11/14/17

Is Peak Permian Only 3 Years Away?

The world’s hottest shale basin, the Permian, is leading the second U.S. wave of tight oil production growth and will continue to do so for years to come, all analysts say.

However, signs have started to emerge that the relentless intensification of drilling leads to diminishing returns, Simon Flowers, Chairman and Chief Analyst at Wood Mackenzie, said in an article this week. Pumping twice as much sand as usual into Permian wells and drilling longer laterals doesn’t deliver commensurate volumes of oil, Flowers notes.

“Drilling costs rise exponentially with depth, and there’s a suspicion that longer wells are hitting a cost efficiency ceiling,” WoodMac’s chief analyst writes.

Moreover, after the early production-exuberance stage, drillers are now much more focused on delivering profits and higher profit margins. They now favor quality over quantity, and value over volumes.

“Might the Permian be reaching the limits of well size and design? Maybe—as Star Trek’s Scotty might observe of an underwhelming high intensity completion ‘you cannae change the laws of physics, Jim’,” Flowers says. But WoodMac suggests that drillers could ‘change the laws of physics’ and that these signs of setbacks may actually be growing pains.

The energy consultancy’s Director of L48 Research, Rob Clarke, argues that there are two basic and very sound reasons that the fading lateral drilling and proppant metrics might be just growing pains. One is much more advanced proppant placement, and the other is the oil majors’ move into the Permian, set to change things.

“Now, pinpoint frac technology can place the proppant exactly where it’s wanted. Science is also being applied to identify the most effective proppant grain size and shape as well as drill bit design and fluid chemistry, all with the aim of boosting EUR,” according to WoodMac.

In addition, ExxonMobil significantly boosted its Permian position earlier this year, and Exxon has “global expertise in extra-long laterals—including a 39,000 footer in Russia,” WoodMac says.

ExxonMobil has already drilled a 12,500-foot well in the Permian and “will no doubt ramp up longer still to test the diminishing returns theory,” Clarke noted.

Now the next challenge will be to deliver an effective completion of such a long well.

“The application of the Majors’ capital and industrial approach will test whether the thousands of wells to be drilled in the future enable the Permian to deliver on the bold growth targets,” WoodMac said.

Two months ago, Wood Mackenzie warned that as drillers are set to continuously develop the hottest U.S. shale play, they may soon start to test the region’s geological limits. And if E&P companies can’t overcome the geological constraints with tech breakthroughs, Permian production could peak in 2021, putting more than 1.5 million bpd of future production in question, and potentially significantly influencing oil prices.

Apart from geological constraints, other factors that could affect Permian growth are increasing service costs and potentially persistently low oil prices.

While oil service margins have increased for oil field service providers such Schlumberger and Halliburton, oil producers, on the other hand, face cost pressure, and “higher well costs may force additional discussion on capital discipline going into 2018, which could be a good thing for the overall supply and demand balance,” BTU Analytics said earlier this month.

At the end of September, Moody’s warned that even if average drilling and completion costs have declined significantly in the past two years, “drillers will be hard pressed to further reduce drill-bit finding and development costs, since drilling efficiencies may be offset by higher service costs.” North American oil producers will need WTI at over $50 a barrel in order to achieve “meaningful capital efficiency”, Moody’s said.

Pioneer Natural Resources, for example, continues to believe in the Permian, but it thinks that the U.S. shale patch is heading toward hitting the ceiling of efficiency gains from larger frackings.

“In the U.S., we are essentially using a sledgehammer approach. We are using larger volumes or sand and fluids and pumping at higher rates,” Pioneer’s CEO Tim Dove said at the Oil & Money conference in London, as quoted by Platts.

“At some point you reach a peak on logistics, limits on sand, water volumes… that’s where we are getting to, [although] we’re not quite there as an industry,” Dove noted.

Still, the expertise of the majors, as well as science and tech breakthroughs in proppant use, may help the Permian outgrow its growing pains faster than expected.

