Oil's Rout Takes Its Toll

Dominoes Are Falling

Reverberations from the oil-price crash continue as more bankruptcies and increased geopolitical tensions are causing a seismic shift in the long term outlook for energy production. With mounting pressure on oil producing countries leading to civil unrest and more bankruptcies of highly leveraged oil companies, the bottom of the commodity cycle is well underway. The dominoes are falling and prices are rising.

The market rebound yesterday was caused in part by reports that Exxon Mobil's (NYSE:XOM) terminal in Nigeria was blocked by intruders but the risk to supply goes far beyond Nigeria. Reuters says that militant activity has cut Nigeria's oil exports to a more than 22-year low of under 1.4 million bpd.

The crash in oil prices has crashed the Venezuelan economy and despite boosts, Venezuela's state oil company PDVSA said its oil production was unchanged in the first quarter. OPEC has reported it fell to 2.53 million barrels of oil, down almost 200,000 barrels a day from the same period a year ago. Obviously if the country turmoil continues, there is a real risk that number will fall further.

Bloomberg News reported that crude-oil output in Iraq, OPEC’s second-largest producer, has probably peaked and is likely to fall short of the country’s target over the next two years, according to an official with Lukoil PJSC, operator of one of the country’s biggest fields. The reason is because Iraq needs more investment to maintain production at current levels and let’s face it, the investment dollars are not there after the oil price crash and lost production due to the war with ISIS.

Even in Saudi Arabia, oil crash money problems are taking its toll. Another report by Bloomberg News said that they are considering using IOUs to pay outstanding bills with contractors and conserve cash, according to people briefed on the discussions. As payment from the state, contractors would receive bond-like instruments which they could hold until maturity or sell on to banks, the people said, asking not to be identified because the information is private. Bloomberg says that companies have received some payments in cash and the rest could come in the "I-owe-you" notes, the people said, adding that no decisions have been made on the measures.

If you are looking for shale production to ramp up and save the day, think again. Unprecedented pain in the shale patch will make it almost impossible to make a meaningful comeback. Big shale names like Sand Ridge Energy, Linn Energy (NASDAQ:LINE), Penn Energy have all filed for Chapter 11 bankruptcy this week along with Breitburn Energy Partners. Layoffs and the lack of capital will not allow the companies to invest and ramp up production when the lawyers and judges are going to be making most of the decisions. On top of that, companies that are filing Chapter 11 are not adding many oil and gas rigs. Already the rig count is again at the lowest level since Baker Hughes started counting rigs in 1949 and maybe at the lowest back to around 1860 or 1900 if only rotary drilling rigs are counted. We should see another drop in rigs today when Baker Hughes releases data at 12 central time today. Even oil majors are dumping assets, cutting spending and are seeing their proven reserves fall along with their credit ratings.

As for Natural Gas Despite storage levels being high, we think that the market has already priced in "peak pessimism" and prices will only rise going forward. According to EBW Analytics President Andy Weissman: In the event we have an ultra-mild summer, and we don't see much likelihood of that but you can't rule it out, and if in fact we have a winter next winter that is just as mild as the last winter, and we don't see much likelihood of that happening, prices will be relatively close to the present forward curve. We see the current prices for natural gas as being almost a worst-case scenario. That doesn't mean that prices will immediately go straight up, and over the next two to three weeks I think we will see further declines. But we view that as very temporary and a direct product of the fact we are in the middle of the shoulder season when demand for natural gas is at its low point for the year.

The crash in energy and the drop in investment is the largest in history. That means of course that overtime the rebound in oil prices will be the largest in history. As I have written before, we are seeing the seed of the next super-spike in oil being planted. We have seen this story played out in oil historically time and time again. This is the time, if history is any judge, to prepare for the shortages that we will see in the coming years.