CIB

Keeping “DUCs” in Order

Date: 11/01/2021

Author: Kent Moors, Ph.D.


The shifts in crude oil prices experienced over the past several weeks have brought some rather specious arguments back by talking heads on TV and pundits spinning the next hike scenario.

West Texas Intermediate (WTI), the crude oil benchmark set each day in New York, has gained almost 10 percent (9.94 percent) over the past month through close of trade on Friday. Brent (the other major and more used global benchmark set daily in London) has risen some 5.5 percent. Of greater interest is the narrowing spread between the two, now standing at 0.25 percent. That is narrower than at any point since May 24, 2016.

With only a few exceptions, Brent has been priced higher than WTI for every single daily trading session since mid-August of 2010. Several factors explain this. First, while both Brent and WTI are less sour (meaning having a lower sulfur content) than over 70 percent of the worldwide consignments traded daily, Brent’s grade is a bit closer to what is actually sold. That means those consignments have to be discounted less when Brent is used as the yardstick.

Second, Brent is easier to use against the grade of the crude actually traded internationally because it has a closer exchange to the Argus Sour Crude Rate. That is also set daily in London and is designed to reflect more accurately the oil being sold on the global market.

Third, until recently, an ongoing glut of US crude at Cushing, OK has lowered the WTI price. Cushing is the main confluence of national pipelines and is the location where the WTI price is actually calculated. New spur and throughput pipelines have eased the blockage and allowed more volume to be moved south for export.

The spread indicates WTI has been rising to meet Brent, rather than the global standard declining to meet the American yardstick. It also means that the US price has been accelerating too quickly.

Nonetheless, there should be a slight additional rise as we move into the OPEC meeting next week. The consensus is that OPEC+ (the cartel plus main non-US producers led by Russia) will continue to limit how much oil makes it to market. That will further constrict supply and provide a base for some additional move up.

On the other hand, the market has already priced in the expected move, so any development from OPEC will provide only a modest bump. Then there is the ongoing uncertainty of how the continued COVID impact on foreign markets will affect demand.

The ratcheting effect I often talk about – in which oil has an overall trajectory in one direction (in this case up) despite volatility in the other – is taking shape. My targets for the end of 2021 are $85-$87 a barrel for WTI and $90-$92 for Brent, assuming of course that there are no geopolitical events changing the landscape.

We are just about there now, once again not factoring in any geopolitics or COVID effects.


 

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Anyway, back to the tale being spun by the gang who can’t see beyond their short positions.

This one involves the additional wells drilled by US operators which could be quickly turned into completed wells. The reasoning concludes that the protracted rise in oil prices prompts companies desperate for revenue to complete the wells and drown the market in new volume, thereby sending crude into another tailspin. Well, I have one word for this bit of creative fiction.

Horsepucky.

Aside from yet another example of why a course in Drilling 101 needs to be taken by these lost souls, it is simply misinformation masking as analysis.

Here is the real picture.

Companies have always had a program of drilling wells and then completing them later. This type of well is called a DUC (for “drilled but uncompleted”).

When prices are in excess of $85 a barrel and domestic demand is rising, DUCs are of no consequence. But when concerns emerge about excess production and low pricing levels, at what point these wells kick in become the topic of conversation.

It should not be unexpected, therefore, that the “explain the situation in a thirty-second sound bite” crew would latch on to it. Remember, most attempts to persuade you that the price of oil is going down have a sponsored short position just below the surface.

I have my own scenario in which the prices decline. But that has to do with the artificial machinations in availability and contract pricing practiced by the traders.

A balance should have kicked in by this point. But trading mechanisms have prevented that from happening. There is little doubt that the price has already had two results.

First, the difference between what the increasingly artificial futures contracts (the “paper” barrels) and the consignments actually in trade (the “wet” barrels) has exceeded what trading arbitrage can easily reconcile. Second, the price commanded is beginning to have an adverse impact on profitability in those market sectors most directly dependent upon energy.

While the initial push up in oil prices occurring several months ago had tangible market causes, what has been ongoing over the last six to eight weeks has primarily been the result of artificial manipulation.

As I write this, my proprietary effective crude price (ECP) calculations estimate the current WTI price to be almost 14 percent higher than what internal market indicators justify. Meanwhile, Brent is approaching 16 percent higher.