Link to original article: https://oilprice.com/Energy/Crude-Oil/Is-Peak-Permian-Only-3-Years-Away.html

By Tsvetana Paraskova for Oilprice.com

11/13/17

Will The Middle East Become A Major Market Catalyst?

By: Kent Engelke | Capitol Securities

Friday stocks limped to a close and Treasuries fell for the third consecutive day. The reason for the weakness… potential tax reform delay.

As noted a gazillion times, this is the first time in 30 years I have observed near universal bearishness as the majority of bulge bracket firms are forecasting a significant decline. The reasons are varied, but the consistency is the change in monetary policy. Some are pontificating that last week was the beginning of a declining trend.

My only comment is rarely does an event occur when everyone is suggesting that it will occur.

To date, there has been little written about the Middle East and its potential impact upon the markets. In years past, any Middle Eastern volatility was met with considerable selling.

Will the purge in Saudi Arabia be of significance, the greatest purge in at least a generation? What about the abdication of the Lebanese President and the subsequent coup in Lebanon leaving the Iranian supported Hezbollah in power? Saudi Arabia has all but declared war on Lebanon. And then there is the Iranian based Yemini Houthi missile fired at the Saudi Arabian capital, an act of war. How will the Kurdistan referendum in Iraq unfold?

The hatred between Saudi Sunni and Iranian Sunni is at least 1200 years old. The potential flash points are at historical proportions. All must remember Iran, Iraq and Saudi Arabia provide approximately 25% of the world’s daily oil needs.

There is little geopolitical premium in either the equity or oil markets. Is this about to change?

Historically it is the unwritten event that becomes a major market catalyst.

This week there are several inflationary indices released as are retail sales. Also posted is industrial production/capacity utilization as well as housing statistics. How will all be interpreted?

Last night the foreign markets were down. London was down 0.09%, Paris was down 0.68% and Frankfurt was down 0.75%. China was up 0.44% and Japan was down 1.32%.

The Dow should open quietly lower. Is the benign inflationary narrative about to change? According to the NY Fed’s underlying inflation gauge, inflation is now at the highest level in more than 10 years, partially the result of a 35% climb in oil from its June lows. The 10-year is up 8/32 to yield 2.38%.

10/20/17

The Wall Of Worry Is Rising

By: Kent Engelke | Capitol Securities

The “Wall of Worry” is rising. Goldman warns there is an 88% chance of a bear market in the intermediate future. Morgan Stanley stated today is an appropriate time to short the market. Vanguard and Fidelity have both issued bearish pronouncements. These are just the bearish comments of the last three days. The warnings issued the last 9 months are bordering on infinity.

The reasons are well known. Valuations. Lack of breadth. Historic change in monetary policy. Geopolitics. Socio-economic issues, etc.

The difference between today’s Wall of Worry and past “Walls” is that in era’s past equities were plunging.

Perhaps the only definitive comment to make is that if equities enter into a bear market as the largest firms are repetitively suggesting, this will be the most forecasted bear market in history.

Speaking of bear markets, the oil narrative is still extremely negative. Crude prices however are rising as inventories are declining at a pace greater than expected. The geopolitical risks are gargantuan, risks in years past that would create an incredibly bullish narrative.

Conversely to rising crude, oil equities are still languishing, internalizing this never ending bearish narrative, a narrative which in my view that is devoid from reality. It has been suggested oil stocks are priced for $35 oil not $52.

I am certain one can write a SAT question surrounding the negative equity narrative… rising equity prices and a negative crude narrative, but rising crude prices and languishing oil equity prices. But I do poorly on standardized tests.

In my view, the market that is entirely devoid from reality is the Treasury market. The FOMC is projecting an additional 100 basis points of tightening in the next 12-13 months boosting the overnight rate to around 2.25% or to the yield on today’s 10-year Treasury.

If the 14-year average of a 180 basis points spread between the overnight rate and the 10-year Treasury is maintained, the 10-year would rise to a 4.0% yield. If this relationship was to be maintained, the 10-year would decline in price by over 28% in the proceeding year according to Bloomberg.

