Oil Creating Double Bottom March 21, 2015

THE OIL PRICE DROP OF 2015 WILL RANK AS AN EPIC EVENT!

Last Tuesday afternoon, April oil price punched through the $43 level and

multiple factors indicate it could fall further before establishing a new but

unknown low. OILMAGEDDON REVISITED…. But by Friday, due to the US Fed

meeting, the oil price recovered to about $46 based mainly on weakness in the US

dollar.

In addition, as shown on the Double Bottom graph below, three resistance levels

are indicated that will be barriers to future price increases. The highest and likely

strongest resistance level is $58. In order to penetrate these resistance levels

and move into plus $60 oil, some significant events must happen in a manner that

creates upward momentum.

Graph 1

The BIG question now is what might happen to the WTI oil prices over the next 4

to 6 years. To answer that question, I propose looking at the 1986 and 1999

events. I believe there is a relationship between these two events that could

provide us with clues regarding our future. As I will discuss later, there are many

obvious and hidden factors even a BLACK SWAN event or two that could

significantly affect the future oil prices. But first let’s just look at what the charts

tell us.

The oil price chart for 1984 to 2015 illustrates the relationship between the 1986

and 1999 events and the associated levels of resistance to increasing oil prices

and support to decreases in oil prices. Note that once the oil price penetrates a

level of resistance, the price level can become a support level as illustrated by the

$20 level at the beginning of 2002 (Graph 2).

Graph 2

The 1986 event double bottom lasted about 3 years before the WTI oil price

obtained and frequently tested the $20 resistances level for 9 years. Over this

long period, the price did not even increase by the rate of inflation. In 1999 oil

prices experienced another price event that lasted about 4 years. This event also

experienced a double bottom but in this incident the $20 level acted as a support

level to the price in late 2003.

I would suggest that the 2015 is forming a double bottom for which the final drop

price cannot be predicted easily. The only bright light on the horizon is that the

2015 cycle appears to be compressed relative to the 1986 Event. It appears that

after the double bottom oil prices will return to the $54 level based on Graph 1.

An alternate method to determine a future critical price and point in time is to

look at the various oil price peaks and toughs (Graph 3). The declining peaks

starting with the $140 peak in late in 2007 defines the upper limit of oil price with

time. The increasing troughs starting with the 1999 low of $11 passing through

the $20 low in late 2001 establishes the lower go-forward oil price. Assuming

that these converging lines define a price and point in time, WTI oil will be

$59/bbl. (2015 Dollars) in approximately 2021. As shown on Graph 3, after

applying an inflation rate of 3% per year over 6 years, the oil price would be

approximately $90/bbl. Although the line time appears to be long but not

impossible, the WTI oil price of $90 seems reasonable. This upward trend is

illustrated by the price increase from $70 to $105 between middle 2009 and late

2014.

Graph 3

Now, the BIG question is what factors and/or events might affect the North

American WTI oil price in a positive or negative manner.

1. US Rig Count

As of the end of week March 13th

, the US onshore rig count had dropped a

total of 43% from a high of 1876 in November, 2014 to 1077 rigs on March

13th

, 2015. Based on the Brent/WTI and U.S. Rig Count chart below, the

trajectory (green line) projects that the rig count will fall to just above 800

sometime during April. Although not as marked as the onshore, the Gulf of

Mexico is now down almost 30% from its 2014 high.

The decrease in rig count is starting to impact production level from the three

main oil basins – Permian, Eagle Ford and Bakken. The chart below sourced

from the March EIA Drilling Productivity Monitor compares March to projected

April oil and gas production for the US unconventional basins. With many

companies now running a “drill but don’t complete” strategy the connection

between rig count (drilling activity) and production is likely to become

somewhat decoupled with the production impact being greater than that

indicated solely by the fall in rig count. If the EIA’s March projections turn out

to be correct, this month may mark the anticipated inflection point for

decreases in U.S. shale output, possibly easing the inventory build seen over

the past several months.

