Who Drove the Bus That Ran Over Us: By Janis Arnold

who drove
Detlef Hallermann an Associate Clinical Professor and Director for the Reliant Energy Trade Center at Texas A&M University

Detlef Hallermann is an Associate Clinical Professor and Director for the Reliant Energy Trade Center at Texas A&M University.  He began his talk at the April 2015 land conference with this disclaimer: All thoughts are my own and I bear no responsibility for your investment decisions based on this presentation. Hang on, the ride is just beginning! In the United States, production is growing and increasing, although our supply is constrained by transportation issues. We’ve got too much crude in the wrong places at the same time we are seeing an increase in Middle Eastern unemployment and unrest.

OPEC figured that if they could cut back on their production, they could keep prices up. They tried to work with Russia. They wanted to cut production in Russia and each OPEC producer 3%, believing that they could get $80 oil, except they all cheat and none of them trust each other. Hence none of them would agree to the collective cuts. Therefore, the current crude market became one big football game.

In North American, the players / producers, are plentiful. There are lots of them out there, sort of like Pop Warner football. With respect to the minor OPEC players, those are all family run businesses, and a lot of those guys are producing quite a bit of oil. Regarding dominant OPEC members, that’s primarily Saudi Arabia.

World oil production levels are up. Over a five-year period we’ve doubled our production, Saudi Arabia is now the second largest producer. Other countries are significant and in Canada, they’ve doubled their production in the last five years as well.who drove 2

The United States is the refining capital of the world; we’re importing at a lower rate due to the production in our country. Our light crude oil imports have shrunk to a tanker a day, and this is from Canada; we’re getting none from Nigeria and Angola,. Needless to say, this is having an impact in those countries. The good news is that we’re really close to becoming energy self-sufficient in North America. We produce 9% of the world’s energy, and we refine and export back out to the rest of the world. The obvious take-away from this fact is that refining firms are good places to put investment money these days as the refining companies are making big profits right now.

North American Transportation Summary: The Keystone Pipeline got shut down again. We still need to move crude from Canada to the U.S. down to Gulf of Mexico where it can be refined.  Keystone alternative: Enbridge Mainline: bringing oil from Canada to Chicago; our crude in Cushing, Oklahoma was selling at $50, we flooded that market. Without the Keystone Pipeline, we would ship by rail crude from Canada to the Gulf Coast, and a little over a million barrels a day will reach ports from Canada. Within two years we likely won’t need to import crude oil from outside of North American. Regarding North American Production: there has been significant growth for the last 2-3 years, and this is just starting to slow down.

With OPEC, we’re seeing a goal line stand. This is really punishing Russia, which supports Iran and Syria. Saudi Arabia is unhappy with this state of affairs. Yeman, the closest neighbor to Saudi Arabia, is in trouble. People have stopped paying attention to the Saudis and they are worried because they don’t control everything that they see. The Saudis are more worried about the Iranians than they are about us. Islamic clerics have historically been in control of what happens in the region and that has changed.

In the second quarter of the game this year, we saw North America’s response: January 2 was national “lay off your contract land-men” day. They kept going until 2015. Now we see rig personnel being laid off, and service companies are experiencing huge layoffs. To put this in perspective, bear in mind that General Electric lays off 10% of their work force every year, and our oil and gas companies grew their workforce by 15% to handle increased demand, suggesting that layoffs aren’t significant at 7%. It is also important to note that producers haven’t laid off anyone; the layoffs are in service companies.

Gas vs. oil: We’ve seen more drops off in crude oil than in natural gas, which hasn’t changed much. We’re going to end up making a lot more money on natural gas as we start exporting.

Horizontal vs. vertical rigs:  In 2009 all vertical rigs that were laid off didn’t come back, the ones that returned came back as horizontal rigs.

Saudi Rig Activity: From Oct 13, there has been a steady increase in rig counts going up. This is when the Saudis started realizing they were losing their monopoly producer status. Increasing their rig rates going up signaled that they were taking off their kid gloves.

What does this suggest for the rest of the year: The companies that don’t have much leverage will be the first to go. Those with a percentage of production that is hedged may be in trouble. Firms with a lot of debt are the most vulnerable.

Bear in mind that 80-90% of the mailbox money comes in during the first 3 years. Right now we’re not seeing a lot of blood in water; that’s going to start but slowly, and dependent upon the amount of reserves a company has. Borrowing base re-determinations happen every spring and fall. Companies at risk are those with a high PDNP. Most of the independents did a real good job of hedging, and banks incentivized the companies to hedge 2016. Right now oil and gas companies are holding their breath.

They don’t want to lay off people, because they don’t want to have to rehire if prices come back up. Fiscal Break Even Prices aren’t the same across the playing field. Related to International Blood Flow, a citizen of Saudi Arabia gets 40K a year. The royal family pays them to live there. Unemployment is very high. Saudi Arabia, with oil prices of $55 a barrel, has a huge deficit, if oil prices continue to fall, they, being self-financed, will likely have to blink first.


Predictions for the rest of year:

Domestically, there will be no Mergers & Acquisition / Divestiture Activity until June/July. We’ll see banks refining and restructuring of lending agreements. We’ll see independents converting PE Debt into Equity. We may also see production declines starting in Q 3. Again, this will not be hemorrhaging so much as restructuring. We will also see production declines starting in Q3. American companies and business are amazingly resilient. One Austin company that was seeing $55 a barrel production is now at $43 a barrel. Over here, we’re adapting.

Internationally: At the June meeting, Saudi Arabia will instill some quotas, and the producers will agree to this because of how badly they have all been hemorrhaging this past year.  By Q4, we will see signals of are covering industry,

Facts that will drive prices: decreasing supply domestically, Eagle Ford, Balkan, Permian, seeing immediate and dramatic response on the supply side


Example: In December 2014 after oil prices fell, there were more SUVs sold in one month than in the previous 24 months, that shows you how quickly Americans respond to lower oil prices, with an increase in demand


Others factors that may come into play: international supply disruption (ISIS), unemployment in Middle East stands at 40-50% so it is easy to understand why so many people can take off work to join ISIS.

Supply growth related to an increase of refining capacity throughout the world

Likely we will see supply and demand responses, prices respond; we’ll come up to $58 a barrel slowly working in fits and starts. There is still an inventory of wells that need to be completed; slowly companies will bring one rig on where they previously had 7 or 8 going. New permits will be issued. The industry will get worse before it gets better. We’ll have a volatile Q2-3 and by the end of 2015 maybe we’ll be up to $70 a barrel.


[By Janis Arnold of REDNews]