Friday, May 27, 2016

Fundamental Friday: 27 May 2016

Crude oil: Crude oil fundamentals improved this week as prices threaten to jump above $50 for the first time since last year. Domestic output sped up its freefall as producers cut 24,000 b/d of production last week to end at a total of 8.767 million b/d. Since the beginning of the year, total crude oil production has fallen over 450,000 b/d. almost 5 percent in just under 6 months. Stockpiles fell as well marking the second draw on inventories in the past three weeks. After falling about 4.23 million barrels last week, total crude oil inventories ended at 1.232 billion barrels. Further confirmation is needed to call these declines signs of a reversal in trend.

Refinery fundamentals stabilized last week after peaking at a local maximum the week before. Refinery inputs dropped just under 100,000 b/d to 16.279 million b/d total. So far May refinery inputs average out to 16.276 million b/d which is higher than any April input values. Utilization capacity came in at 89.7 after a drop of 0.8 percent last week. The utilization estimate for the week of April 29th matches this week's value but its input was over 400,000 b/d lower. This suggests refinery are speeding up output expecting heavier summer demand to kick in soon.

Both spot prices continue to creep closer to the $50 a barrel mark which could be a very bullish milestone for investors. A five-day gain of 2.27 percent left WTI at $49.51 a barrel. Brent crude just barely closed above at $50.08 a barrel on Friday.

Natural gas: Natural gas stocks continue to send mixed signals to futures traders. Underground storage grew by 71 bcf to end at 2,825 bcf by the end of the week. While the gains remain largely bearish, the gains are occurring at a slower pace than the 5-year average which leaves a bullish twist on fundamentals. Operating rigs increased by 2 to 87 after briefly dropping to a local minimum. More demand and higher prices should cause this to increase in the coming weeks. Supply change from last week fell 0.6 bcf/d to 79.6 bcf, and demand change dropped 2.2 bcf/d to 63.7 bcf/d.

In the EIA weekly natural gas update, it reported on the addition of LNG powered supply vessels which should increase demand for the energy commodity. As it's prices has fallen below other petroleum-products, LNG's use has a fuel has increased significantly.

Volatility continues to plague Henry Hub spot price traders. A loss of 1.81 percent left natural gas at $2.167 despite gains of 0.74 percent on Friday.

Gasoline: Gasoline prices continue to rise as supply and demand fundamentals get tighter. Finished gasoline stocks flattened to a gain of just 34,000 barrels to 24.339 million total. Component gasoline stocks jumped over 2 million to 215.772 million last week. Refineries slowing down this week led to the growth in component stock but should be temporary. Finished gasoline production fell about 130,000 b/d to 9.866 million b/d. Product supply also decreased to 20.438 million b/d, a decline of 340,000 b/d.

After a mixed week last week, gas prices posted a stronger move last week. Average regular gas prices jumped $0.058 to $2.30 per gallon. Diesel prices grew by $0.060 to $2.357 per gallon as well. Prices haven't been this high since late October of 2015 before the price of oil crashed in late 2015 and early 2016.

Thursday, May 26, 2016

Chevron to Lead $37 Billion Investment in Tengiz Oil Field

In an interview on Wednesday, May 25th, the Kazakh energy minister, Kanat Bozumbayev, announced plans for $37 billion to be invested in the Tengiz oil field led by Chevron Corp. Since 1993, the oil-rich basin has been known as one of the largest crude reserves in the world pumping out over 200,000 b/d worth of crude oil production. The local company, Tengizchevoil (TCO) is in charge of the operations with equity in the operations divided across Kazakh, Russian, and U.S. sources. According to the Wall Street Journal, Chevron owns 50 percent, Exxon-Mobil owns 25 percent, Kazakhstan's Kazmunaigas owns 20 percent, and Russias Lukarco owns 5 percent.

from IEA
The new investment plans mark one of the first announcements of major capital spending by an oil major since oil prices caused capital expenditures to be reduced. The Wall Street Journal reported that "companies have been forced to delay or cancel about $270 billion in projects through March." With oil prices plunging at the beginning of 2016, hopes of an oil recovery were abandoned and only the most economical plays were kept online. Weekly estimates from the Energy Information Agency show that U.S. production is in a freefall dropping below 9 million b/d this year. Shale producers have been cutting their plays in search of cheaper oil in domestic and international plays. The size and location of the Tengiz and Kashagan oil fields in Kazakhstan may prove to be cheaper operations with relatively easy transportation to China, Russia, and Europe. If the optimal scenario is played out, the project would be good news for both Chevron and Kazakhstan.

Estimates of Tengiz production are around 500,000 b/d according to the Wall Street Journal. Chevron planned to expand output to as high as 760,000 b/d before the slump delayed the investments that would help achieve the higher production levels. Equity analysts are saying this newly developed component in Chevron's portfolio will be "the most visible component of Chevron's growth beyond 2019." The large oil field is connected to the now expanding Caspian Pipeline Consortium which Chevron says, "provides an important export route." The new investments will only solidify the claims over equity in Tengizchevroil which has a promising potential growth in the long-term. Estimates for the Tengiz reserve size start at 6 billion and go up to 9 billion barrels says Tengizchevroil. Since 1979, the field has provided anywhere from 17 to 20 billion barrels to the oil markets. Chevron will also gain access to the Karachaganak fields which boast the second largest petroleum reserves in Kazakhstan. These two plays not only bolster the Chevron position but its dominance in a more competitive, blood-thirsty market which is just now experiencing the oil economics without OPEC.