Wow! All must remember the Committee missed its “central tendency” (which is different than a projection) from 2010-2015 when a comparable increase was suggested. Because of history, I think there is total complacency in the Treasury market.

Perhaps the only definitive statement to make is tomorrow will be interesting where fortunes can potentially be made and lost.

Last night the foreign markets were up. London was up 0.28%, Paris was up 0.23% and Frankfurt was up 0.29%. China was up 0.80%, Japan was up 0.04% and Hang Sang was up 1.17%.

The Dow should open nominally higher on tax cut optimism. The 10-year is off 11/32 to yield 2.36%.

10/13/17

Trump’s EO Halting Insurance Subsidies Comes from Boehner

By: Denise Simon | Founders Code

CNBC: The Trump administration will immediately stop making critically important payments to insurers who sell Obamacare health plans, a bombshell move that is expected to spike premium prices and potentially lead many insurers to exit the marketplace.

The decision to end the billions of dollars worth of so-called cost-sharing reduction (CSR) payments came after months of threats by President Donald Trump to do just that. The news came only hours after Trump signed an executive order that Obamacare advocates said could badly harm the individual insurance marketplaces.

Advocates, along with insurers, health-care provider groups, patient groups and officials in many states, have expressed concerns for months that the cost-sharing reimbursements would be cut off by Trump.

Senate Minority Leader Chuck Schumer, D-N.Y., sharply criticized Trump in a series of Twitter posts late Thursday.

Two months ago, the Congressional Budget Office estimated that individual health plan premiums would be 20 percent higher than originally projected if the payments ceased. It also projected that premiums would be 25 percent higher than they otherwise would be by 2020, and that the federal deficit would be increased by almost $200 billion if the subsidies ended.

The payments, worth $7 billion or so to insurers this year and up to $10 billion or more next year, reimburse insurers for discounts in out-of-pocket health costs they give to low-income Obamacare customers. The discounts must be offered by law.

However, congressional Republicans successfully challenged in a lawsuit the Obama administration’s decision to make the reimbursement payments to insurers without getting the express budgetary authorization from Congress.

Now, both California Attorney General Xavier Becerra and New York State Attorney General Eric Schneiderman said they would file lawsuits seeking to prevent Trump from ending the subsidies.

The two were part of a group of 18 state attorneys general who were given permission this year to intervene in the pending appeal of the federal court decision that had ruled the payments were illegal given their lack of congressional authorization.

*** While the Democrats are crying sabotage, they refuse to tell you that there is a legal ruling that says this funding is illegal. The Obama administration via the Treasury Department essentially stole money from various government agencies to subsidize insurance providers since Congress did not appropriate the funds.

In part it played out this way:

When House Republicans first came up with the idea to take the president to court nearly two years ago, they planned to sue the administration over a completely different part of Obamacare. Then-Speaker John Boehner was, as usual, facing pressure from conservatives who were frustrated at Obama’s liberal use of executive authority and their inability to derail the hated health-care law. So he and his leadership team hatched a plan to file a lawsuit accusing the president and his administration of exceeding their authority by unilaterally delaying the implementation of the employer mandate in Obamacare. The requirement that businesses with more than 50 employees provide insurance to their workers had long been a big target for Republicans and one of the more contentious policies in the law. It was the middle of the mid-term congressional campaigns, and Republicans suspected the administration was delaying the mandate to put off the political pain of compliance until after the election.

“The president changed the health-care law without a vote of Congress, effectively creating his own law by literally waiving the employer mandate and the penalties for failing to comply with it,” Boehner said in a statement at the time. “That’s not the way our system of government was designed to work. No president should have the power to make laws on his or her own.” The irony was that House Republicans had repeatedly assailed the employer mandate as a jobs killer, and yet here they were suing to force the administration to implement it faster. Read more here.

10/10/17

The “Amazon Effect” Is Coming To Oil Markets

While OPEC mulls over further steps to once again support falling oil prices, tech startups are quietly ushering in a new era in oil and gas: the era of the digital oil field.

