Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

I've seen Disney movies with more suspense than OPEC's upcoming meeting. Spoiler alert: It'll maintain its cuts to oil supply.

A crop of data heading into May show why -- and why doing so still won't solve OPEC's fundamental problem anyway.

The U.S. Energy Information Administration on Friday released its updated estimates for oil supply and demand in February. Earlier weekly estimates had suggested a jump of about 180,000 barrels a day of supply from January, which seemed aggressive. As it turned out, they weren't aggressive enough; the revised gain was 193,000 barrels a day. As if to emphasize the point, later that same day Baker Hughes Inc.'s weekly rig-count data showed the number of those drilling for oil in the U.S. increased for the 15th week in a row.

Renewed Energy
U.S. oil production has been remarkably resilient during the crash and is now rising again along with the rig count
Source: Bloomberg, Energy Information Administration, Baker Hughes
Note: Indexed to November 30th, 2014. Monthly data on U.S. crude oil production ends in February 2017.

Demand data, on the other hand, were decidedly less sprightly. Americans burned 218,000 barrels of gasoline a day less than in February 2016 -- which was when oil prices hit their low point in the crash -- a drop of 2.4 percent.

This was in line with January's drop and happened despite an estimated increase in the miles driven by America's motorists. If that seems puzzling, then Monday's release of lackluster consumer spending data for March, after tepid readings for January and February and Friday's dismal first-quarter GDP number, offered some clues as to why.

Now add in the weekend's news that oil output in strife-torn Libya, which is exempt from OPEC's supply agreement, has rebounded to more than 700,000 barrels a day (for now, anyway). Unless something drastic occurs in the next three weeks or so -- and Venezuela is a wild card -- these bearish supply and demand signals mean OPEC and its partners must extend their supply agreement if they don't want oil prices to slide even further. After the market's initial euphoria about November's agreement, Brent crude has given up most of the gains already:

Retraced
Brent is already close to where it was trading before OPEC's cuts were announced
Source: Bloomberg
Note: Generic 1st month futures price.

Yet the very act of supporting prices also supports the rival supplies working against it. I've written before about how OPEC serves a reluctant role as the mother of shale's invention. But it doesn't end there. Friday also brought a slew of headlines about a comeback for Big Oil, as Exxon Mobil Corp. and Chevron Corp. announced first-quarter results that beat expectations.

As comebacks go, though, it's a qualified one. The number investors are focused on most with the majors is free cash flow, as in: Can they generate enough to invest in the business and fund their all-important dividends? Generally, these companies are given something of a free pass by adding proceeds from disposals into their cash flow, as they are always monetizing some bit of their large, global portfolios of assets. Even on that generous basis, though, the recent upturn, while welcome, isn't a knockout:

Green(ish) Shoots
Exxon and Chevron are back to positive free cash flow, but only just and disposals remain a critical component
Source: Bloomberg, the companies
Note: Adjusted free cash flow calculated as cash from operations plus disposals less capex and dividends paid.

The more telling data came in the two companies' walk-through of which factors had increased profits from a year ago. Chevron's net income swung up from a negative $725 million in the first quarter of 2016 to a positive $2.68 billion, a change of $3.4 billion. Exxon's shift upward was $2.2 billion. Yet of those changes, higher realizations -- i.e., better prices for oil and gas -- equated to 75 percent of the improvement in Chevron's profits; for Exxon it was more than 100 percent.

Chevron's results were, overall, better because, in contrast to Exxon, it has a clearer path to raising production, and several cash-hungry megaprojects are now flipping from being cash drains to cash contributors.

The pertinent point for OPEC, though, is that its efforts to support oil prices are buying time for the likes of Exxon and Chevron to keep grinding down their costs. Those higher realizations, over which the majors have virtually no control, are a gift straight from the conference rooms of Vienna to the boardrooms of Texas and California.

In a rational world, where OPEC's members hadn't built their economies around artificially inflated oil prices, they would simply have taken market share and forced shale producers to rationalize and majors to cut their dividends or production (or both). As it stands, even Saudi Arabia, which saved a big chunk of the supercycle windfall, struggles with this strategy.

And yet, as attention remains fixed on OPEC's supply cuts, and supply in general, weak demand data from the U.S. point to a dilemma that won't go away. OPEC must somehow find a price level high enough to fund its members' lopsided economies but low enough to keep consumers coming back to the pumps. And that price must also somehow keep rivals investing in just enough new production to prevent a supply shock that would crush demand while not being so high they flood the market again.

How exactly this balancing act plays out for OPEC remains to be seen, but it's safe to say it isn't headed for a Hollywood ending.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net