Using Chevron's numbers, one can assess the potential daily realization of the project assuming a consistent expansion in production over time. Using the World Bank's projection of Brent crude prices, it can be shown that the projects revenue should match 2014 levels in 2017 and surpass it in 2018. The output should double over the three years, so costs would increase proportionately with operation costs jumping with each barrel. Transportation costs may see a small decrease as the CPC pipeline expansion adds to export efficiency with more access to regional demand. This all contingent upon spot prices in the $50 a barrel range which may prove to be a likely scenario in the coming years with that level being approached now. Chevron's plan to invest this money might have been triggered by a $50 a barrel. Additionally, Kazakhstan's desperate economic situation has no doubt forced them to provide extra incentives in the deal. The Future Growth Project is definitely something to be bullish as it could translate to future Chevron growth and hint at the reemergence of capital spending from oil majors like Chevron and Exxon-Mobil.

On the Kazakh side, this deal is necessary to relieve the desperate financial situation in which they find themselves. The local energy minister has even admitted, "For us it's good news. This future growth project is very important for us." As an emerging economy that has felt very hard done by the oil crash, any foreign capital looking to develop the natural resources into jobs and revenue is quite desirable. According to the Extractive Industries Transparency Initiative, the oil and gas sector accounted for about 25 percent of the total Kazakhstan GDP in 2013. As this sector deflated, its GDP entered negative territory in 2015. The new deal with Tangiz shareholders could bring as many as 20,000 jobs by 2018 according to the same source. Chevron itself cites its work with the Union of Artisans which has 100 Kazakh members. The company also referenced work with the British Council Kazakhstan in improving local education. Tengizchevroil, from 1993 to 2014, has plowed more than $995 million into "social projects for the community and employees in Atyrau Province." There's no doubt that the growth project will help the Kazakh economy get back on the path to development. Because of this, cooperation and desperation will make Tengiz investments welcome and as the country seeks to expand.

Monday, May 23, 2016

How the Fed Could Break the Economy

Stocks continue to move sluggishly at the beginning of this week with the Dow Jone Industrial Average moving at a flat 0.08 percent today. The S&P 500 and the Nasdaq indices are just as uninteresting with movement around the nil mark today as well. Trends in either direction have flatlined with daily market fluctuations stabilizing to a tight trading range. The limp movements have caused just a -0.74 percent change in the S&P 500 index, a change from more volatile times. As oscillations have dampened, the VIX volatility index has risen 6.4 percent over the past five days to add on to a monthly gain of 10.94 percent total. It seems that with no clear direction, the stock market has entered a very tense position where neither bulls nor bears show that they have the trend in their favor. In these situations, bears often win out.

from Trading Economics
The U.S. manufacturing PMI came out today with an expectation of 51 or higher for the month of May. Unfortunately, the index came in lower at 50.5 losing 0.3 off of April's reading of 50.8. The news erased any chances of early gains for the S&P 500 sending daily trading below yesterday's close by midday. Afternoon trading looks more promising as traders are likely to break even by the end of the day. The falling manufacturing index certainly does little to justify the recovery from the early 2016 losses as it reaches its lowest levels since late 2012. Fundamentally, the metric points to a weakened supply base that has been optimistically traded to highs before the minor crashes in August and January. Have we seen the through? Higher stock prices might only be salvaged by a reversal in the latter part of 2016. At the moment, there are only two things we know. First, the manufacturing sector is very weak right now with lagging domestic and international demand causing supply slowdowns. Second, the manufacturing sector has the potential to improve its fundamentals with mid-2014 highs around 58. Longs will be hoping for an increase in inflation to spur an increase in inventories. Contrarians are pooling their bets with the bears citing this index as support for their position.

Industrial production growth has been equally as disappointing with the lowest levels seen since the financial crisis. While data for May have not come out yet, estimates may be around -1 percent for the month as a slight recovery from the lows in late 2015 looks viable. Ever since September 2015, monthly growth has been below zero as a fundamental contraction stretches into 2016. In the face of these negative industrial growth rates, investors have continued to value industrial shares with a high level of earnings potential. Using the industrial production index produced by the Federal Reserve, we can see how investors have valued the U.S. industrial sector using the Dow Jones Industrial Average. Plotted above is a DJIA-to-industrial-production ratio over the past year and a half. After building throughout 2014, a resistance at 170 is where investors held their evaluations before crashing in the months of August and January to the mid-150's which is where the ascent began in January 2014. March and April of this year both had readings about 170 which could signal another devaluation to come in the near-term. Speculation without supporting fundamentals rarely goes unpunished. 

from Conference Board
Leading indicators, on the other hand, support a near-term bullish outlook with The Conference Board's "Leading Economic Index" growing by 0.6 percent in the month of April. This index typically peaks before stock market peaks as they measure expectations for future fundamentals. Recently, the growth of the metric has slowed over 2015 and 2016 hinting at a long-term peak in the economic cycle. In fact, the indicator is reaching levels seen only during the boom in 2005 and 2006, before the stock market crash in 2008. A slowing LEI might deter some long-term bullish entries while causing short-term traders to rush for last minute profits before the indicators signal something worse.

For now, eyes and ears will be fixed on the Federal Reserve with governors and analysts pitching their opinions on a potential rate hike during the June 15th meeting. Of particular interest were comments made by St. Louis Federal President James Bullard a member of the party set to cast their votes in about three weeks. In an interview, he predicted that a "tight labor market in the United States may put upward pressure on inflation" making a case for higher interest rates stronger. According to the CME Group's FedWatch tool, the probability of a rate hike sits at 30 percent up from 26.3 percent before the Fed President's comments. While a majority of investors are expecting economic pressure to force another pass, many are coming to terms with the need for a normalization of monetary policy. The Fed's inflation projections support the conditions for these policies to be adopted. 

from Federal Reserve
By 2017, the Fed hopes to increase the Federal Funds rate faster than flattening inflation. This will give the effect of increasing real interest rates which can be contractionary if the economy is not growing sufficiently. If inflation does increase by 1.2 percent by the end of 2016, the Fed should be able to continue with a normalizing of policy to a Fed Funds rate of 1.4 as the real effect will be a 0.2 decrease in real interest rates. These calculations are currently guiding the hand of the Federal Reserve as they want to be careful to maintain a balance in tightening the money supply and allowing inflation to return to its long-term target. Oil price movement, which is closely related to inflation fluctuations, will have more of an effect on Yellen's team than ever before as one slip back into the $30's could spell disaster for the global economy. 

