Market Notes
December 2019 Issue 

As the decade draws to a close, we note a quiet but staggering milestone - the world consumed more than 100 million barrels of oil per day. In addition, the shale oil & gas revolution in North America has upended the established geopolitical order. Since 2017 OPEC has been playing defense by cutting production and biding its time in waiting out the storm. Beginning in 2020 that strategy may finally bear fruit.

In 2019 a few significant events developed or continued to play out that shape our view of 2020 and beyond. Here are ten observations.
  1. Shale production growth appears to be running up against a wall. After hitting the limits on lateral length and sand, some industry experiments had revealed the limits of downspacing due to parent-child well interference. The perception is that the tricks are running out.
  2. Enhanced oil recovery (EOR) in shale formations using associated natural gas, is another experiment that is garnering attention and effort. But the added recovery is incremental and likely not enough to move the needle.
  3. Public investors have started to perceive the end of an era when production grew by leaps and bounds. Beginning in 2019 investors have been bailing on oil & gas sector en masse.   
  4. Demand expectations have been hampered by threats from trade war and the likely end of the longest economic expansion in history. OPEC, EIA, And IEA forecasts have all indicated surplus ranging from 200,000 to 800,000 bbl/d.
  5. Investors who are still invested in oil & gas have been demanding capital discipline from companies. Free cash flow, not production growth, is king. Public equity and debt markets have been largely inaccessible of late.
  6. Since scale allows companies to lower G&A, optimize production footprint, leverage service providers, and grow within cash flow, it makes sense for industry consolidation. M&A activity may pick up while asset-level A&D continues to languish.
  7. Climate change activism has picked up steam globally and negative sentiment toward fossil fuel should continue intensifying for the foreseeable future. Peak oil demand has been touted a lot in 2019.
  8. Hence the rationale and urgency of Saudi Aramco’s $2-trillion IPO, the biggest the world has ever seen. Their explicit goal is to grab the cash while they can to diversify their overly oil-dependent economy, starting with investments in petrochemical industry.
  9. Geopolitical events that historically caused spikes, e.g. Strait of Hormuz tension, collapse of Venezuelan production and export, and the Saudi oil facility attack, were received with calm. With the startup of major export pipelines from the Permian, WTI-Brent spread should tighten in 2020.
  10. Due to capex reduction, production growth from the U.S. is expected to slow toward zero in 2021. But the “shortfall” from the Americans can easily be made up by OPEC countries who retain much spare capacity, despite their 2017-2020 production cut agreement.
Since I wrote about the structural decline in oil’s volatility in 2017, the central thesis of this balance of forces between OPEC’s massive swing production and America shale’s fast response time has borne out, resulting in the compressed commodity cycle and relatively tight price range. To the extent that an estimated 1 million bbl/d pf new oil from Norway and Brazil coming onstream next year, they are more or less a one-time event. Would anything be fundamentally different in 2020? Not unless you count the slight shifting of power back into the hands of OPEC. With a fair balance between sheiks vs shale, it is hard to see prices make a big move either way. However, the nagging threat of a recession could mean there is an asymmetric setup for a downside move.

Apart from trading and research, we provide technical advisory services for oil & gas midstream transactions. We conduct due diligence for lenders, private equities, operators, and investors by evaluating asset quality, operations, system design, capital budgeting, project feasibility etc. We can be a valuable resource to anyone needing an expert opinion on pipelines, gas plants, terminals and other midstream assets. Contact us for details.


Jeff Lee

CTA, NFA member 499079

Kronos Management, LLC

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