
3.  Nat Gas -- whole 'nother story and one I have no knowledge base in so I'll keep my mouth shut.
   
4. I'm talking my book.  My guess in the pool is around $52 Feb WTI/$51 Feb Brent on Dec 30, 2005 (31st is a saturday so no quotes).

With apologies to Jerome (who will be right eventually) there are a number of good reasons why crude oil prices are dropping and will likely stay down unless winter bites really hard this year:

Upward forces:

1.  Fear -- will there be a big hiccup in a producing country such as Saudi/Nigeria/Venz.  Readiness of the EIA to sell into shortages is mitigating this fear.
   
2. 1.4 MMBD of crude production down in the USGC.
   
3. Hedge funds holding length leaving the trade short and nervous

Downward forces:

1.  Demand destruction -- mogas at $3 bucks and jet fuel over $2 is starting to really bite hard.  US oil demand was down 3% (600 MBD).  Some of this is lost industrial demand on the USGC due to hurricane damage.

2. Saudis offering crude with no takers.  While lighter crudes make more mogas, heavy sours produce more fuel oil which may well be needed to offset the loss of natgas for electricity generation (sorry birds/lungs).  

3.  more refinery throughput lost than crude production.  Right now there's about 500MBD to 1MMBD more lost refining capacity on the USGC than lost crude production capacity.  Sounds like most of the refineries will be back within about 4 weeks though.  Only the 3 near NO + Valero Pt. Arthur sounding really screwed.  Chevy Pasc may start some units with Oct, and most by T-giving.

But why are products fading too?  First, imports to the US are gushing.  Mogas imports are up 500 MBD as European/S.Amer/other refiners keep refineries maxing mogas in a period that ususally has mogas demand slumping.  Diesel/heat imports are up 200 MBD as well.  Even with all this production lost, diesel/heat stocks only dropped from 133 MMB to 128.  We're not that far off last year's stock levels (lucky to have been ahead of the curve a bit).

Demand destruction.  Once people change habits they don't rush right back to piggery.  And it's not like the pump prices are moving down much.  My price at the pump is still up from $2.85 to near $3.40.  We've shut down most optional trips just on general principle.

Refineries are deferring maintenance from this fall to next spring (get ready for high mogas next April/May) to play catch up.  

Hoarders arms are getting tired.  At some point you sell your "fear" stocks rather than have your ass handed to you when/if the bottom drops out.

Recession brewing?  Stock market thinks so at least this week.

Oil prices could drop even as high natgas screws the US royally.  $14+ gas (effectively $84 crude on btu basis) is deadly for the plastics industry (ethylene etc come from gas in the US instead of the naphtha feeds of Europe) and will crush the east coast and midwestern home heat end users.  These folks have not yet begun to pay up while their newspapers are screaming the bad news.  You have to figure that with natgas doubling in price, utilities are doing everything they can to burn less while maximizing coal and still the price is rising.  This does not bode well for winter..

Jerome may have to wait a couple of years for the 3 digit crude barring Al Qaeda taking out Ras Tanura.  Yet we may have 3 digit natgas equivalent (about $16.5) very soon indeed.

Fair warning:  my bet in the pool is about $52 so I'm talking my book.  Even a cheap bottle of Cremant is enough to influence the average oil trader.

 The situation is not good as far as price goes.  We're all going to pay a lot more without much good reason in my opinion.

A healthy chunk of US refining capacity was/is shut down due to the storm, lack of power and some will stay down a while with damage.  But what does is really mean and what, if anything, can regular folks do to mitigate the problem.