There are many signs that point to a sluggish economic outlook that could endanger the current recovery. The Federal Reserve will play an integral role in the upcoming months as it begins to raise interest rates above the near-zero levels which they are at now. Increasing rates too quickly or failing to normalize in time could end in another mini-crash like August and January. Based on the track record of Yellen's troupe, I wouldn't bet on things running as smoothly as they should. Not only do the Federal Reserve members have to move concisely and cohesively, but they must work with the world's monetary institutions to create the right atmosphere for fundamentally sound growth. For that reason, meetings in June and July will be very important events coming up this summer.

Friday, May 20, 2016

Fundamental Friday: 20 May 2016

Crude oil: Domestic production continues down its bullish path reaching another milestone this week. Output fell 11,000 b/d to 8.791 million b/d as producers continue to limit their operations. After crossing the 8.8 million b/d level, the pace of decreases might slow as higher prices give the incentive to keep more wells online. Crude oil stockpiles failed to confirm a reversal that occurred last week. After falling the week before, stocks grew by 1.4 million barrels to 1.236 billion barrels total. Stabilization could occur somewhere around the 1.24 billion level if refineries can keep up with extraction rates.

So far, the domestic downstream operations are gearing up for summer demand. Refinery inputs increased by about 200,000 b/d to 16.371 million b/d this week. A streak of four straight weeks of refinery input gains should be bullish for the crude oil market while bearish on gas prices. Percent operable utilization increased by 1.4 percent to 90.5 percent total. With utilization above 90 percent, traders should prepare for maximum downstream capacity during the summer. Look for these trends to become less volatile and more directed in the upside in the future.

WTI and Brent crude prices inch towards the $50 level. The WTI spot price grows just over 3.5 percent this week to $47.86 a barrel, and Brent adds 2.3 percent to reach $49.25 a barrel.

Natural gas: Natural gas fundamentals continue to be bearish on the supply side countered by rising bullishness on the demand side. Underground stocks grew at a faster pace this week up 73 bcf to a total of 2,754 bcf. A new metric from the EIA weekly report estimates that daily production grew by 0.1 bcf/d to 80.2 bcf/d while demand grew faster, a jump of 1.6 bcf/d to 65.9 bcf/d. The start of the cooling season should continue the trend of steeper demand growth. Baker Hughes reported two new offline rigs this week with a total now at 85, the lowest ever recorded.

A saturated domestic natural gas market could see some relief with the first liquefied natural gas export facility coming online in the beginning of May. The Sabine Pass terminal has already exported almost 32 bcf to countries around the world. With the construction of five more LNG export facilities ongoing, the United States has the potential to increase exports of LNG to nations around the world above the current 9.2 bcf/d.

The Henry Hub spot price continues to be volatile with losses of 2 percent this week. On Friday, trading is flat closing around $2.203 at the end of the week.

Gasoline: Motor gasoline fundamentals remain volatile on the downstream end with minor fluctuations week after week. Finished gasoline stocks dropped by 680,000 barrels to 24.305 million barrels this week. Component stocks fell by about 1.8 million barrels to 213.764 million barrels total. Both stockpiles reached six-week lows as refinery capacity and demand reach near term highs. Finished gasoline fell about 50,000 b/d to 9.997 million b/d, just below the highs of last week about 10 million b/d. Product supplied also remains at high levels with a boost of over 800,000 b/d to 20.775 million b/d. High supplied levels are most likely keeping finished stocks at bay which will surely put pressure on prices at the pump.

Regular and diesel gas prices moved slightly higher this week as crude oil prices continue to recover. Regular U.S. gas prices jumped $0.022 to $2.242 per gallon. From a year ago, prices are down over $0.50 meaning summer demand could be more robust with more consumption possible. Diesel prices are up $0.026 to $2.297 per gallon. With a trend similar to regular prices, diesel consumption is expected to be higher in the summer as well.

Thursday, May 19, 2016

The Green Premium

With oil and gas production at its highest levels in years, no one would guess that its demise is not too far off. The debate over what the future of energy generation will look like continues to heat up as economic viability clashes with climate change politics. Since the beginning of the 2000's, energy companies have had to keep their ears to the ground as they prepare for the stampede of alternate power sources. Support for initiatives like the United Nations Framework Convention on Climate Change and the United States' own Global Climate Change Initiative have forced the market for cleaner sources wide open. The sleek, green feel of solar and wind power has already topped the dirty, industrial reputation of fossil fuel sources. As the markets for green energy quickly improve, the shrinking of the "green premium" will become more and more tolerable to a population with an intensifying concern for the environment.

What is the "green premium?" In short, the green premium is the extra costs associated with the implementation, operation, and use of renewable energy sources. Most of these costs are monetary which is why individuals and families have been reluctant to take on the burden. Other costs may be the extra time needed to install a certain technology, the lack of availability, the extra space that is needed, and extra maintenance costs. The "green premium" continues to weigh on demand for renewable energy as it still only accounts for 13.5 percent of net U.S. electricity generation. Although, the National Renewable Energy Laboratory reports that new renewable energy capacity is on the rise while coal is no longer the most popular method of electricity generation. Thus, the green premium is either becoming smaller or consumers and producers are more willing to take on the extra costs. The analysis provides evidence for both trends.

