Primary Vision Insights – Enterprise Subscribers

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U.S. completion activity is set to ramp up over the next few weeks, and will likely get back to about 300 spreads by the time we get to the middle of March. The drop in frac spreads is very close to the seasonal norm with some additional pressure driven by inclement weather. The little blue dot in the corner (just above the green 2022 line) shows we are kicking off just above last year. The chart also depicts how there is a steady increase in activity when compared to 2022, 2021, and 2017. Other years just had spikes as we progressed through January, but as the market continues down the path of “manufacturing mode”- the steady increases of 2022 and 2017 is the standard. By manufacturing mode, we are just highlighting the steady/ repeated process that has been adopted in the oil patch. We aren’t going to see massive builds in DUCs (drilled but uncompleted) wells anymore- but rather a steady process of rigs and spreads. We will get some swings driven by seasonality/weather/ holidays, but the more common structure will be steady activity.

If we follow the steady path of 2022 and 2017, we will get to about 300 spreads as we head into March supported by activity in the Permian, Eagle Ford, and Haynesville as the biggest drivers.

The Permian is already starting the year near the high, and we expect to see a quick ramp up to the highs once again in the region.

There are about 325 spreads available in the U.S, but only about 315 will see the energy patch. This activity will be enough for the U.S. to hit about 12.7M barrels a day, but it will be difficult to get north of that without a meaningful increase to equipment. We are picking up efficiencies from dual frac/simulfracs, but those options are limited by horsepower, pad construction, and geology (can the source rock support it). We will see more adoption of the process over the coming year, which will help drive some additional efficiencies. This will also help offset some inflationary pressures still happening today. Labor, steel, proppant, diesel (just to name a few) still remain in a tough spot- especially labor and steel. The below chart gives you an idea at just how INSANE OCTG prices are and even a reduction I process by 50% would still put us at record levels.

The rig count didn’t move down to the same degree as spreads heading into Dec/Jan, which is VERY common. The below chart puts into context the ratio between rigs and spreads. There is always a drop to about .32 as we head into winter followed by an increase in Q1 of spreads vs rigs. This will put us back to about .37 over the next few weeks and likely top out at .42. The amount of rigs running will keep the ratio moving back to the upper end of the extremes.

Drilled but uncompleted wells (DUCs) have come way down from the highs, but as we have been describing- they have leveled off and started to gradually rise. We just don’t need the level of DUCs from ’19-’20 because the U.S. isn’t heading to 19M barrels a day of production. The U.S. can handle about 13.3-13.5M barrels a day based on storage, exports capacity, refining, and petrochemical demand. We can get to about 12.7M barrels if we get about 350 spreads- it’s unlikely we get to 13.3M in the next 24 months given the shortage of equipment. As we move into “manufacturing mode”, the U.S. doesn’t need the elevated levels of backlog wells. Things are moving in a stable environment that will keep rigs and spreads operating in a steady state.

The pricing environment for the U.S. remains strong enough to keep activity moving at an elevated rate and supports us getting back to 300 spreads. WTI pricing at $78 and Brent at $84 is more than enough to keep E&Ps activity at this rate. Natural gas still above $3.50 is also going to support completion activity- especially in the Haynesville. The issue for natural gas in the U.S. is the bifurcation between hubs because if you are selling into Waha vs Perryville- economics are vastly different. We see this continuing to be a problem because the pipeline bottlenecks are long lasting at this point until new capacity comes online. A lot of these new pipelines are also directed to new LNG capacity, which will support NG pricing in the long term because new capacity will still be directed to the international markets. On the NGL front, pricing has come under pressure in the U.S. as supply has grown and demand has slowed with petrochemical demand waning and warmer weather. But, even as local demand has fallen- international demand remains robust, and as local pricing falls- it keeps the U.S. very competitive on flows. This is why we expect exports to maintain a record setting pace even against tough comps. Another supporting factor is the lower production levels from KSA, which will keep Asia buying from the U.S.

On the refining front, Europe is buying diesel aggressively from Russia ahead of the sanctions that come into place on Feb 5 th for refined products. This will continue and limit the amount of U.S. diesel that is purchased in the near term. We expect to see builds in PADD 3 (Gulf of Mexico) as refiners ramp back up following the shut down caused by the freeze off. As Russian flows wane, Europe will pick up their buying again from the U.S., Middle East, and India. Diesel shipments will probably average about 600k-700k in the near term from Russia into Europe.

