PRIMARY VISION INSIGHTS TUESDAY 30 July, 2019

By Mark Rossano

U.S. Completions

The U.S. energy market remains under pressure as E&Ps limit activity to remain within CAPEX/ Cash flow guidance. Capital expenditures are coming under pressure with independent oil companies- especially SMID caps limiting activity as crude pricing weighs on earnings. The majors have slowed activity, with only one (XTO) increasing activity in the Permian as other basins see large declines as they compete for internal capital. There is a growing oversupply of light/sweet crude that the U.S. is competing with in the global market. This is a core reason why E&Ps with firm transport and export capacity (Pioneer and Diamondback) or majors that can ship directly to their refiners will outperform. Even for these companies, the oversupply is impacting the curve, which is pricing in the Permian’s Cactus II, Gray Oak, and Epic coming online with a total capacity of about 1.6 million barrels a day. These pipes will have to be filled, and E&P companies will be utilizing their deep drilled by uncompleted (DUC) wells to fill the new capacity. Why fill a pipe into an oversupplied market, and the answer depending on the company 1) take or pay contracts 2) hedges protecting economics 3) control of the full hydrocarbon life cycle.

Haliburton discussed an increased in completed stages and pumping hours, which should continue through 3Q in oily basins while seeing a slow down across the gas regions. This is a tale of two cities as the large oilfield services benefit from a recovering international market, and can be more competitive in NAM while also offering a broad scope of services. Some of the SMID caps that have managed their portfolio (ProPetro) will be able to remain competitive given their targeted approach and relatively young equipment.  Primary Vision has clearly shown the discrepancy between oil and gas, which is projected to continue at least into 4Q. Activity still remains well off 2018 levels and has resulted in multiple spreads/ equipment being stacked. Several of the large oilfield service companies have announced 2Q earnings that are moderate to disappointing with soft guidance going forward as active remains sluggish in NAM. The reduction in activity can be seen in multiple areas, but highlighted in some of the below charts:

These declines are reflected across multiple basins and operators with only a select few shaking off the trend and seeing an increase in activity. XTO, Cimarex, and Energen are some examples of increases, but these companies have fallen short of absorbing the spare capacity resulting in stacking. By taking equipment off the market, it has helped protect some pricing for companies such as Haliburton- but others haven’t fared so well- such as RPC.

The frac spread count rose into the beginning of July, but has quickly pared back as E&Ps reassess their 2H plans and address issues surrounding CAPEX and cash flow. The below chart helps highlight the seasonality adjustments across the national frac spread.

US Oil & Gas Exploration & Drilling Frac Spread Count- Seasonal

It will be difficult for other basins to compete for capital within E&Ps as each company looks to stay within cash flow or at least CAPEX guidance. This will keep the Permian active, especially as there are new pipelines coming online to debottleneck some of the region. The natural gas basins will see continued downward pressure as the natural gas curve remains near or below all in break-even costs. It will be difficult to see growth in these areas. The NGL basket price that was helping to support economics in some of these other basins has also weakened hurting completions in areas such as Mid-Con and Eagle Ford. Based on oilfield service guidance, 3Q will see north American completion activity flat to down, but given the increasing pressure on crude pricing- there is more downside risk across all basins. The pipelines coming online will help support some Permian activity, but all the other basins will remain under pressure.

International Markets

The international market is signaling a growing oversupply-specifically in light sweet crude blends. There are about 30 Nigerian shipments waiting for sale in Sept as weakness spreads through the North Sea and West African slates. Time spreads continue to slip as refiners are concerned about demand as the market prepares to purchase shipments heading into Sept. The market remains skewed following the explosion in Philly and permanent closure of PES’s facility, and Hurricane Barry cutting production, limiting refined product demand, and causing some refiners to reduce runs. The market has started to normalize with more diesel heading to Europe and gasoline to PADD1 (east coast). Weather events tend to be transitory, so this is just a normalizing process post Hurricane as the shuttered U.S. production is already back online, and pressure mounts across crude contracts. Heavy blends remain priced at a premium as the growing number of light, sweet shipments struggle to find an end market. The shortage of heavier barrels has prompted Saudi and Kuwait to find a way to bring back the Neutral Zone. While this is a positive development, the first barrel of oil is still a long way off. The Middle East to China crude tanker rates remain relatively soft as demand numbers continue to disappoint across India and South Korea. The negative Global Economic data keeps coming across Primary Vision’s, export/import data, and shipping information. The below highlights a key issue currently impacting the market- Iran- and the tension that continues to hit the market.

