Energy Prospectus

Raymond James, June 29, 2015
Energy: Energy Stat of the Week
Energy Stat: When Will U.S. Crude Production Roll Over? It Already Has!
In keeping with our recent focus on tracking down “missing barrels” of oil around the world, this week’s “Stat” will turn our sights to
the U.S. oil market data. Over the past two weeks, we have proposed that the imbalance (or plug) within the IEA’s global oil model
has been driven largely by the combination of underestimated oil demand and Chinese crude stockpiling. Because of this, the
world oil markets are probably tighter (or more bullish) than the initial data suggested. While many investors are aware of the IEA’s
global plug that typically represents understated demand, many are probably not aware that the U.S. Department of Energy’s Energy
Information Agency (or EIA) weekly oil data also has a plug number used to balance its measured weekly U.S. oil supply, demand,
and inventories. As opposed to the IEA, we believe that the largest component of the EIA weekly plug is currently overstating U.S.
oil supply growth. While the agency does not retroactively revise its weekly data set, it does provide more accurate oil supply/
demand data when it publishes its monthly report. This means the most accurate U.S. oil data we have today is from the March
monthly report. So, why is this a problem? It is a problem because the EIA’s weekly data shows U.S. oil supply continuing a steady
climb to current all-time highs, while our production-by-play model shows U.S. oil supply has been falling at an increasing pace since
March.
In this week’s Stat we will detail the discrepancy between the EIA’s weekly data and our proprietary oil supply model, and
show why we think that the EIA’s weekly inventory data is not only overestimating U.S. oil production but has completely missed
the U.S. oil supply rollover. Put another way, we believe that the misinterpretation of the negative U.S. plug in the weekly oil
inventory has sent the signal of an incrementally looser (or bearish) U.S. oil market while we believe U.S. oil production is already
falling.

I believe U.S. crude oil production will decline by over 100,000 barrels per day starting in July and that the rate of decline will accelerate as we move into year-end. It is simple math. It is impossible for oil production not to decline with so few active drilling rigs. Natural gas production is also on decline. - Dan

RJ's Conclusion: "U.S oil supply has probably already rolled over, but don’t expect it to last long. While the EIA weekly supply data
shows that U.S. crude production has continued to grow through June, we think U.S. oil supply has been falling for the past three
months. The fact is, weekly changes in U.S. oil supply is the most uncertain variable in the U.S. supply-demand picture and the EIA
can’t accurately measure “real-time” U.S. oil supply number . That said, we think a reasonable (and more accurate) proxy can be
formed by adjusting the weekly U.S. supply estimate with the EIA’s own weekly “missing barrels.” After making this plug number
adjustment, the weekly U.S. oil data appears to show that U.S. crude production peaked in March, and has been falling since that
time. This conclusion fits far closer with other, more macro-focused, models such as the EIA Drilling Productivity Report and our
reengineered production by play model. Why the difference? Our U.S. oil supply model is built on specific basin type curves
(vintaged monthly) yielding U.S. oil declines should first be rapid and then quickly slow the rate of decline steadily through 2015.
Thus, our model shows production decline rates peaking about now, followed by much slower rates of decline in the back half of the
year. Given this trend, our model suggests that U.S. oil production should approach bottom by year-end, before beginning to grow
modestly again in 2016. Bottom line: We think U.S. oil supply has already been declining for the past three months even though
the weekly EIA data does not yet show any decline. Additionally, U.S. crude-only supply should bottom at the end of 2015 and
gradually increase though 2016."

My take is that the only way the production decline bottoms late this year is if oil prices move higher. I do believe will see WTI above $70/bbl by year-end. If so, we should see an increase in drilling activity in 2016. My SWAG is that we need 1,000 rigs drilling to increase oil production. No matter what happens this year, we will not see the oil rig count over 800 again until the upstream companies have a high level of confidence in higher oil prices. - Dan