ECP involves an algorithmic set to determine the genuine (or fair) market price of crude oil once shorts, derivatives, artificial supply moves, and other outliers are removed. Putting it bluntly: an increasing portion of the crude price has been the result of manipulation, not what the market signals. The spread between futures contract pricing set by traders and the price of consignments is now higher than at any point in over sixteen months.

There will be a noticeable oil pricing decline coming, presaged by an unusual indicator of rapid supply increases hitting the market. However, in point of fact, this will simply be excess oil already in the market but offset by heavily structured (and in some cases heavily leveraged) artificial paper. This will have an impact well beyond the energy sector.

There has been some advantage to retail investors in this pricing rise. The move back down, on the other hand, will be even swifter. Unfortunately, the primary winners in this grand charade have not been average individual investors or even the operating companies producing the crude.  It has been private paper cutters trading that paper in a closed, private market.

If you loved the MBO and CDO collapses brought upon by the subprime mortgage implosion beginning in 2007, along with the adverse impact it had on the global dollar-denominated asset and credit markets, you are going to be endeared to this one currently “frying” in oil.

Once the dust has settled, I will explain in detail how this played out and the negative impact it has on broader market elements.

 


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I was first apprised of what was transpiring late in August. Principals in one of the private international networks I advise contacted me to provide market analysis on the move. I refused. We all enjoy making some investment money. But I will never acquire consulting fees off of a blatant manipulation.

But back to our DUCs. An analysis of the current state indicates that those using them to advance a bearish oil outlook may have seriously overstated the problem. Figures tell us the number of U.S. wells drilled over the past three years has averaged about 12,500 a year. At any given time, there are slightly more than 3,500 wells “in preparation.”

Yet there are no signals that companies are drilling more wells with the express purpose of turning them into DUCs awaiting a further rise in prices. In fact, after surveying some two dozen of the largest American E&P (exploration and production) companies, the analytical team at Bernstein has recently concluded no more than 400 of the wells drilled can be considered DUCs.

Even then, evidence indicates that some of these – perhaps as much as 25 percent – are meant as replacements for already producing but maturing wells. In other words, about 100 of these DUCs are not expected to add a drop of additional oil to the total production nationwide.

Yet even if there were no replacement wells in the figures, the increase would be marginal at best. Should every one of these wells be completed, comprise new net volume additions, and be put into production at the same time, estimates put the aggregate additional oil coming on the market at no more than 80,000 barrels a day (and that is on the high side of the projections). Such an increase amounts to less than five-tenths of one percent (00.5 percent) of total daily American production, easily absorbed by market demand.

And even then, all of my industry sources tell me that, if their companies had DUCs in their planning cycle, the intention would always be to complete and release the volume slowly.

Even if there were far more volume available from DUCs, nobody in their right mind would flood the market short term, guaranteeing a decline in profits. That would be the budgetary equivalent of shooting yourself in the foot. Oil in place and easily retrievable is a known (and booked) asset.

But that does not mean it is cheap.

Here is the major reason why DUCs do not pose any significant problem for oil prices. Completing a shale or tight oil well involves running the casing, fracking, moving in the blow out preventer (BOP), setting up pad wellhead production operations, among other matters.

All of that comprises at least 60 percent of the costs involved in a well. Drilling the hole is the easy (and least expensive) part of the operation. With current horizontal, deep, fracked shale/tight oil wells, the completion part alone (taking place upon an already drilled well) runs on average over $3 million in expenses…per DUC.

Average overall expenses for each of these wells now demands a market price of about $80 a barrel. Completing a DUC, unless it is a replacement well (and thereby does not add to the oil in the market), makes no sense. It is expensing a known asset at a loss.

Remember, an operator does not receive the market price. Rather, the producing company receives the wellhead price, representing the first price when the oil comes out of the ground (and is sold to a distributor or wholesaler). At a market price of $80, wellhead prices are averaging about $65 a barrel.

Short of a collapse in the Persian Gulf situation or some similar geopolitical mess, we are not going to see any move to triple-digit oil this year, although the pricing floor will be rising.

The only ducks having any impact on oil prices are those found in a Looney Tunes view of the world.

Dr. Kent Moors


This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).

After moving through the inner circles of royalty, oligarchs, billionaires, and the uber-rich, he discovered some of the most important secrets regarding finance, geo-politics, and business. As a result, he built one of the most impressive rolodexes in the world. His insights and network of contacts took him from a Vietnam veteran to becoming one of the globe’s most sought after consultants, with clients including six of the largest energy companies and the United States government.

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