Iran Timeline

  • May 2- US lets waivers for Iranian crude expire.
  • May 5- US deploys aircraft carrier group to the ME
  • May 8- Iran relaxes curb to nuclear program
  • May 10- US Maritime Admin wans of Iranian attacks on shipping
  • May 12- 4 ships attacked in the Gulf just outside the Strait of Hormuz
  • June 13- 2 tankers attached south of the Strait of Hormuz
  • June 20- Iran shoots down US drone
  • July 4- Royal Marines seize Grace 1 near Gibraltar for breaching EU sanctions against Syria
  • July 5- Iranian Revolutionary Guard commander threatens to seize a British ship unless Grace 1 is released
  • July 7- Iran will boost uranium enrichment above the cap set under the 2015 nuclear deal- reducing its commitment to the pact. The limit was set at 3.67% by the JCPOA, but Iran is looking to increase it to 4.5%. It was also stated that in another 60 days it would implement a third phase of reducing commitments to the nuclear deal. The reduction in adherence will increase every 60 days, and reach uranium enrichment to 20%. The U.S. called for an emerging meeting with the IAEA that took place on July 10th.
  • July 10-British ship is threatened but any issue is avoided
  • July 18th– U.S. shoots down Iranian drone
  • July 19th– MV Stena Impero is apprehended by Iran and Mesdar is seized and later released.

Vessels are now being escorted through the straight to secure the flow of goods.

Iran has escalated tension by taking action against the MV Stena Impero following additional sanctions levied by the U.S. and the Royal Marines seizing Grace 1. Iran can only use guerrilla tactics to impede shipping, but it will be enough to slow flow as every ship will need an escort and/or incur large increases in insurance premiums. The EU had initially announced a potential structure through INSTEX- Instrument in Support of Trade Exchanges (Germany, France, and UK) to get around U.S. sanctions- but Iran has announced it won’t work without a formal oil deal. This is obviously complicated by the fact a key country in INSTEX is the UK, which seized Grace 1. The bargaining position continues to deteriorate as Tehran demands the ability to export 1.5M barrels a day in order to stay in the nuclear deal. The EU can trigger the JCPOA’s dispute settlement process that takes 45 days. If nothing is fixed by the end of the period, the U.N. sanctions come back automatically without China/Russia able to veto. This will be a key topic of discussion on July 15th when the European Foreign Ministers meet in Brussels. The dependence on the Middle East has shifted away from Europe, with more flow heading into Asia- and some key allies of the U.S.

The growth of crude flow initially spiked into Asia as China built out additional chemical/refining assets with two massive facilities- Hengli and Zhejiang- coming online now with capacity of 800k barrels a day. This initial spike has slowed considerably over the last view months as local run cuts have persisted to make way for the large facilities and local demand declines. Chinese National oil companies currently have 50M metric ton export quota for 2019- which has hit regional margins and is likely to increase pressure as exports rise. China is also sitting on a large position of Iranian crude that is currently bonded, but could be outright purchased at any given time- also slowing their total demand needs. Singapore storage was emptied to flow into Europe/US as disruptions rocked PADD 1 between Philly and Irving. This opened the arb from Europe into PADD 1- which as shown below has more than enough supply. Singapore storage continues to fall as product is moved into competing areas and storage needs remain depressed. Product supply across most of Europe remains well over seasonal averages as demand stays soft. Even with new flow coming into PADD 1 (East Coast) from Europe, the data remains bearish as crude storage remains above seasonal norms and demand for product remains weak. The bigger issue will be the shifting flow of refined products as Chinese facilities saturate the Asian markets, and displace large chunks of MENA flow that will back up into Europe. Europe/Lat AM will become the dumping ground for product coming out of MENA, Europe, and the U.S.

 ARA Gasoline Inventory- Seasonal

Soft refined product demand has been a constant theme that has abated a bit from extremes following the MI receding (ending floods across the Midwest) and supply disruptions across PADD1. Gasoline demand has trended back to the highs, but as we are more than halfway through the driving season and a big disruption hitting with Hurricane Barry- it is hard to see anymore price appreciation in the near term.