With the rise of environmental policy and support for the cause of fighting climate change came the popularity of clean energy sources that could dramatically reduce carbon emissions. The last two decades of technological proliferation have allowed the advancement of the wind, solar, and many other electricity generation methods. Coal companies have been under pressure, both financially and environmentally, to leave coal for cleaner energy sources or be labeled as economically obsolete and dangerous to the environment. The NREL report points out that demand for coal energy is slowly fading. U.S. electricity generation from coal has dropped from 49.7 percent in 2004 to 38.5 percent in 2014, a descent that has surrendered the top spot to natural gas. In the investment arena, the end of coal is near if not already here. The chart above shows the apocalyptic fall of the four biggest coal producers in the United States. Despite a combined output of 49.2 percent of the country's coal, the four firms' shares have crashed an average of 97.95 percent from 2011 to today. The low costs of producing and using coal are quickly being overwhelmed by what may be called the "black premium" of environmental unsustainability. Investors and company leadership should have seen the writing on the wall by now. A Gallup poll measuring American's prioritization of economic and environmental issues reported that 50 percent of respondents prioritized environmental issues versus 41 percent who chose economic growth. The results of the survey, conducted in 2014, show that the willingness to take on the green premium is growing. For the young- (18-29) and middle- (30-49) aged demographics, the largest group of consumers over the next two decades, environmental support was even stronger with 60 percent and 52 percent choosing the environment respectively. These generations are showing that they will be inclined to spend the extra dollar for green energy while ignoring the sources deemed "dirty" by their peers.

From Lazard
Over the past ten years, the cost effectiveness of alternative energy technology has been increasing in pursuit of the cheaper conventional methods. As people have continually become more tolerant of the green premium, the actuals costs associated with it have dropped simultaneously. Lazard Asset Management provides excellent insight on the size of the green premium with data measuring the levelized cost of energy. With a comparison of alternative and conventional sources using a dollar to megawatt an hour unit, the trends start to reveal themselves. An assessment of the three rising renewable sources with the highest electric generation, wind, solar, and biomass energy, becomes possible.


Wind energy accounted for 4.4 percent of total U.S. electricity generation in 2014. The second largest renewable energy source (behind hydroelectricity) is famous for its large windmill hooked up to generators harnessing the limitless kinetic energy of the wind. As one of the oldest and most researched alternative methods, the costs of wind energy are surprisingly low compared to its peers. Lazard estimates a price range of $32 to $77 per MWh, the cheapest of the sources researched. It's lower bound beats all conventional forms of electricity generation, including coal and natural gas burning. The scalability of wind turbines allows for cheap per unit energy generation, especially in the appropriate climate. With subsidies factored in, the pricing is reduced to $14 to $63 per MWh. The bargain looks real and the trend of cost efficiency looks even more promising. Since 2009, Lazard's levelized cost estimates for wind energy have decreased 61 percent. But before dismissing the green premium concept in the wind energy market, consider non-monetary costs.

When looking beyond the capital-intensive construction of wind turbines (accounting for 78.1 percent of the cost), the energy it provides is actually quite cheap. Well, not exactly. The differences in geography and climate of the United States cause costs to differ across regions. For example, the flat, windy Midwest region has an estimated low of $32 per MWh, but the hotter Southeast region has an estimated low of $59 which is higher than the low for natural gas combined cycle generation. However, that's only a regional green premium that could easily be sidestepped by the implementation of the appropriate alternative at a more efficient cost. The true green premium for wind energy is space. The United States is still expanding in population and consumption. Therefore, the nation is going to have to sustain the houses, food, and cars of larger generations. Constructing large fields of wind turbines constricts the construction of more buildings and the planting of more farmland. The solution may already exist in offshore wind turbines, but the estimated cost for that technology is over twice the highest onshore wind estimate ($152 per MWh).


The next renewable source accounts for about 0.8 percent of total electricity generation. Solar panels are a clean energy source embraced by individual residences with the funds to pay for the capital costs of installation and upkeep. Often a small metallic patch of these photovoltaic cells can be seen perched on the roof of the individual hoping to finally break from the local energy company contract. Unfortunately, the dream of residential energy independence is buried under large costs and scalability problems. Lazard's estimated range for these structures starts at $184 and runs to $300 MWh topping the costs of every conventional source except one. Rooftop panels for commercial and industrial purposes are cheaper with a range of $109 to $193 per MWh as well as community panels at $78 to $136 per MWh. The serious discussion begins when considering the utility scale or large fields of panels powering a particular location. This large-scale operation would cost $58 to $70 per MWh for crystalline cells or $50 to $60 per MWh for thin film cells. These estimates are more precise but not as cheap as wind energy source, but still just as viable as conventional methods. With subsidies, the low costs are reduced into the $40's.

Once again, the data fails to produce an observable monetary green premium, but that doesn't mean one doesn't exist. In fact, the externalities are quite similar to those of wind energy. Certain geographical regions are exposed to a varying amount of sunlight, thus, increasing the amount of panels needed in shady regions. Lazard estimates the biggest gap between Southwest lows of $53 to Northeast lows of $82 per MWh. Thus, it might not be worth the cost of taking up the extra space to gain the necessary capacity when other energy generation methods are preferable. That points to another green premium, one that's already been mentioned, space. Creating enough power for entire cities would necessitate the construction of giant fields of solar panels that occupy precious life as the country continues to grow. Although, this component of the green premium will continue to shrink as residential rooftop panels become economical. With solar panels, time also becomes an issue as the photovoltaic cells and technology used to enhance its efficiency will need constant maintenance and repairs as it can be relatively sensitive. This could create extra variable operating costs that haven't been factored into the comparison. Solar technology will be best implemented when it becomes sensible for individual households to take on the burden of the time and space costs, spreading out the overall effect that large-scale solar implementation will have.


