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Glimmer of Higher Oil Prices on Horizon, While (Mostly) Warm Weather Stressing Natural Gas

For the oil market, the start to 2016 represents a vicious cycle fed by "apparent market misconceptions and momentum," analysts with Raymond James & Associates Inc. said Monday. Other analysts also have chimed in, noting that oil supply has begun to tighten up, which should lead to better pricing later this year.

However, Bank of America (BofA) Merrill Lynch Global Research on Monday reduced its forecast for U.S. natural gas prices through 2017 on the supply surplus and warm winter temperatures. The note was issued the same day that Washington, DC, and parts of the Northeast remained shuttered on the massive winter storm over the weekend.

Oil prices are in the cellar, but there are some signs of light, said Raymond James analysts Pavel Molchanov and J. Marshall Adkins.

"It doesn’t really surprise us that things have gotten worse before starting to get better in the oil market. Clearly, the start to 2016 represents an extreme example of a vicious cycle that we believe is fed by apparent market misconceptions and momentum."

One perception is that Chinese oil demand is about to disappear, even though oil demand has been robust over the past year, said Molchanov and Adkins. Another are fears that global oil storage "is at imminent risk of becoming physically over-full, even though there is ample room in the U.S., internationally, and floating storage capacity. Third, while the lifting of Iranian oil sanctions has been widely telegraphed (and modeled) since July 2015, apparently not everyone received the memo."

The Raymond James analysts said the "undeniable fact [is] that oil prices cannot stay below the level of cash operating costs for any length of time. Putting all this together, we believe that the longer oil prices stay at current low levels near $30, the higher they will bounce toward the end of this year and into 2017."

Goldman Sachs analysts Damien Courvalin and Raquel Ohana also see U.S. oil output on the decline, in a positive for prices. Using U.S. rig count numbers issued last Friday, it implies domestic production will drop by 95,000 b/d this year. Five directional and one horizontal oil rig were idled week/week, while the vertical rig count rose by one (see Shale Daily, Jan. 22).

The horizontal rig count dropped by two in the Bakken Shale, one in the Eagle Ford Shale and one in the Mississippian Lime, while it was unchanged in the Permian Basin, Niobrara formation and the Granite Wash play.

"The current rig count is still pointing to U.S. production declining sequentially between 2Q2015 and 4Q2015 by 320,000 b/d at the observed path of the U.S. horizontal and vertical rig count across the Permian, Eagle Ford, Bakken and Niobrara shale plays," Courvalin and Ohana said. "The decline would only be 165,000 b/d if we account for the impact of a 10% delay in well completion."

Goldman's updated framework suggests that domestic output would decline by 95,000 b/d this year at the current rig count under its well deferral scenario, which is higher than the 75,000 b/d estimate just one week prior.

"While we attempt to take into account the impact of increased productivity, factoring in that well productivity in the first half of 2015 is double its 2013-2014 trend, we see risk to our production modeling as skewed to the upside later this year given producer comments and results during the 3Q2015 earnings season," said the Goldman team. "Finally, a rapid drawdown of the observed backlog of uncompleted wells could lead to higher production in 2016."

Analysts with Barclays Capital said large-scale capital expenditure cuts worldwide, estimated to be more than $200 billion, have thinned the upstream project pipeline, "which should create a far more constructive balance by the end of this decade..." The market focus "is currently on the prompt surplus. And it is here that supply cuts are only trickling through, while the outlook for demand growth cools further as macro sentiment deteriorates."

Meanwhile, BofA Merrill Lynch's team has revised its average 2016 gas price forecast to $2.60/MMBtu from $3.00 on warm winter temperatures. Production costs are down, but output now is in decline, as is output, analysts noted.

"Still, we are also lowering 2017 natural gas prices from $3.50/MMBtu to $3.20/MMBtu on the back of a massive reduction in operating costs. This shift is also reflected in the price-to-storage relationship, which now implies a lower price for any given deficit or surplus. The price equilibrium for the U.S. natural gas market, where weekly storage levels are in line with the five-year average, is now $3.00/MMBtu compared to $4.00 several years ago. Even then, our estimates for 2017 remain constructive relative to the forward prices.

"In our view, falling U.S. natural gas production and rising demand in the second half of this year will lead to tighter balances through 2017, eventually pushing prices higher."

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