The crude story has taken center stage with several factors:

  • The Iran issues in the timeline above- everything will remain fluid as Iran uses guerrilla tactics to force ships to be escorted and drive up the price of insurance.
  • OPEC+ agree to an extension of production cuts for 9 months
  • Russia’s two largest entities: Transneft and Rosneft continue to blame each other for the tainted crude resulting in Transneft refusing to flow oil originating from Rosneft’s largest field. This has pushed Russian production to 3 year lows from 11.19M to 10.79M.
  • Venezuela sanctions remain in place with new sanctions placed on ranking government members
  • Mexican fields remain in terminal decline

These are items that should have helped tighten the global market, as they all occur during peak demand season. Instead, we are seeing draws slow and build accelerate globally. The bullish points above have been offset by the following overarching themes:

    • Global demand is slowing for refined products, which leads to a reduction in crude pricing
    • This is being reflected in the large amount of crude tankers available and falling rates
    • China is exporting more refined product than ever before, and it is set to shift even higher
    • PMIs/PPIs globally are now below 50- highlighting we are in a contractionary period.
    • Nigeria/ Iraq continue to pump above their allotted amount- specifically Iraq
    • S./ Brazil flow continues to trend higher offsetting the drop off in other parts of the world.
    • Saudi has set contracts with the new Chinese facilities coming online
    • High seasonal demand is now past the halfway mark with more MI River flooding going to impact refined product demand.

PRIMARY VISION INSIGHTS MONDAY 01 July, 2019

By Mark Rossano

U.S. Completions

Plains All American’s Texas Cactus II pipeline is tracking on schedule with partial service in late 3Q with full service by 1Q, as pipeline capacity expands to 670k b/d from the original 585k b/d. The differential between WTI Midland and WTI Cushing has normalized to shipping costs as refiners have ramped activity and exports have been hitting close to 3M barrels a day. Refiner utilization rates have recovered to 94.2%- inline with seasonal averages. Imports dipped across the complex, but are set to rise as Brent pricing softens due to weak demand abroad as other regions are forced to roll out economic run cuts (specifically in Asia). The U.S. will be able to maintain market share in Lat America as more Middle East and Asian product flows into Europe. This will challenge the arb from the U.S. Gulf into Europe, but maintain activity into Lat Am along seasonal averages. Another shifting dynamic is the shut down of the refiner in Philly following the explosion, which will pull more product from Europe into PADD 1 (East Coast).

Rig activity continues to trend lower as E&Ps focus on the reduction of drilled but uncompleted wells to maintain cost in a volatile pricing market. The forecast for frac spreads remains off the 2018 pace with an expectation of about 450 spreads (which will slowly trend higher) and a rolling average of about 452. Activity in the Utica and Marcellus will continue to slow as natural gas pricing remains under significant pressure. The Permian and Eagle Ford will be the most active, with activity in the Eagle Ford remaining below seasonal averages as the Permian slowly increase activity over the next several weeks pushing the national average higher.

The volatility in crude pricing and uncertainty in the market (OPEC+ meeting, G20 Meeting, global growth concerns) will keep E&Ps cautious, but in the short term- won’t cause any adjustment to drilling plans. EOG, Continental, Chevron, and Exxon have maintained their top spots in drilling activity, but the merger of Anadarko and Oxy will propel them into the top three. The new data from Primary Vison coming next month highlights activity growth, and indicates companies with the largest chance of expansion vs decline. Range Resources and other natural gas names fall into the category of challenging pricing frameworks, while Pioneer’s steady activity highlights its firm transport capacity. Pioneer remains a premier takeout target for the majors looking to pick up contiguous acreage in the Midland (heavier vs the Delaware) with decades of running room and firm transport.

Completion Activity will remain well off 2018 highs for several reasons:

  • A larger portfolio of producing wells- even though they have a large decline curve- each one will contribute to the total production level.
  • Newer vintage wells (post mid-2016) were fracked in ways that lend themselves to refracs and workovers with greater effectiveness- reducing the need for “new” jobs
  • Pipeline constraints and export limitations will cap activity
  • Merging companies and shifting into full development mode will focus activity and growth profiles (producing more with less)

The last point lends itself to the roll out of electric frack fleets that can utilize centrally built turbines and powered by associated gas from the wells. The total cost of the fleet can adjust between $35M-$50M depending on who incurs the cost of the turbine. For example, does Haliburton come in with a turnkey solution or does Exxon purchase and operate the turbine and outsource the rest of the equipment needed? The electric spreads are more efficient, less wear and tear increasing equipment life, and cheaper to operate. The biggest hurdle is the upfront cost of the fleets, which will play into the hands of the large major’s oil field service companies and integrated E&Ps, while sending the smaller operators scrambling.

Pressure will remain across the U.S. energy market driven by weakening energy and economic fundamentals abroad and soft demand globally. As refiners are the largest buyer of crude, refined products are the best way to gauge future demand and price movements. The market is showing signs of oversupply on a global level based on product movements, crack spreads, and storage builds. This will keep Brent range bound and targeting the low $60’s and WTI along mid $50’s level. This will limit the activity of the private E&P companies, while the majors/ independents maintain guided activity, because they typically won’t adjust drilling programs unless soft pricing is expected to last for six months or longer. With the impeding OPEC+ meeting and rising tensions with another tanker attack, the market could shift- but the oversupply would take time to clear. Even if OPEC+ announces a “larger” cut, countries such as Russia, Iraq, Angola, and Nigeria have been slow to meet targets, ignored them completely, or received waivers.