The last method to analyzed is responsible for 1.6 percent of electricity generation in 2014 and has important implications for the both automobiles and homes. Biomass sources use organic material as a burning fuel in place of the typical combustion of fossil fuels. The biomass inputs vary from animal and human waste to corn and other foods with the necessary chemical make-up for combustion. Estimates from Lazard put costs for biomass electricity generation at $82 to $110 per MWh just cheaper than the conventional nuclear energy source. Although, subsidies keeps it competitive reducing the range to $63 and $95 per MWh. Unlike the wind and solar energy where the fuel is free and limited, costs for biomass fuel sources factor into over 25 percent of the total costs while capital costs exceed both solar and wind implementation expenses. 

Biomass technology is the newest of the three alternative sources mentioned here. The research and development occur mostly on the chemical level with combustion techniques being perfected for efficiency. The green premium here is most obviously monetary as the costs continue to keep large-scale biomass capacity off the market for the time being. Other than its inability to be competitive, biomass methods have other positive externalities. Waste sources can eventually be used as a fuel which helps clean up the excess of disposed materials in the long run. The space premium is not applicable here, and the time premium is only evident in the time necessary for research and development to optimize the technologies. Streamlining biomass combustion methods into automobiles may be the next step after its large-scale implementation for electricity generation. Keep one eye on biomass developments as it enters the future with potential to revolutionize the energy industry.

This article has only looked at the three most popular rising alternative energy resources and the green premiums associated with it. Energy firms going forward will be feverishly looking for new green technologies, like fusion, that will satisfy the growing demand for environmentally friendly technology. The incentives are certainly clear as higher price toleration would boost revenue and income with the innovation of new. efficient technology. Behind those innovations come a whole new world of investment opportunities to capitalize on the markets boosted by the green premium.

Before ending, it might be worth mentioning some of the assumptions made in Lazard's levelized cost data. In particular, their assumption of $3.50 per MMbtu for the price of natural gas seemed a little high to me. The shale plays in the Marcellus and Utica regions have been pumping a record amount of natural gas despite hundreds of rigs going offline at the end of last year and the beginning of 2016. The high underground storage numbers might keep prices below the assumed price for much longer than expected. In addition to that, natural gas is just now emerging as the leading source of the United States electricity generation. Further advances in its combustion efficiency could cause the green premium to increase.

Tuesday, May 17, 2016

With Lower Volatility, Open Interest Will Grow

Using the open interest metric, an investor can determine the support behind the current trend and whether it has the liquidity to continue. Technically defined, open interest is the amount of contracts that are open on the market at any given time. The data is usually provided in aggregated form which is the sum of the open interest of each monthly contract. As expected, the month up next for delivery will have the highest open interest as traders try and put themselves in a good position by the delivery date. The data, provided by the CME group and the CFTC, is used by traders to measure where the money in the market is located. The CFTC records weekly trader commitment data which differentiates between long and short positions as well as different kinds of traders. Analysis of this data, in particular, describes the fuel behind the trend.

Open interest data can be hard to find especially if you want to use historical open interest data to analyzed past trends. The CME provides difficult to read daily bulletins with hundreds of different futures contracts to sift through. Reports from the CFTC are easier to read, but they only provide data for weekly open interest. On the other hand, their breakdown of the commitment of traders is very detailed and comprehensive. Using these reports, I will begin to compile a data series for crude oil futures contracts traded on NYMEX that can be found on the data tab on this website. There should be some free source of this data as the metric is extremely valuable when analyzing the futures market.

Over the past month, futures contracts have been trading at highs for the year. A year to date rebound of  18.84 percent has shrunk losses over the past 52 weeks to -21 percent. The WTI spot price hasn't been this high since November 10th, just before a plunge ran into the new year. The new bulls have created new hopes for oil and gas companies looking to lock in higher prices for their crude oil on the market. Platts reports that a number of companies are looking to get more involved with futures trading in the next couple of months. The U.S. oil markets are quickly tightening as production dropped below 8.9 million b/d last month after peaks of 9.5 million b/d last year. Companies like Devon Energy, ConocoPhillips, Marathon Oil, and Pioneer Natural Resources are just a few who discussed their plans to get in on the action with Platts. Open interest data showed a growing market as prices jumped from April 5th to April 12th. About 30,000 open contracts were opened during that same period. The chart shows how traders joined the market as prices posed a significant rebound. The next week's losses in both open interest and price could be attributed to non-commercial traders cashing in on short-term profits. A solid rebound could be in store with more gradual increases in open interest and price as May closes out. Although, if open interest drops for the second week in a row, a bearish signal of less liquidity could signal lower prices.

The CFTC's Commitment of Traders data allows investors to dissect the futures market into the individual contracts that make it. In the chart above, a comparison of long and short positions suggests how producers and merchants are trading. Currently, short positions heavily outweigh the long positions representing the lasting effect of falling prices earlier this year, There are still a low of companies out there that are hedging against the worst scenario, another possible crash sending prices to the $30's. On the other hand, long positions grew at a faster rate over the past six weeks as building bullishness is encouraged by Goldman Sach's new hopeful oil price analysis. Expectations are slowly improving as the futures market sidesteps from its typical volatility. Barring any major events or energy fundamental change, slowing U.S. production will dampen the fluctuations that have scared hedgers away from the WTI market. With this in mind, rising open interest could support a stronger recovery into the $50's if all holds throughout the rest of the year.

Friday, May 13, 2016

Fundamental Friday: 13 May 2016

Crude oil: Crude oil production continues to fall for the 9th straight week continuing to justify the recovery in prices. With a drop of 23,000 b/d, last weeks production came in at 8.802 million b/d. Further declines of 300,000 b/d over the next couple of months will put output levels at July 2014 levels. The WTI spot price was above $100 per barrel then. Stockpile data this past week has reached a potential reversal point. A decline of about 3.4 million barrels to 1.235 billion barrels marks the first draw on inventories after four straight weeks of surplus. Since the beginning of the year, 58 million barrels of crude oil have been stored away despite reductions in downstream operations. Keep an eye on stock change over the next couple weeks to see if this reversal represents a shift in crude oil fundamentals.

