Chaos Across The World Is A Good Thing For Oil

Dear Resource Hunter,

This week, I felt I needed to sit down and put on paper all of the oil supply outages currently happening around the world. Combined, there is a lot of oil production off-line.

Some of them would have been impossible to predict. Others… not so much.

Oil prices are way up from the bottom that we saw in February, but I still believe the second half will be very good to those of us who are positioned to profit from rising oil prices.

Nigeria — up to 800,000 Barrels Off-line

I can’t say that I wake up every day and remind myself how lucky I was to be born in Canada. When I spend 20 minutes reading the news, I quickly realize that I should.

While it is missed by most of us living in Canada and the U.S., the unfortunate reality is that most of the world is a mess. Countries like Nigeria that are reliant on oil revenue increasingly so.

Nigeria is a significant oil producer. Going back 25 years, Nigerian oil production has exceeded 2 million barrels a day a lot of the time.

Today, a pipeline or key piece of oil infrastructure being blown up is a near-daily occurrence in Nigeria.

Nigeria’s new President Buhari was elected last year based on his stance against corruption. In an effort to end corruption, he put a stop to pipeline “security payments” that were being made to militants.

The stated reason for those security payments was that the militants were protecting the pipelines. The truth is that the payments were to keep those same militants from blowing up the pipelines.

Extortion would be the word, I believe.

President Buhari tried to do the right thing and stopped the payments. The result of this being… you guessed it, the militants started blowing up pipelines.

Nigerian Oil Output Drops Further

Apparently, they are good at it, too. Nigerian production is down 800,000 barrels per day from the end of last year. That is a big number in the global scheme of things.

I don’t know how long the outages will last. It is going to depend on how willing the new Nigerian government is to take on some serious pain to do the right thing. I certainly wouldn’t expect these militants are going to stop blowing up pipelines simply because they feel it is wrong.

Venezuela — at Least 200,000 Barrels Down, More to Come

I referred to Nigeria as a country that is a mess. Venezuela takes the idea of mess to an entirely new level.

Like Nigeria, Venezuela is also a significant global oil producer. The first quarter of this year saw Venezuela’s reported production at 2.5 million barrels per day. I say reported because who knows how reliable those numbers are.

The oil price collapse has been a big part of the Venezuelan problem, but economic mismanagement over the long term is equally to blame. I guess revenues from $100 per barrel oil can keep big problems hidden. Today the country faces inflation in the triple digits and virtually no remaining cash reserves, and it is virtually certain to default on its debt.

The population is facing food shortages, lack of medicine and violence. I’ve been watching the news from Venezuela for months trying to understand how the country’s oil production hasn’t completely collapsed. So far, it is down 200,000 barrels per day year on year.

Venezuela’s problems just keep getting worse.

The country gets 60% of its power from hydroelectric dams. A long-lasting drought has water levels at the crucial Guri Dam so low that the entire country is being forced to curtail consumption of electricity.

The Venezuelan government just mandated a two-day workweek to conserve electricity. Despite that, rolling blackouts are still being experienced.

The entire country is on the cusp of a meltdown. International service companies like Schlumberger have abandoned operations in Venezuela. There is no telling how low Venezuela’s production might go.

A mass walkout of Venezuela’s oil workers is a real possibility at any point.

Saudi Arabia — Paying With IOUs

Zero interest rates and eager lenders were the main original cause of this oil crash. Too much money thrown at American horizontal producers allowed U.S. production to soar.

It is the Saudis, however, who have kept oil prices this low for so long.

It must be wonderful to have the power that the Saudis do. They just keep pumping away without feeling any financial pain like Nigeria, Venezuela or the American oil producers.

But are the Saudis really feeling no pain?

Bloomberg just reported that the Saudi government is planning to use IOUs to pay contractors. That certainly does not sound like a plan from someone in good financial shape.

I would imagine that policy won’t go over pretty well with the contractors as well. This is, after all, a country where citizens are used to being paid for good behavior.

