Once again, we wake up with markets reacting more to macro data versus fundamentals, Goldman Sachs reiterating its bearish call on oil and the EIA back tracking on its data (again). Firstly, all asset classes tend to react to central bank moves and/or macro data more so than actual fundamentals. The weaker dollar, in particular, has created more swings in oil than any other macro factor in recent months.
My view is that the U.S. economy, despite a plethora of excuses for weak GDP figures in the first quarter, is poised to underperform on a relative basis, especially when compared to Europe. The short term reaction to quantitative easing (QE) boosts to economic growth has been proven here in the U.S. and is now playing out in Europe. But just like here, the effects will only be temporary.
Here in the U.S. we have a structural problem with a declining standard of living as wages stagnate and under-employment continues. Higher paying jobs aren’t being added at nearly the pace of other recoveries and politicians are attempting to mask the wage problem by boosting employment at the lower end of the pay scale.
In any event, it appears the U.S. dollar is poised to weaken despite the Fed’s numerous threats to raise rates based on sketchy economic data. My view is that not only will rates not rise but it’s becoming more likely that QE4 is on the table. As I said before, if you’re an oil bull, that’s exactly what you want to hear despite the media acting as the mouth piece for the Fed by talking rates up. Thwarting equity price bubbles seem to be the motivation here on rate threats, but a real increase is probably off the table.
Now let’s turn to the “less relevant” fundaments.
According to Cornerstone Analytics, demand for oil is accelerating in April, up almost 3 million barrels, and on top of waning production, this is also bullish news. The hints from producers from first quarter earnings calls is that oil breaching $70 will signal higher production down the road later in 2015. That means the Goldman Sachs call has some merit. I can see caution on prices rising, but to continue to call for prices to fall is simply ridiculous.
Recall one of the premises of the EIA’s earlier predictions on continued supply ramps in 2015 was the assumption that production via Permian and Eagle Ford would continue. But as the EIA apparently now admits, that premise was way off: the EIA just issued a new forecast that called for big declines in production for the month of June.
The Eagle Ford will see production fall by 47,000 barrels while the Permian may rise by a meager 7,000 barrels per day. Further, the Bakken is expected to decline 31,000 barrels per day (I have predicted in the past that declines were coming there). Overall for June, U.S. production will fall some 86,000 barrels per day; far steeper and faster compared to prior expectations.
Overall, the false premise of the global markets being over supplied by some 2 million barrels per day is greatly exaggerated, especially when considering that demand will probably be revised higher in the coming months.
On the natural gas side, the EIA expects production to reach 46.19 million cubic feet per day (Mcf/d) in the major shale plays in June, a decline of 112 Mcf/d from the month before. That’s a big change particularly when inventories are still below the 5 year average. Output declines in the Eagleford and Bakken will lead the way, offset somewhat by Marcellus and the Utica, which will experience its slowest increase since early 2014.
These downward revisions come on top of previous changes to forecasts. Shale gas regions will experience their first declines since 2013. The EIA continues to be overly optimistic about production levels, and it has been forced to constantly dial back its projections.
We have seen it all before, but the markets and the media are missing what is really going on with energy fundamentals.
By Leonard Brecken of Oilprice.com