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Schork Oil Outlook: Summer Supplies Don't Matter

ENERGY PRICES WERE STRONG ON THURSDAY… as bears had to step out of the way after they failed to parlay Wednesday’s DOE induced selloff.

As we analyze in today’s issue of The Schork Report, a year ago the NYMEX term structure was in a well defined backwardation, i.e. the summer and winter strips were trading at large premiums as we moved out into the future along the x-axis. In other words, the market was willing (and able) to pay up, as it were, for spot molecules.

This year the market is in a steep contango. A year ago you could have purchased the remaining summer strip (K08-V08) at a 70 cent or 7.1% discount to the winter (X08-H09). Today you can buy the summer (K09-V09) at a $1.49 or 37.3% discount to next winter (X09-H10). In other words, the market is simply not concerned regarding supplies this summer.

Producers have a tremendous incentive to build storage this summer. That is important, because the latest numbers per the EIA’s monthly natural gas production report (EIA-914) are not encouraging.

Given lousy margins and the obvious knock-on to rig counts, the report was not difficult to reconcile. For example, per the Fed’s latest Beige Book:

Activity slowed significantly for producers of natural resource products. Reduced global demand and lower prices for oil have prompted a sharp cutback in oil extraction activity since last fall, with Dallas noting an “unprecedented” decline in the domestic rig count that was largely concentrated in their District. Respondents from the Kansas City District expect oil extraction activity to fall further as the year proceeds, and Minneapolis noted that natural gas and mining activities also faltered during the reporting period.

In other words, drilling companies are responding accordingly, i.e. activity is falling off the proverbial cliff. For example, as we already know, rig economics prompted an early spring breakup in Canada. According to Baker Hughes, north of the 48 conterminous states rigs have dropped by 331 or 76 percent since mid February. As a result, rigs are currently 155 or 60 percent below the five-year average.

At the same time, U.S. rig counts have dropped for eighteen straight weeks. In fact, after peaking at 2,031 rigs back at the end of August the count has plunged by 992 or 49 percent. More to the point, the number of total rigs employed in the U.S., 1,039, is now at the lowest point since May 2003 and the number of U.S gas rigs alone, 810, is now at the lowest level since April 2003.

The bulk of this decline has occurred in onshore Texas, 42 percent. Consequently, Texas’ share of the overall U.S. count has dropped from a high of 47.3 percent to 39.4 percent as of last week. With that said, rigs are falling across the board. To wit, outside of Wyoming, January onshore production fell in every other market area per the EIA’s 914 survey.

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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.