Submitted by Erico Matias Tavares of Sinclair & Co.
North America Crude Oil Production Remains Strong
There are signs that crude oil production in the US remains strong, despite the strong correction in prices recently.
The American Association of Railroads (“AAR”) publishes rail traffic data for a variety of commodities in the US and Canada. The subset for petroleum and petroleum products can provide a sense of crude oil volumes being railed across North America (although it also includes refined products like gasoline, distillates, jet fuel and so on).
Here’s the latest monthly data for the US.
Monthly Average of Weekly Railcar Loads, Petroleum and Petroleum Products, US: Jan12 – Jan15 (in 000’s)
Monthly volumes up until last January remained strong, far higher than January of the prior year, although slightly below the high recorded last September.
Volumes in Canada were even stronger.
Monthly Average of Weekly Railcar Loads, Petroleum and Petroleum Products, Canada: Jan12 – Jan15 (in 000’s)
Last January was a record year in Canada. No signs of low oil prices impacting volumes there.
We also track the weekly data published by the AAR, which is more up to date. This is shown in the following graph.
Weekly Railcar Loads, Petroleum and Petroleum Products, USA: 2015 YTD (Green Line) versus Last 5 Year Range (in 000’s)
2014 is at the top of the previous 5-year range (grey cloud), given the strong growth in volumes since 2009. As we can see, 2015 (green line) remains near those highs, at one point even surpassing them.
But there’s an even faster way to gauge volumes being pumped out of the ground in North America, on a daily basis in fact: analyzing the Brent-WTI spread. The evolution of this spread since 2009 is shown in the following graph.
Daily WTI Crude Oil Prices (LHS) and 20d Average of Brent-WTI Spread (RHS): Jan 09-Present (US$/bbl)
Source: US Energy Information Administration.
As crude oil production in North America ramped up in earnest in early 2011 (once prices truly conquered the US$80/bbl level) the WTI discount to Brent, which reflects prices in the international market, exploded higher. There simply wasn’t enough mid-stream capacity (pipelines and railcars) to handle the growth in volumes. The resulting buildup of inventories all the way down to Cushing (a huge storage facility where WTI prices are marked) forced domestic producers to significantly discount their prices. As new midstream infrastructure was built or adapted to the new production reality, those bottlenecks started disappearing, along with the Brent premium.
As such, this spread can be used as an indicator of the robustness of domestic production over the near-term. If volumes remain strong the discount of WTI to Brent should increase accordingly (assuming no major changes in the supply chain). And that is exactly what the arrow in the graph above is showing in recent weeks.
So why would domestic producers continue to pump at these relatively low prices?
Many have some discretion in managing well / drilling costs, and to the extent that these can be reduced, the negative impact of lower prices on investment returns can be mitigated.
More importantly, many producers hedged their production going forward. Now, being a perennially bullish crowd, the industry has historically shown some hesitation in hedging more than a few years out. And there is evidence that this hedging period is not very long indeed.
Source: Oasis Petroleum Investor Presentation, December 2014.
The table above shows the hedging strategy of Oasis Petroleum, a major producer in the Bakken region, as of October 2014. As can be seen, the hedges for their production back then will come off substantially in the second half of this year.
We can certainly debate whether Oasis’ hedging policy is representative of the broader US tight oil industry, but we have seen evidence of this in our discussions with other players. If this is the case, producers should continue to have some price protection at least into the first half of 2015, affording them some staying power and the ability to maintain a decent portion of their original production plans.
And what has been the result of this so far?
Weekly US Ending Stocks (Excluding Strategic Petroleum Reserves): 1990 – Today (in 000’s bbls)
Source: US Energy Information Administration.
As shown in the graph above, a massive build-up of crude oil inventories in the US, to levels never seen in recent history. The International Energy Agency has even warned that the US will run out of storage soon [as Zero Hedge first noted a week ago].
It seems that at that point someone will have to finally stop pumping crude oil out of the ground.