That having been said, while near-term production may flatten or decline in

the U.S., in other locations it is still going to take some time before the oil price

fall has a material impact. Canada added a further 100,000 barrels per day this

week from two heavy oil projects, and developments already in progress are

scheduled to add more than 1.5 million barrels per day by late this

decade. Similar momentum can be seen in the Brazil pre-salt projects, and

other major developments projects around the world.

2. US Storage Capacity

U.S. oil inventories reached an 80-year high at 458 million barrels as of 13

March 2015 (up 10 million barrels on prior week) according to the EIA. The

United States may soon run out of spare capacity to store crude, which would

put additional downward pressure on prices. That process would last at least

until the second half of 2015, when U.S. oil production growth is expected to

start abating. At last count, U.S. crude stocks stood at a record 468 million

barrels, the IEA said. "U.S. stocks may soon test storage capacity limits”.

What would the price received for the first barrel of oil production after the

storage capacity is full?

3. North America Fracklog

If oil drillers expect prices to rebound after the biggest drop in six years, some

have come up with an alternative to storing their crude in tanks: They’re

keeping it in the ground. This is accomplished by not completing the well and

placing the well on a fracklog (backlog of unfracked wells) for completion

when oil prices increase to an economic level.

As of March 2015, Harold Hamm, CEO of Continental Resources Inc. estimates

that 85% of US wells are not being completed. Anadarko Petroleum plans to

have 440 uncompleted by the end of 2015 and EOG expects to start 2015 with

a fracklog of about 200 wells and plans to build the inventory though the first

half of the year.

Initial production from these wells range from 750 to 1000 barrels per day

therefore the backlog could represent gross production of as much as 3 million

barrels per day, at least at the outset.

The larger the fracklog becomes, the slower the rebound because the backlog

will have to be worked off.

4. Strong US Dollar

A weaker dollar makes dollar-priced crude more expensive for buyers using

their stronger currencies. Therefore the oil price increase during the week of

March 15th

could have been a dollar play.

5. Corporate Discipline Regarding Capital Preservation

Oil and gas corporations are actively preserving capital by cancelled or

deferring projects, salary reductions and staff layoffs. In addition, some public

companies have raised new capital through the sale of new shares.

Black Sawn Events

1. Negative Interest Rates

As of 2014, the world central bank started to go to negative interest rates. To

date, as much as $3.6 trillion of debt in Europe and Japan trades at negative

yields. This is new territory and the impact of this action is probably unknown.

With negative interest rates in Germany, Switzerland, Ireland, Belgium and

Denmark, almost 1.2 trillion euros worth of European government bonds give

negative yields.

In June 2014 the European Central Bank (ECB) began paying -0.1% on deposits

held in its vault, before lowering the rate to -0.2% in September. Denmark and

Switzerland have negative rates, as well. And on February 12th the Swedes

joined the party: the Riksbank cut its benchmark interest rate to -0.1%. Since

the ECB introduced negative deposit rates the euro has fallen against the

dollar by nearly 20% creating DEFLATION.

2. OPEC 2015 Production Cut

Later this year it is always possible that OPEC or Saudi Arabia/Russia negotiate

some form of production cut that could increase WTI oil price to $70 to $80 a

barrel. The differential to Brent would be of the order of $10 a barrel.

3. Geopolitical Event

With the continuous military conflict in The Ukraine and the expanding activity

of the Islamic State, the level of geopolitical risk is very unpredictable and very

high!

Currently The Ukraine is working on their second cease-fire in the last couple

of years but the situation could deteriorate and explode into a major conflict

again with numerous economic impacts that could destabilize Europe.

Islamic State is now the largest, most dangerous, global terrorist organization

of modern times. Islamic State is creating chaos not only in Iraq and Syria, but

also in Libya and Nigeria … not only in the Middle East and Africa, but also in

Central Asia, Southeast Asia and even Europe … not only by deploying a

propaganda machine aimed at lone-wolf copycats, but also by franchising its

ideology, brand and tactics to pre-existing, well-established terrorist armies on

three continents.