The issue remains the lack of storage in the region even with a big drop in demand (slowing economy) and rising imports. The limited storage is going to keep Europe beholden to the export market.

We also won’t see a huge surge in refining activity because of the economics of crack spreads in the area. European refiners are buying more crude from CPC, Libya, and the U.S while limiting the purchases from WAF and ME. Most of this is coming by way of ship instead of the piped crude that normally flows from Russia. This increases cost and puts pressure on the crack spread. The economics are further pressured by the record setting amount of gasoline in storage so only the diesel crack is carrying the economics.

The below chart helps show the economics of buying Urals vs Brent, and they have averaged well below $50. This will keep India and China active buyers given the underlying economics. It will also allow both countries to increase their exports of refined products and undercut other refiners in the market.

Differentials are firming a bit in the market as we have an increase in Feb and March sales.

“West Africa’s sales of crude for loading next month have increased in recent days, according to two traders who specialize in the region’s crude. Atlantic Basin oil majors such as Exxon Mobil Corp. and Phillips 66, as well as Asian giants like China’s Unipec, have stepped up their purchases for February-loading, the people said. Unipec purchased between three and four shipments of West African crude so far this week alone, alongside other supplies from the US and the Middle East. The West African sales suggest improving demand for the region’s crude after a slow start to the February trading cycle that got under way in mid-December. It may also signal the start of a pickup in China’s buying as the nation discards its longstanding Covid-Zero policy. About four-fifths of Angola’s crude for February loading has now been sold, according to the people. Meanwhile, three out of five shipments for next month of the Republic of the Congo’s Djeno crude — a grade typically popular with Asian buyers — have also found final destinations. Still, Nigeria — another of the region’s main suppliers — is as yet struggling to find destinations for its output. More than 20 cargoes of Nigerian crude for February are unsold, almost half of the 44 shipments scheduled. “

Even with the increase in sales, we are still seeing Nigeria struggle to clear it’s slate of crude. This is why we don’t believe there is a reason for Nigeria to push production back to 2.2M as they have stated and even 1.7M would be “too much” given the level of floating storage and lack of near term demand. “Nigeria sees oil production reaching 2.2 million barrels per day by year-end, the state-owned energy company’s managing director said in a post on Twitter. “We see a trajectory of restoring production including condensate within the year,” said Mele Kyari, managing director of the Nigerian National Petroleum Co. “Definitely we believe we can hit a target of 2.2mbpd but our budget target is 1.8mbpd, but we know that it is practical to do 2.2 within 2023,” Kyari said.”

China has increased their import quotas in line with market expectations: “According to the document from the Ministry of Commerce, 44 companies, mostly independent refiners, were given 111.82 million tonnes in import quotas in this round. Combined with the 20 million tonnes in 2023 quotas granted to 21 refineries in October, that takes the total for this year to 131.82 million tonnes, up from the 109.03 million tonnes issued in the first batch for 2022. The second batch of quotas for 2022 was released in June last year.” This is married with the step-up in export quotas, which will put more pressure on Asian crack spreads. The only thing supporting Asian refiners is diesel because light disty (gasoline) is at record levels in storage with falling demand.

The big tell will be Lunar New Year with the vacation period in China starting Jan 18 th . We don’t expect to see a big increase in travel as many residents stay local for another year as to not spread COVID to family members. We have seen some increase in travel following the adjustment to the zero covid policy, but we expect things to normalize lower.

We believe that Chinese local demand is going to come in below market expectations, which will put more refined product on the water. KSA expects something similar, which is why they cut OSPs further in Asia to help support refining activity. We don’t think it will be enough, and KSA will either have to cut OSPs further or we will see economic run cuts. This can come by way of “pulling forward” maintenance that normally takes place in the spring season.

On the U.S. front, demand still remains a problem, which we have been calling out for some time. We don’t expect things to improve all that much over the next quarter as economic pressures outweigh cheaper product.

We will get a bounce in gasoline demand back to about 8.2-8.3M barrels a day, but it will still underwhelm vs historics and sit at a decade low.

We also don’t see a big bounce in trucking demand, which will limit underlying diesel consumption.

Once we factor in a weakening global economy and micro-economic impacts to local consumption, we expect crude demand to disappoint to the downside. This is being matched to some degree by a fall in supply, which will keep crude prices fairly range bound over the next few weeks.

Next week I will provide a bigger update on the global economy especially as we have had some new data come out regarding inflation and housing. The housing market continues to miss estimates and disappoint to the downside and will act as a big drag on economic growth.