Global Energy Markets

Global oil storage is rising as product builds and inherent oil demand remain lackluster, which has already struck throughout Asia, and is now reverberating through the system as product looks for a home. Two tanker attacks weren’t enough to push the crude market higher, as global oversupplies persist. The OPEC+ meeting is now set for July 1-2, which will be a focus because the deteriorating global economy, growing oversupply, and reduction in global oil demand may push for a steeper cut in production. The fact the group has been unable to agree on a date to meet could be a precursor for the inability to increase let alone maintain, current production levels.

The energy market remains awash in refined products, which will weigh on the recent rally in crude pricing. Singapore builds have started to increase following large exports of product into the U.S. and across parts of Europe. Diesel exports remain strong out of Asia- highlighting softer demand, which is manifesting in weak industrial data. India indication for crude demand was down 4%, while refined product exports were up close to 20%. For example, India has additional shipments of diesel and refined products flowing into Europe as local demand for refined product falls under pressure. For example, a shipment was initially destined for the U.S., but the degrading market sent the high-octane gasoline blendstock into Cyprus. This comes at a time when Europe product storage is reaching seasonal highs, and counter seasonal builds have the U.S. markets. Demand for refined products in the U.S. has recovered as flooding and rain slowed across the Midwest. PADD 2 is important for U.S. demand as the region accounts for the most miles driven, and the consistent rain set records, broke levees, and sent the Mississippi over its banks in many regions. PADD1 (with the shut down of the PES Refiner) will now require additional imports from Europe, and whatever can be priced to flow from PADD3 (Jones Act restrictions drive prices higher). Product tanker rates have already started to respond to additional product being pulled in from Europe.

The growth in crude builds will continue as global demand faces economic growth headwinds, and oil supply continues to rise into a soft market. U.S. product demand and exports have recovered, but even with a big crude draw the U.S. is still well above seasonal storage norms. Refiner rates are now along seasonal norms of 94.2%, but unlikely to rise much higher in the near term. Imports of oil are also expected to rise into PADDs 2 and 5- offsetting some of the bullish numbers this week. While the below chart from the IEA is from May, the trend has only accelerated sending OECD oil inventories closer to 3,000 (in millions) as we close out June.

Angola has been unable to sell out the remainder of July with more shipments slipping into Aug, and Nigeria running into the same issues (Angola and Nigeria are the first to sell their cargoes and the quality of crude -Medium sweet- is the “goldilocks” of the industry). A big driver of this decline remains Asia as oil demand weakens further with limited flows into Asia (specifically China- accounting for a large portion of the drop) sending the available VLCCs to multi-year highs with rates dipping again. Russian Urals traded to eight-month lows also highlighting the oversupply of physical crude in the market.

All these negative data points are compounded with a slowing global economy causing central banks to ease abroad. The base case from Osaka is a pause in the trade war between the U.S. and China, but the underlying economic data will weigh down any positive news from the G20 meeting. Asia data for June will be pivotal, but the early indications based on crude and product flows points to further weakness. Economic data has softened considerably in Asia across exports, freight, and lending. China has experienced growing concern in their banking sector with a takeover of the Baoshang Bank and some small repo contracts going defunct. Short term liquidity in China has seized up creating a problem for inter-bank lending. Besides China, “India’s largest refiner Reliance Industries Ltd. is shipping its second cargo in a month of high-octane gasoline blending components to the U.S. at a time when nationwide fuel demand is lagging behind the pace of the previous three years, according to data compiled by Bloomberg. The tanker Arctic Flounder loaded about 60,000 tons of 93-octane alkylate at Sikka, India, in late May.” Europe will put in soft numbers again, but should be slightly better versus the beginning of the quarter. The focus will remain on Brexit and export data out of Germany as softness persists in the fringe countries. Italy remains the weak point, but deteriorating French data could structurally shift the conversation. Emerging markets are in a challenging position as each central bank/local government is running out of optionality to address local level problems. The shift lower in USD acts as a small reprieve, as the market priced in FED cuts- but the move was controlled and stopped right at support levels. The dollar remains range bound, but more aggressive action from foreign central banks and a potential for no FED rate cut at the next meeting will send the dollar out of this range higher. A stronger dollar, weaker economic data, compressing industrial output, and slowing exports will all result in reduced product demand and oil price.