Much talk has revolved around how software can completely transform the energy industry, but until recently, it was just talk. Now, things are beginning to change, and some observers, such as Cottonwood Venture Partners’ Mark P. Mills, believe we are on the verge of an oil industry transformation of proportions identical to the transformation that Amazon prompted in retail.

According to Mills, the three technological factors that actualized what he calls “the Amazon effect”, which changed the face of retail forever, are evidenced in oil and gas right now. These are cheap computing with industrial-application capabilities; ubiquitous communication networks; and, of course, cloud tech.

The Internet of Things is entering oil and gas, and so are analytics and artificial intelligence. These, Mills believes, will be among the main drivers of a second shale revolution, reinforcing the efficiency push prompted by the latest oil price crisis.

It seems that shale operators have been paying attention to what growing choirs of voices, including Oilprice, have been saying: they are talking more and more about the benefits that software solutions can bring to their business, potentially leveling the playing field for independents, a field that has been tipped in favor of Big Oil for decades.

Long-standing mistrust of technology is now dwindling as the benefits—including streamlining operations, maximizing the success rate of exploration, and optimizing production—make themselves increasingly evident, not least thanks to a trove of tech startups specifically targeting the oil and gas industry.

In a story for Forbes, Mills notes several examples of such startups that are already disrupting the industry with cognitive software for horizontal drilling, an on-demand contractor network, and an AI-driven software platform for well planning, among many others. The common feature among them all is they are narrowly specializing in various segments of the oil industry to deliver solutions that promise to substantially reduce times, labor, and costs, while improving outcomes. What’s not to like?

Tech investments among oil independents are still much below the level already characteristic of other industries such as healthcare or financial services, to mention just a couple. Yet this will also change. In the not-too-distant future we may see a flurry of M&A in oil and gas software development.

The reason for this future consolidation is already evident: there are many oil and gas independents in the shale patch. Technology improvements will soon separate the winners from the losers, so it’s a pretty certain bet that more M&A—a lot more—will likely happen over the next few years.

But independents in the shale patch are already burdened with debts that they took on in order to expand their production, and not all will survive the digital disruption. And they don’t just have Big Oil to contend with; oil and gas independents also have renewable energy solution providers breathing down their necks every time oil prices rise—renewable energy that’s already married to software.

That should be strong enough motivation for shale boomers to make sure they catch up, and catch up fast.

Link to original article: http://oilprice.com/Energy/Crude-Oil/The-Amazon-Effect-Is-Coming-To-Oil-Markets.html

By Irina Slav for Oilprice.com

10/9/17

Was The Unemployment Numbers As Ugly As The Headlines Suggested?

By: Kent Engelke | Capitol Securities

The headline numbers of September’s jobs report were disappointing. Non-farm payrolls contracted for the first time in seven years, albeit August’s data was revised higher. The unemployment rate however fell to the lowest level since February 2001.

At the risk of becoming too technical, non-farm payrolls are determined by calling 140,000 plus businesses employing over 400 workers and asking whether or not they are hiring.

The unemployment rate is determined by calling approximately 60,000 households asking whether or not they have a job.

The labor participation rate (LPR) is an overlooked data point that I think is of great significance. This measures the percentage of people who have a job or are actively looking for a job. If the person exits the work force, that person does not count.

September’s LPR rose to 63.2%, the highest level since August 2013’s 63.3% level. Analysts thought the LPR would remain flat at 62.9%. If the LPR stood around 2009’s level of about 65.7% when the great recession ended, the unemployment rate would be around 8.5%, or about double today’s 4.2% rate.

It was summer 2013 when Dodd Frank started to be implemented. Full implementation was September 2014. The LPR began its decent in August 2013, bottoming two years later in September 2015 at 62.4%. It remained mired around this level until January 2017.

Capital formation is the life blood of capitalism and job creation. Without such, growth will be anemic. Dodd Frank restricts capital formation and job creation. I think there is a direct correlation between the LPR, Dodd Frank and wealth/job creation.

