We get to $40 and all I’m saying is cue the G ‘n R.
April WTI futures are finally off the board. Instead of asking for Guns 'n Roses, perhaps we should be playing Taps. We came so close to hitting the buzzer beater. Back a few weeks ago, the hype in the market was that once we made it to $40, U.S. oil producers were going to open up the floodgates and crude oil was going to flow free once again. This was oh-so-important because the other buzz bandied about the market was that once we hit April, the death knell was about to toll and the bell tolls for thee. Credit lines were coming due and hedges were coming off.
For those that are big players in the WTI futures market, you all saw some abnormal trading activity through the day and into the close (TAS). More than likely we were seeing a lot of book balancing. Hedges were pulled off during the day and the banks were slicing off the end of day swap values. Again, all up front and right there during the month of the April WTI contract.. If anything, it lent validity to all the talk about April as time to get the devil’s due.
Now as for these ruminations about oil coming back online at $40, well, no. The way this all works out is that a bank has to first value the producer’s risk before they lay out more credit or extend the current line. Let’s start out with that risk factor first. It’s true that a lot of U.S. producers have spent the last year figuring out how to squeeze oil from a rock and do it a lot cheaper. I wouldn’t argue with the idea that producers are making money at $40 a barrel. The problem starts with the fact that the margin they are making isn’t all that big.
I’ve heard break even down to as much as $28/bbl in some areas of Texas. The general consensus though is that $34 to $38 is about where the low point lies for most. Everything here though is about location. If you’re producing in the USGC area, there’s plenty of cheap storage, transportation costs to refineries is about as low as you can get and in the best efforts of marketers, you just might be able to export that out of the United States to foreign buyers. On the other hand, if you’re in OK, CO or ND, well you might just be running out of time and time is money.
This is where banks are willing to give money, but time is not something they will deal in. This $40 level has left not a lot of room for slippage. Start locking in production with a $40 hedge and prices dip down again and it’s a matter of time before your unhedged production sinks you. Since producers are already under water, trying to make up losses with margins this small, it’s like bailing out the Titanic with a sand pail. If you haven’t noticed, Wall Street has not only missed the mark on $20 oil, they have been on the wrong side of the USD and interest rates for a few years running too.
No way they let a pop to $40 become the next Mortgage Crisis. Where we really might see production come back online is more realistically in the $50 area. That gives enough cushion to drop back to $40 and gets us in an area where the mindset is more focused on $70 and not $20. Banks don’t care about winners and redemption, they care about how they are going to make money. And the one thing that is most important to them, the teeming millions know oh so well, it’s always about time.