Refinery inputs jumped by 190,000 b/d to 16.18 million b/d adding onto gains at the end of April. In fact, last week's input levels are already above the April average perhaps responding to the start of the summer driving season. Utilization fell by 0.7 percentage points to 89 percent. The contradicting readings this week broke a streak of parallel movement showing the flattening trend in upstream operations. Refinery capacity may be expected to increase above 90 percent for the summer especially since gas prices have been in an uptrend. Last year, summer utilization peaked at 96.1 percent at the end of July.

Crude oil prices continue to build a larger recovery this week as a 5-day gain of 3.52 percent extends 3-month gains to 31.19 percent. Despite losses of just under 1 percent on Friday, WTI crude trades around $46.27 and Brent crude at $47.87.

Natural gas: Underground storage of natural gas continued to build as seasonality weighs on demand. A jump of 56 bcf brought last week's total to 2,681 bcf total. Also, natural gas rigs jumped by 1 to a total of 87 this week, the first net gain in over 5 weeks. Markets continue to be oversupplied despite slightly lower temperatures that are 8 percent lower than last year. Suppliers have their eyes on the January 2017 futures contract as they try to gauge what winter's demand will be like this year. Currently, the premium averages just above $1.10 per MMBtu more than double the $0.52 per MMBtu gap last year.

This week, energy companies have had to cope with wildfires near the oil sands plays located in Alberta, Canada. The disruption of operations has caused a decrease in demand for local natural gas which sent Canadien spot prices lower for a small period. The EIA reported that most of the decreases in consumption were caused by evacuated oil mining operations which natural gas heavy processes. No pipelines or facilities were damaged so offline systems should be brought back online soon.

Despite wildfires in Alberta, the natural gas Henry Hub spot price adds 2.1 percent this past week. Gains of 8.79 percent over the past month have natural gas trading around $2.286 on Friday.

Gasoline: Gasoline fundamentals this week reflected the acceleration of refinery capacity. Finished gasoline stocks jumped just over 100,000 barrels to 24.985 million barrels. Component gasoline stocks fell sharply by almost 1.4 million barrels to land at 215.579 million barrels total. Both have started new trends that could continue into the summer weighing on gas prices. Finished gasoline production grew by 240,000 b/d to 10.051 million b/d this past week. Since the beginning of April, refinery production has been up over 400,000 b/d to reach the 10 million level. Product supplied fell by approximately 300,000 b/d to 19.952 million b/d.

Prices at the pump stabilized this week as refinery output increased supply. The average U.S. regular gas prices fell by $0.02 to $2.22 a gallon. Mixed movements across the United States caused a small reversal of the recent trend with prices in the Midwest applying the most pressure. Average diesel prices held flat with just a $0.005 increase to $2.271 per gallon. Most regions had little to no change.

Wednesday, May 11, 2016

Can the World Still Rely on China's Demand?

The Chinese slowdown did more than drag down its own economy, it singlehandedly created financial tremors throughout the world's markets. With growth rates well over 6 percent, China's robust development has become an integral part of global expansion. Just last year, investors saw the disintegration of billions of dollars worth of wealth on the Asian giant's stock market. The globalized economy experienced economic withdrawals with lagging Chinese demand, a substance to which both foreign and local industries have become addicted. It goes without saying that industrial and manufacturing demand in the Chinese economy acts a relevant indicator of the world's financial condition similar to the status of the United States. For that reason, investors have no choice but to realize the implications that can come from changes in demand for foreign goods, services, and capital.

A country's stock market is often a leading indicator of its economic performance. In China, two dramatic corrections occurred in the middle of 2015 which translated to the weakness that would infect the global economy. From its peak last year, the Shanghai CSO 300 Industrial Index has lost over 50 percent of its value in a downtrend that has depressed sentiment surrounding the industrial and manufacturing sectors in China. The downtrend has softened but continues to devalue large-cap industrial shares approaching values seen in mid-to-late 2014. As far as projections go, the stock market is predicting the slowdown to maintain the bearish pressure on share prices and the contraction in demand. Investors looking to pump capital back into these Chinese firms need to consider the bubble-like symptoms that caused four freefalls in the past year. This weakness may deter wary traders to flock around these stocks in the future.

The China Caixin Manufacturing PMI is one of the most watched industrial economic indicators for domestic and global demand trends. The index tracks the monthly growth of the manufacturing sector, one of the largest components of China's GDP. Readings above 50 translate to expansion while readings below 50 represent contraction. February 2015 was the last month where an expansion was reported before the drop that occurred later in the year. Just after the major correction in August 2015, the September reading was recorded at its lowest point, 47.0. From there, the contractions have been slowly shrinking to just below 50 in March 2016 which read 49.7. The worst of the losses look to be over with a trough most likely formed in late 2015. The next milestone for recovery will be getting the PMI back into positive growth territory. Demand will only fully come back online when the levels of mid-2014 are approached. But, at the very least, investors shouldn't expect to see the worst again as the Chinese corrections have successfully repriced the stock market in relation to the country's manufacturing strength.

When the Chinese manufacturing and industrial sectors are strong, their consumption of raw materials, machinery, and just about anything else is equally as robust. The relatively undiversified economy of China is required to import huge amounts of these products to support the 40 percent of the economy composed of industry according to 2014 numbers. As the slowdown set in, businesses started to import less. In April 2016, Chinese imports dropped by 10.9 percent to $127.2 billion USD. Compare this number to the March 2013 peak of $183.1 billion USD and one will see a 30.6 percent slide in China's demand in foreign markets. That translates to about $56 billion worth of demand or $56 billion of lost foreign revenue. The loss of this capital has resulted in economic weakness infecting China's biggest trade partners which include developed nations like the United States and Germany. To make matters worse, imports may never recover to the level which they were at peak Chinese development. The emergence of the service industry as a major component of the Asian giant's GDP has created a dynamic economy that can rely less on industrial growth. For exporters, the shrinking of the world's largest source of demand could mean bad news.

