The drop off in rig counts is the litmus test for the health of North American crude production

If one train is travelling at 80 mph from one direction, and another is traveling at 100 mph from a different direction, which one gets to Albuquerque first?

I remember being asked this question in grade school, and at the time I suspected it was a trick question posed by that trickster teacher Mrs. MacDonald! In my Grade School wisdom, I concluded that there was no answer because first of all where were the trains coming from? And secondly, I didn’t know where Albuquerque was or still don’t for that matter.

If we take Albuquerque out of the posed question, then the current crude oil game of chicken has two trains heading directly toward each other. One is engineered by OPEC, and the passengers on the other train are all the other oil producers in general and North American oil sources in particular.

OPEC, which is another name for Saudi Arabia, continues to maintain production and is even offering discounts off of already dangerously low Brent prices to increase their market share. This move has raised the ire of fellow OPEC member namely, Iraq, that is now matching, if not undercutting the Saudi prices.

The OPEC stance on this market flooding is that it’s not their fault.

They won’t cut back because they claim it’s the North American producers who are playing economic Russian roulette.

Hate to say it but they may have a point.

Shale oil and oil sands production continues unabated to the point that U.S. crude inventories are at the highest levels in 80 years for this time of year.

If you add in the Strategic Petroleum Reserve to the commercial inventories that means the U.S. is sitting on over 1.2 billion barrels of crude – and this could increase even more when the Gulf Coast refineries go into their annual scheduled maintenance to prepare for the upcoming driving season. These scheduled refinery closings will increase inventories further and diminished demand for crude will produce yet another uptick in crude inventories, and of course this will drag down crude prices even further.

The bravado preached by the drilling rig operators two months ago has begun to wane. Rig counts are dropping on a weekly basis, even though we’re at peak drilling season.

Drilling contracts are being honored, but the crude is being left in the ground as current crude price levels are challenging the financial viability of even the once thought safe production wells. The drop off in rig counts is the litmus test for the health of North American crude production.

Normal seasonal shutdowns begin in March or April but when we look at crude prices, the economics – or lack thereof – may force the rigs to be silenced in February.

Once the flow rates begin to show a slowdown in crude inventory builds, then that will be the floor price of crude after which prices can then increase, but not at the rate that OPEC let them decrease.

I suspect, or is it ‘susguess’ that the floor will end up at $40/bbl, and look for this in late March.

So the game of Choo-Choo-Chicken is going to carry on, and it will mean that the lowest cost producers – the Saudis – will win.

The North American consumer will be pleased with lower transportation costs. The industrial segment in Central Canada will get a boost with higher exports thanks to a Loonie that is taking up SCUBA lessons.

Albuquerque’s claim to fame is that it was the setting for the TV series Breaking Bad. Western Canada is now getting bad breaks.

But history shows that westerners may bend but they’re tough to break.

~The Grouch

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Roger McKnight is the Chief Petroleum Analyst with En-Pro International Inc.
Roger has over 25 years experience in the oil industry, and has held senior marketing management positions responsible for national and international accounts. He is the originator of the card lock concept of marketing on-road diesel that is now the predominant purchase method of diesel in Canada. Roger's knowledge of the oil industry in North America, and pricing structures has resulted in his expertise being sought as a commentator by local, national, and international media. Roger is a regular guest on radio and television programs, and he is quoted regularly in newspapers and magazines across Canada.

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