This Massive “Crunch” Means Higher Oil Prices
As oil prices inch forward, there’s an inevitable consequence of lower prices building that will help them climb even higher.
It’s called the “reserve crunch.”
Faced with significantly lower oil prices, the replenishment of oil reserves is beginning to take a massive hit.
In fact, Royal Dutch Shell (NYSE: RDS-A) recently reported that it had replaced just 25% of its 2014 production. That’s just 300 million barrels of new reserves to replace 1.2 billion barrels of production.
Now you know why I call it a “crunch.” It’s yet another sign of shrinking future production.
Shell isn’t the only one. Other operators large and small have begun to issue similar statements.
Now in today’s environment of surpluses, it’s hardly surprising that forward-looking production may take a hit. After all, there’s very little reason to continue producing excessive amounts of crude if it’s merely going to depress the price.
Oil Prices: The Impact of Falling Reserves
Of course, the impact of the crunch on oil prices is obvious and easy to understand. Any uptick in demand will result in a disproportionate rise in prices for oil futures contracts – especially as rates of replenishment fall.
As for its impact on stock valuations, it’s actually the “booked reserves” – oil in the ground and readily extractable – that influences what investors will pay for a stock.
Companies do not drill for new oil simply to add to the product flow for the refining of oil products. They also drill to add to their booked reserves, boosting their share price in the process.
Typically, the more reserves a company has, the more it can command in the stock market. Conversely, falling reserves usually depresses the price.
Now you might think that in times of excess supply, the reserves on a company’s books may be less of an advantage. But that’s just not the case this time.
Here’s why: Demand is not dropping. That’s especially true during this time of year.
Once again, it’s useful to remember that today’s low prices were caused by too much supply, not too little demand. It’s the demand side of this equation that will keep oil prices from falling much further.
In fact, this is the period when we begin to see a run up of prices in advance of the primary driving season.
For instance, take a look what is happening with gasoline prices.
While West Texas Intermediate (WTI) has climbed nearly 11% over the past month, futures prices for RBOB (“Reformated Blendstock for Oxygenate Blending,” the gasoline futures contract traded on the NYMEX) have raced ahead by more than 25%.
And just this morning, the continuing conflict in Libya has closed Sarir, the nation’s largest oil field. That follows earlier interruptions of the primary pipelines, along with other port and production facilities.
As a result, Brent has spiked again in London, given the more direct influence MENA (Middle East North Africa) events have on the European market. As of noon today, WTI is up 1% and Brent is up 1.2%. Meanwhile, Brent has doubled the increase of WTI for the month, climbing 24% versus the 11% increase in WTI.
Higher Oil Prices Ahead
Against this volatile backdrop, the overall condition of global reserves places an even greater pressure on oil prices. It’s true, WTI can rely on more secure U.S. reserves. But on the other hand, Brent is very sensitive to the availability of worldwide reserves.
Remember, Brent is used as the benchmark for far more actual oil consignments internationally than WTI. The increasing lack of reserves outside the U.S., therefore, is likely to result in the expansion of the Brent-WTI spread.
This pricing difference has favored Brent for all trading sessions except three since the middle of August 2010. The reserve crunch means that spread will now be increasing again.
Several years ago, declining reserves would have been ammunition for the “Peak Oil” crowd that was always quick to point out the signs that we were running out of crude.
Today, falling reserve figures have morphed into something quite different. Yes, oil is a finite resource. But the advent of huge (and increasing) reserves of extractable unconventional oil (shale, tight, oil sands, ultra-heavy) found in regions across the globe has significantly muted the “sky is falling” approach to crude.
This has become an issue of new price ranges. But not one where $200 a barrel is in the offering. The reserve replenishment situation will be rebalanced along with supply and demand.
But with one caveat…
As the reserve crunch worsens, it will introduce another factor that will help to put a floor under oil prices. It will take the market longer to address the falling reserve balance, especially going into a period of heavier use.
That combined with continuing geopolitical uncertainty (now a market staple, not an outlier or exception to the rule) produces one overriding conclusion.
Despite ample options on the supply side, oil prices are stabilizing and will continue to move up.