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January cover


The growth in U.S. crude production
Cost Management Solutions    
Cost Management Solutions
In last week’s Trader’s Corner, we began a short series on crude. As we stated, crude is like a fighter jet and propane is a missile fixed under its wing. For the most part, propane follows along with crude, but sometimes fires off in its own direction due to its own fundamentals.

It is important that propane retailers follow the factors that affect crude prices if they are to increase the odds of properly managing the risks associated with buying propane supply. Last week, we discussed the “big flip” in the dynamic of the crude markets.

The Organization of the Petroleum Exporting Countries (OPEC) has been the self-appointed swing producer for crude. Traditionally, to support prices, OPEC countries have cut back on production when the world was oversupplied and then increased production when demand was high. That strategy worked during times when growth in non-OPEC crude production was less than what was needed to meet typical annual growth in crude demand.

But recently, with the weak global economy resulting in slower annual growth in crude demand, and with U.S. crude production increasing at a rapid rate, growth in global production has been greater than growth in crude demand. The result is a glut of crude.

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The table above shows the rapid growth in U.S. crude production. Every week last year and this year set new production highs for that week of the year. The trend has been going on for several years. In 2008, domestic crude production averaged 4.9 million barrels per day (bpd). In 2014, it averaged 8.5 million bpd. So far in 2015, the average daily production has been 9.2 million bpd, which is approaching double the rate of production in 2008.

Because there did not appear to be any end in sight for the growth in U.S. production, OPEC knew that if it lowered its production to try and balance supply and demand - thus keeping crude prices supported - the United States would simply take more market share and the net revenue going to OPEC countries would fall.

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In a paradigm shift, OPEC is taking itself out of the role of swing producer. Instead, it is using its greatest leverage - very low production costs compared with other nations, especially the nonconventional production of crude from shale formations - to push high-cost U.S. and Canadian shale projects and deepwater projects onto the shelf.

Non-OPEC producers responded the way OPEC had hoped: By making massive cuts to capital spending, mostly to drilling programs. Active rigs drilling in North America have dropped from more than 2,400 to about 1,600 in the past few months, and the trajectory remains down.

In January, OPEC production actually fell, but don’t be fooled. It was not by design and it was not in an effort to support prices. In fact, Saudi Arabia increased production. OPEC production fell because bad weather limited exports from Iraq, and Libyan production was interrupted by civil unrest.

In fact, OPEC said it believes a steady period of Brent crude pricing around $60 per barrel would be good for the market and will increase demand. Indeed, and you can bet that OPEC is going to actively take as much of the new demand as it can, thus improving its revenue.

To be sure, crude at $60 per barrel is hurting many OPEC countries that have set up government budgets highly dependent on crude at much higher values. But OPEC is setting itself up to sell even more crude when prices begin to recover.

Crude prices will begin to firm up when OPEC can no longer meet global demand. As prices rise, taking up the slack will be the higher cost U.S. and Canadian shale and deepwater projects that will begin to get active again. These high-cost producers will play the swing role by bringing on incremental production to balance supply and demand as the global economy recovers.

It could be quite some time before that happens. By then, oil company leaders may be slow in committing to more capital spending on fears prices will be driven back down. Further, rigs that have been stacked for a long period of time - and the crews for those rigs, many of which will have moved on to other careers - will not become active at the drop of a hat. The ramp-up period could be quite slow.

Unfortunately, that is likely to mean spikes in crude prices. We have to remember that when OPEC was acting as the swing producer, Saudi Arabia had reserve capacity of already-drilled wells that simply needed to be opened. The lead time to balance supplies was only 30 to 60 days.

If OPEC reduces its reserve capacity by increasing market share, that reserve capacity will become much less elastic. It could be months to years before the higher-cost producers will react enough to balance supplies and drive prices lower.

So as propane retailers, we should probably expect a period of relatively low and stable crude prices that will keep our propane prices at relatively low levels. Many think crude prices are going to recover starting the second half of this year. Frankly, we think that might be a little soon. Therefore, we should probably consider the possibility of flat crude pricing, even into next winter. But the big consideration is this: Once the global economy gets on better footing and crude demand increases, we better be ready for a period of potentially high crude prices.

The fighter jet to which our missile is attached may climb to very high altitudes in a relatively short period of time. We must be absolutely vigilant in looking for the recovery of the global economy and begin guarding against a price-spike scenario when it occurs. It could be next year, or it could be three years or more before we get to that point.

The more time that passes before it happens, the worse it could be. The thicker the rust accumulates on all the drilling rigs that are being stacked today, and the fewer of the highly experienced crews that are available when the need resurfaces, the higher the potential spike. We will have a period of time that is going to lull a lot of propane retailers into a false sense of security. They may not be prepared when the almost-inevitable price spike occurs, and propane consumers will suffer the consequences of their complacency.


Strong winter weather and an above-average draw on propane inventory helped propane gain, even as crude slipped. Some of the speculative fervor left crude, and a slight downtrend has developed since Feb. 17. Crude fundamentals remain bearish, leaving many to believe crude prices could turn sharply lower again.

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Last Week's Highlights
Worries about high crude inventory and reduced refinery throughput sent crude lower. Propane resisted the fall in crude, but was little changed from Friday’s close.
Propane managed a small gain ahead of Wednesday’s inventory report, with expectations of a large draw on inventory. Crude was up much of the day, but faltered at the end after the Organization of the Petroleum Exporting Countries (OPEC) made it clear it had no intention of conducting an extraordinary meeting to discuss ways to support prices and would not meet until its regularly scheduled June meeting.
Propane prices moved higher after the Energy Information Administration (EIA) reported a larger-than-average draw on inventory for week eight of the year. The draw was not as high as industry expectations, which appeared to limit the upside. Surprisingly, crude prices surged higher, despite the EIA reporting an 8.4-million-barrel build in already record-high U.S. crude inventory. Three-million-barrel draws in gasoline and distillate inventory were supports. An improvement in China’s factory activity provided additional support.
The bearish fundamentals for crude that had been ignored on Wednesday were in full focus. Crude prices plunged, easily giving up all of the previous day’s gain. Propane prices were pulled lower by falling crude. A sharp rise in the U.S. dollar added to the loss for crude.
Big gains in crude to close out the month, as drilling rig activity continued to slow. Mont Belvieu was pulled higher with crude, but Conway lagged the gains.

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Cost Management Solutions LLC (CMS) is a firm dedicated to the analysis of the energy markets for the propane marketplace. Since we are not a supplier of propane, you can be assured our focus is to provide an unbiased analysis.

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