Saudi production has been steady since they really cranked things up a year ago. There is very little room for the Saudis to increase production further but plenty of room for it to fall if the general population becomes restless.

Even the strongest OPEC member is on shaky legs.

Iraq — It Is Only Going to Get Worse From Here

Along with Saudi Arabia, Iraq was the worst thing that happened to oil prices in 2015. Billions of dollars of investments that were made in the preceding years came to fruition and Iraq production soared.

The next several years are going to look very different. The country is going to feel the effects of the lack of investment that has taken place since ISIS really got rolling and the oil price crashed.

It only takes some pretty-simple math to figure out where Iraq production is headed. The oil ministry in the country has actually gone to the foreign oil firms operating in Iraq and asked them to slow their investment.

The reason is that the Iraq government can’t pay them for their work. Oil prices cut by two-thirds and huge amounts of money being spent on the war against ISIS have tapped the government coffers. Throw in the rampant corruption that exists within the Iraqi government and you have a real money problem. An official agreement has been reached with most foreign companies to reduce their investment by 50%.

When you cut spending by that much, it isn’t just going to put an end to production growth; it is going to make it nearly impossible to just maintain production.

The Iraq oil production growth engine is stalled.

Fort McMurray — 1.2 Million Barrels Down for How Long?

Then there is this unexpected nightmare. It is hard to care about oil production when an entire city is on the verge of being destroyed.

Estimates that I have seen are that production has been down by 1.2 million barrels per day for a couple of weeks so far. When all of this production comes back on stream is unclear at this point.

This Fort McMurray situation is not like Nigeria or Libya or Venezuela where the countries are so messed up that the production could be down for years. This production will come back.

Still, this is a huge amount of oil that has gone down, and it has happened at the same time that Nigeria has lost a similarly huge amount.

What this forest fire outage is going to do at the very least is help pull 20 million-plus barrels of oil out of storage, which is a positive that the market never expected. I’ve been saying for months that daily oil supply and demand weren’t too far out of whack and that the problem is the huge amount of oil in storage.

Then There Is the Decline Everywhere Else

The 2 million-plus barrels of outages listed above were all unexpected heading into this year. We knew that the low oil price was creating the potential for chaos, but I wouldn’t have thought this much production would be lost.

There are declines elsewhere, though, that we knew were coming, and they have transpired as expected.

US Production

For the graph above, I pulled the EIA weekly U.S. production figures. The spring and early summer 2015 bounced around a bit, as the EIA was changing its data-gathering process.

The key point to be aware of is that since peaking at 9.6 million barrels per day, U.S. production has dropped 800,000 barrels per day. Monthly production declines are currently roughly 100,000 barrels per day.

Those declines haven’t ended. They are likely accelerating due to the fact that hardly any drilling is going on.

The Bakken rig count, which peaked at 206 rigs in 2014, is now at 25. That is 25! The U.S. could leave this year down another 800,000 barrels per day.

The truth is that I’ve got more declines to report than I have space to write. Chinese production in April was down 5.6% year on year. That is another 200,000 barrels of production lost.

With Pemex struggling (and admittedly having a liquidity problem), Mexican production is also down close to 200,000 barrels per day. Columbia can chip in another 100,000 barrels (with more coming with a recent pipeline bomb of their own). The former Soviet Union states are struggling, too.

All This While Demand Marches Ever Higher

Outside of Iran, there is no country with the ability to raise oil production significantly in the next 12 months. The list of countries with supply declining is long, and the declines are significant.

Meanwhile, demand for oil shows no signs of slowing. In fact, the IEA just raised its estimates of demand growth for Q1 2016 to 1.4 million barrels per day as India, China and Russia were surprisingly strong.

Since oil crashed in the second half of 2014, global oil demand has increased by 3 million barrels per day. Much has changed, folks.

We are set up here for much higher oil prices over at least the next 18–24 months. Perhaps a lot longer as we start to see the true consequences of two full years of underinvestment in this sector.

Keep looking through the windshield,

Jody Chudley

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