The great job generation era of 1996-1997 was where 90% of jobs were created by small businesses that are defined as companies employing less than 499 people. The LPR was consistently around 67% during this era. Dodd Frank is a major reason why small business creation has been stifled.

In June 2017, Dodd Frank was repealed in the House. Reiterating, I think this repeal is directly related to a rising LPR and 3.0% economic growth.

And then there are rising wages. Wages in September rose at a pace considerably faster than expected. Some are blaming the distorting effects of the hurricanes. Only history will state whether or not this is an accurate conclusion.

This week is the commencement of earning season. How will the early results be interpreted?

The economic calendar is comprised of the Fed Minutes from the September FOMC meeting, various inflation indices, retail sales and sentiment surveys. What will this data suggest?

Last night the foreign markets were quiet. London was down 0.24%, Paris was down 0.01% and Frankfurt was up 0.03%. China was up 0.76%, Japan was up 0.30% and Hang Sang was down 0.46%.

The Dow should open quietly. The bond market is closed today for Columbus Day.

09/28/17

Two Year Treasury Yields Are Now The Highest Since 2008

By: Kent Engelke | Capitol Securities

Equities were mixed as President Trump announced his tax plan; the approval of such will cause a brutal fight in Congress. The NASDAQ and the smaller capitalized companies out performed yesterday. The former because of an acceleration in the expensing of capital good and the later because of potential greater economic activity and inflationary pressures as well as lower tax rates. Financials were also strong on rising interest rates.

The immediate response of the proposal was what all expected complete condemnation from the left side of the aisle and internal bickering on the right side.

I think it is accurate to write society is exhausted by the ineptitude and the inability of Washington to accomplish any objective. The environment is toxic, a toxicity that I am certain will continually be reflected in any immediate or intermediate election.

Speaking of elections, the Iraqi Kurds voted overwhelmingly for independence. The vote is nonbinding, but both Iraq and Turkey are adamantly against the referendum. Will Turkey follow through on its threat to close the Kurdistan pipeline that runs through Turkey? This is the only source of revenue for the Kurds, pumping about 500,000 barrels a day.

If the pipeline is closed, how will the oil markets be affected? Global demand is greater than current production by over 1.2 million barrels a day. Will oil prices rise to $60 barrel in the immediacy if a closure does take place? Will such an increase cause inflation to rise, negatively impacting the bond market?

Speaking of the bond market, long dated Treasuries fell about 1 1/2 points as yields are quickly approaching 2017 highs. One month ago, yields were around annual lows. The reasons for rising yields… delayed response to Yellen’s remarks, durable goods orders that were stronger than expected, and potential tax reform. The two-year Treasury, or the instrument most sensitive to monetary policy, is now yielding the most since 2008.

What will happen today? There is little on the economic calendar, thus suggesting headlines may overly influence the markets.

Last night the foreign markets were mixed. London was down 0.22%, Paris was up 0.05% and Frankfurt was up 0.34%. China was down 0.17%, Japan was up 0.47% and Hang Sang was down 0.80%.

The Dow should open flat. The 10-year is off 4/32 to yield 2.34%.

09/26/17

Will The Bearish Forecasts Come To Fruition?

By: Kent Engelke | Capitol Securities

If the averages stage a considerable decline, it would be the most predicted drop in history. It appears everyone is now forecasting a drop between 10% and 25%. The primary catalyst for the decline… rising interest rates.

Some firms are more detailed about their prognostications, rationale ranging from an “extremely crowded trade” in the mega-sized technology growth issues, to the breakdown of the cross-correlated trade to the radical change in the geopolitical and macroeconomic environment.

I too think the popular averages could decline 10% to 15% for all the reasons listed above, amplified by the massive passivity of most investors. It is my first-hand experience that most are more risk adverse than suggested. Moreover, I ardently believe that if passivity was the pathway to outperformance, all would become gazillionaires over time.

In my view, markets can only operate so long in a period of little research or socioeconomic/geopolitical analysis. There must be some forward looking thought and thesis.

Yesterday, the NASDAQ fell about 1%, a decline lead by mega-sized technology issues as money rotated into the value (aka oil and financial shares). The Dow ended nominally lower.

