Why $50 Oil Works Against Future Price Increases

Despite oil bulls’ wishful thinking, the real reason oil soared from $30 to $50 a barrel was Wall Street speculators.
At one point this spring, hedge funds had accumulated a record amount of bullish positions in oil futures and options.
But now they have begun liquidating those positions. That’s why we’ve seen the 5% plunge in oil the past few days.
All along, supply/demand fundamentals were and continue to be very poor.
Let’s take a closer look at some of those fundamentals.

Oil Demand Not Making a Dent

Oil bulls can’t stop talking about record gasoline demand in the United States.
And yes, demand for gasoline in the U.S. is setting records. In the week to June 17, the U.S. Energy Information Administration estimated gasoline consumption at 9.815 million barrels a day! That beat the previous peak, set in 2007.
But the bulls are conveniently forgetting about the other side of the equation: supply.
The EIA also reported that more than 237 million barrels of gasoline are  sitting in storage tanks. That is 8.7% more than a year ago. And it is the highest inventory level in June – the start of the summer driving season – since the 1980s.
Adding to that are U.S. inventories of crude oil. They are down – but not much – from all-time record highs set in May.

Oil Supplies Everywhere

Even though U.S. production of oil is down, overseas producers are not slowing down their output.
Russia? Record high production. Iraq? Record high production. Saudi Arabia? Record high production and threatening to raise output even more.
Meanwhile, Iran’s production has come back online faster than anyone expected. Exports are already 700,000 barrels a day higher than before the lifting of sanctions. The country is on course to raise output to 4.7 million barrels a day, an increase of 700,000 barrels a day.
Another word out of oil bulls’ mouths quite often is “Nigeria.” Yet, a look at Nigerian oil exports in May showed that, while down, oil exports were much higher than the bulls portrayed.
Maritime intelligence firm Windward, Reuters reports, found that Nigeria exported between 300,000 and 500,000 barrels per day above what market participants had expected.
The biggest conundrum around oil prices, though, lies right here in the United States

Lots of Wells Coming Online

The biggest danger to oil prices is the vast number of fracklogged wells or DUCs. DUC stands for wells that were Drilled but Uncompleted.
These are wells that can be quickly be brought online and producing, in less than 90 days. As Citigroup analysts told the Financial Times, “DUCs represent the low-hanging fruit for U.S oil producers.”
And sure enough, a whole raft of producers have begun picking that “fruit.” These include Continental Resources (NYSE: CLR), EOG Resources (NYSE: EOG), Oasis Petroleum (NYSE: OAS) and BHP Billiton (NYSE: BHP). A number of other companies including Whiting Petroleum (NYSE: WLL) have said they are also nearing a decision to bring some of their DUCs online.
There are a good number of these wells. Bloomberg Intelligence estimates there were 4,290 such wells in the U.S. at the end of 2015. Consultancy Rystad Energy says there are now about 3,900 in the U.S. Importantly, Rystad estimates that 90% of these wells can be profitable with oil prices at $50 a barrel.

Oil Prices and Well Activation

So the longer oil prices hang at around $50 a barrel, the probabilities rise that more and more of these wells will be brought onstream. That likely possibility can be seen in the increased amount of hedging by the shale producers. Hedging takes the risk out of completing their DUCs.
Rystad and another energy consultancy Wood Mackenzie say that anywhere from 100-120 of these wells will be brought onstream a month.
How much oil will that mean coming onto the market? The two firms’ estimates are close – 250,000 to 300,000 barrels per day will be added to U.S. production by year-end.
Adding that increased output to what the other big other producers around the world are doing and I don’t see a bullish scenario for oil prices.
And when oil turns, look out. All of these momentum-chasing hedge funds may shift their position to the other side of the “boat.” In other words, as they piled on to the upside, they may do the same on the downside.
For me, that makes oil ETFs, such as the United States Oil Fund (NYSEArca: USO), ones to avoid.