The now limited Chinese demand is most bearish for the energy sector as crude oil accounts for about 6 percent of total imports, the largest demand for a commodity. Its regional suppliers have recently felt the negative effects of less oil consumption with weak demand weighing on Brent and OPEC basket spot prices. According to EIA data, members of OPEC already account for 58 percent of China's oil supply with its leader, Saudi Arabia, the highest at 16 percent. Revenues coming from contracts in Asia have decreased amidst the drop in prices caused by shale production. As my previous article pointed out, the weight on cash reserves has increased tension on national social programs and the populace's tolerance for a shrinking economy. Now, the surge of the services sector and a global push towards renewable energy sources further threatens the already fragile Chinese oil consumption. Because its government continues to pursue the goal of a stable energy policy with the appropriate diversification, securing a permanent import deal has become more and more difficult. China has already exchanged the volatile supply of Sudan, Iran, and Syria for deals with its neighbor, Russia. More shifts could be due in the near future and here's who may be affected:

  • Saudi Arabia, Angola, and Oman are all countries that supply at least 10 percent of China's crude oil. But recently, the Wall Street Journal reports that Russia has overtaken the trio to take the top spot of on the list of crude oil exporters to China. Instability in the Middle East region, the failure to reach a deal in mid-April, and al-Naimi's firing have all contributed to volatility in the geopolitics of the region and the economic viability of the oil cartel. In the first quarter of 2016, Saudi Arabia's exports to China have only increased by 7.3 percent despite low oil prices encouraging larger increases in consumption. Instead of OPEC members securing Chinese contracts, they will soon find themselves fighting each other for market share if Iranian capacity increases rapidly and a cheap energy environment settles in for the long run. The disinterest of the cartel's biggest customer could mean a more competitive market, or worse, the disintegration of OPEC.
  • Russia has had the advantage of being in good terms with China while they shift their supply chains to more secure channels. Deals like the $400 billion agreement between the Chinese government and Russia's Gazprom have given their neighbor preferred access to the demand that has the oil markets fighting for contracts. As Saudi exports fell, Russia logged a 42 percent increase in crude oil shipments to China in the same period. Their status as the top producer in the world has seduced their customers with the prospect of cheap oil for longer with deals done out of desperation so that Russia can kickstart their struggling economy. The new partnership has increased tension present in the rivalry between OPEC and non-OPEC members. The shift in Chinese imports might convince Saudi Arabia and its peers to increase production a threat already used by Saudi crown prince bin Salman. But has Russia won this "race" before it began? According to the EIA, Russia and China have signed a deal to send "up to 800,000 b/d of crude oil by 2018."  With the country securing more demand for its enormous oil and natural gas stocks, they might be in prime position to benefit from a stabilization, or maybe a recovery, in energy prices.
  • The United States is in a unique position in this changing market. With shale production spurring a renaissance in domestic supply operations, the world's second largest oil importer now has options on the supply side. Energy independence (no imports) may never be in the equation, but the U.S. could begin to balance their energy trade deficit with the ban on exports lifted. However, limitations on Chinese demand could pose an interesting dilemma where domestic oil prices fall, but it becomes cheaper to import foreign. Or, demand wastes away the economic viability of petroleum, and the shale revolution withers away with it. Either way, the United States' supply and demand will turn out to be the counterweight when a winner is finally realized in the global fight for energy market share.
The days of global reliance on Chinese demand are soon coming to end as seen by the decline in growth rate, decline in imports, and increase in service sector strength. The implications have already been great as stock markets across the developed world fell into peril when China's GDP growth rate fell below 7 percent. Withdrawal symptoms may last for awhile until a recovery in demand alleviates some pressure. But one thing is certain, the world's markets will have to adjust to a developed China as what is being called the "new normal" sets in. In the oil market, the effects are even more accentuated with its top customer showing signs of flattening demand. As a result, suppliers will fight to justify their stability and efficiency as China chooses from the desperate bunch. Lately, their choice has shifted from OPEC producers to their neighboring giant, Russia. The energy players and other foreign businesses that once relied on China's robust growth will no longer be able to depend on its expanding demand. A new group of emerging economies will have to step in. Who will they be?

Monday, May 9, 2016

GDP Growth Trends during the Glut

The widespread effects of the oil glut have been well known in the corporate arena as multinational firm's earnings reports dominate the headlines of the financial news. National banks across the globe have drawn most of their concern from the dwindling of profits and the shrinking of prices. The WTI and Brent spot prices for crude are followed every day as well as their implications for the next quarter's bottom line. Meanwhile, several nations are being brought to their knees as a result of the downturn while others have pushed through. The internal dynamics of this unique period has once again separated the global economy into two factions: the oil-exporters and the oil importers.

Oil shocks can have numerous effects on the global economy, but typically, there are two different economic reactions that occur in oil exporters and oil importers. The price collapse we have seen can be characterized as a supply shock with flooding markets weighing heavily on spot prices across the world. Naturally, the changes in spot prices affect the buyers and the sellers differently. The chart on the left shows the top ten oil importers as well as their most recent quarterly growth rates. With China and India leading the way, GDP expansion has continued at a stable rate at or above 2 percent (with the exception of Japan and Netherlands). The average quarterly growth rate for this group of countries is recorded as 2.96 percent, a healthy expansion despite the volatility in markets and fluctuations in manufacturing capacity. Oil importers usually have the advantage of lower input prices and lower motor fuel prices which reflect positively on corporate profits and personal income. Governments also see a decrease in their spending as their own costs fall as well. Trading deficits fall for these countries as the value of their petroleum imports. Emerging economies like China and India tend to enjoy more efficient growth at lower prices, other beneficiaries are Brazil and South Africa who are in this key development stage as well. Some may argue that these benefits were not realized this time around because of the Chinese stock market crash, but do they stop to think how much worse things could have been if struggling Asian manufacturers were paying over $100 for crude oil? The low energy price environment could have done much to cushion the correction that was always going to happen. A 3 percent average growth rate across the importing world speaks to the expansionary effect of the oversupply of crude oil amidst struggling stock markets in China, the United States, and Europe.