Today, FRB Chair speaks in Cleveland. Will her comments be of any significance?

Last night the foreign markets were mixed. London was down 0.06%, Paris was down 0.03% and Frankfurt was up 0.08%. China was up 0.06%, Japan was down 0.33% and Hang Sang was up 0.05%.

The Dow should open nominally lower as clarity is lacking on interest rates, taxes and North Korea. The 10-year is unchanged at 2.22%.

09/22/17

Welcome To A New Era

By: Kent Engelke | Capitol Securities

I do not think it is a stretch to write that the markets have officially entered into a new era. QE is now replaced with QT. QE lasted about six years and QT is expected to last for five years. How will all markets respond?

Perhaps the only accurate statement to write is that we don’t know. The pontifications will be great, but only history will dictate the outcome. The Fed’s balance sheet is at a record size and such a feat has never been attempted. Mistakes or missteps will happen. It is not a question as to if, but rather as to when.

As noted many times, the vast majority of bulge bracket firms have made bearish pronouncements before Wednesday’s anticipated announcement with Vanguard yesterday reiterating their heightened concern.

A primary component of all valuation models is corporate cash flow discounted by some interest rates. The higher the interest rate, the lower the valuation if everything else remains the same.

It is now widely known there is a great disparity between value and growth. For this discussion, I will define value as energy and the financials and growth as the technologies. Some benchmarks suggest the disparity between the two is as much as 40%, the greatest difference in almost a generation.

Hypothetically speaking, value should outperform in a moderate rising rate environment. Will there be a prolonged period of value out-performance comparable to the prolonged period of growth out-performance, ending only when all declared growth investing is dead just as many have today declared value as dead?

Yesterday, value outperformed closing nominally higher. Growth was down about 0.50%. Is this a harbinger of things to come?

Last night the foreign markets were mixed. London was up 0.17%, Paris was up 0.39% and Frankfurt was up 0.24%. China was down 0.16%, Japan was down 0.25% and Hang Sang was down 0.82%.

The Dow should open nervously lower. The 10-year is up 5/32 to yield 2.25%.

09/21/17

Will The Two Year Treasury Yield 2.75% By December 2018?

By: Kent Engelke | Capitol Securities

The S & P is stuck in one of the tightest trading ranges in history as all attention is now on the endless commentary on reducing the Fed’s balance sheet. Oil is almost at $51 barrel, the highest level in about five months as OPEC is in 116% of compliance of production cuts. Inventories are declining faster than expected as demand is accelerating because of greater than anticipated global growth.

Speaking of the Fed, the Committee’s forecast calls for inflation to remain under 2% for the next 12 months. I ask if oil rises to $55-$60 barrel, will the Fed maintain this forecast? The FOMC intends to increase rates one more time in 2017 and three times in 2018.

If the Committee takes this path, the overnight rate will be yielding more than the yield on today’s 10-year Treasury and close to the current 30-year Treasury yield.

The FOMC also announced its intentions to begin reducing the size of its balance sheet next month in a gradual but consistent manner. What will QT be met?

As noted many times, the consistency from 2010-2015 that was projected for Fed policy did not unfold. In January, I opined about the odds of expected Fed policy again not materializing, defined this time as greater than expected rates because of stronger than anticipated growth.

Yesterday, it was reiterated for the first time since 2007 that all 45 OECD countries — the 45 largest countries in the world — are expecting their economies to expand in 2017, an expansion lasting into 2018. This is a rarity. Such contiguous expansions last occurred in 2007. Before that was in the late 1980s and before that was 1973.

Equities were mixed on the news. Treasuries were essentially unchanged.

Last night the foreign markets were mixed. London was flat, Paris was up 0.51% and Frankfurt was up 0.33%. China was down 0.24%, Japan was up 0.18% and Hang Sang was down 0.16%.

The Dow should open nervously lower as many are questioning the valuations of the market leaders in a potentially higher rate environment and the impact of QT. The 10-year is off 2/32 to yield 2.28%.