One might suspect that low oil prices have the opposite effect on oil exporting nations where the petroleum industry accounts for large parts of revenue in the economy. He wouldn't be too far off. The chart on the right describes the most recent quarterly growth rate for the top ten oil exporters. Although three countries record quarterly GDP growth of about 4 percent, the average was calculated as 0.83 percent. Russia is one of the oil exporters that is experiencing a recession caused by the devaluation of their economic staple. Poverty and unemployment are increasing, and consumption falls as well. Similar dynamics define the effects on other exporting economies. Governments lack the funds to spend on social programs and public sector jobs. Corporate profits taper off, which translates to wages dropping in tandem. The "resource curse" sets in for emerging economies who rely on the energy industry as a singular source of revenue. Often times, economic stability can spill into political vulnerabilities especially in the geopolitics of OPEC. This oil shock is especially troubling because OPEC's member nations have found they don't have control over the production that has caused the oversupply. For that reason, tension in countries where growth rates have fallen below zero like Venezuela, Kuwait, and Iraq has risen. With no freeze deal or output quota on the table, the length of the depressing effects is indefinite.

David Goldwyn, president of his own Goldwyn Global Strategies LLC said last year, "At $40 a barrel, everybody's budgets are underwater, and some quite dramatically. It's increasing the fiscal deficit and requiring countries that were already facing low growth to suffer even higher pressures." He emphasized that these countries that are short on cash begin to have problems with civil unrest. Venezuela, sustaining GDP contractions of -7 percent, is one particular country that is feeling the squeeze. According to the International Business Times, the Venezuelan government needs oil prices of over $100 a barrel to break even. The same source estimates that Nigeria needs $119 per barrel for its budget to break even. The scary truth is that numerous economies are collapsing because of the debt accumulated at high oil prices which were thought to be sustainable with OPEC's power. The macroeconomic effects of this position are frightening in hindsight.

Oil exporters with peaceful societies are feeling the cash crunch as well. Saudi Arabia's vast cash reserves are draining fast as the price of oil fell over 50 percent in a year. The wealth available to the princes and their people is waning causing policymakers to be more conservative in government and personal spending. The old oil minister al-Naimi, heralded for his able control of the oil market, was just recently fired to be replaced by Saudi Aramco's chairman, Khalid al-Falih, who will be tasked with ending the Saudi dependence on oil. The World Policy Blog estimates that $70 billion of the $660 billion of cash reserves were used to cover new deficits caused by depressed oil prices. The large social programs put in place to persuade the younger generation to accept the Saudi lifestyle are now shrinking. While a the coffers and production capacity of Saudi Arabia can allow its government to resist economic collapse, any whiff of vulnerability sensed in its social fabric could have implications within the region. The "Saudi-Iranian oil race" that officially started in mid-April hints more at regional religious sectarian issues that could spillover into the Syrian conflict. Saudi Arabia should separate their oil production and geopolitics if they want to avoid domestic economic conflicts.

In both camps, the interest rate policy of most national banks has elicited negative effects described by an IMF paper about real interest rates earlier this year. Because inflation has slowed down to near zero, nominal interest rates set by banks and monetary institutions are having a more contractionary effect even though they haven't changed. The economy in Brazil has responded negatively to this implicit tightening of credit in most developed countries. Loans with U.S. and European banks are suddenly becoming more expensive and harder to finance when Brazil's blossoming private sector seeks to thrive amidst unrest in the government. Petrobras, the local nationalized oil major, has succumbed to many of the pressures that oil exporters are facing especially debt-riddled financials. The loss of the oil company's revenue has brought with it threats of stagnating growth that could compromise an already unstable social environment. Petrobras is just one example of energy corporations struggling to adjust to the new environment; over 50 have gone bankrupt in the United States.Going forward, interest rate policy and monetary cohesion will play crucial parts in the development of inflation and a new crude oil market.

Friday, May 6, 2016

Fundamental Friday: 6 May 2016

Crude oil: Crude oil production falls at an even faster pace this past week. Down 113,000 b/d from the week before, the EIA estimates have extraction rate estimated at 8.825 million. This single week alone tops all of the losses in the last three weeks. Stocks continued to grow, though, and even picked up pace. A gain of 2.8 million barrels brought total crude stocks to 1.238 billion barrels.

Refinery statistics remained relatively flat throughout the week. Inputs jumped just 139,000 b/d to 15.986 million b/d, a level consistent with the monthly average. Utilization jumped in conjunction with inputs. Up 1.6 percent, capacity was measured at 89.7 percent total, higher than the past three estimates.

Natural gas: Natural gas fundamentals continue to get more and more bullish as the weather warms. Underground stocks grew by 68 bcf to 225 bcf total. The accelerated trend is only topped by last weeks growth which combines for a 140 bcf growth over the last two weeks. Natural gas rigs dropped by just one to a total of 86 operating. Once again, lagging demand appears to have the largest effect on fundamentals.

Bentek energy reports a 0.7% supply change and a 4.6% demand change for this week. These estimates tend to fluctuate representing the volatility taking over the market. Natural gas rigs continue to remain representing about 20% of the total operational rigs. Producers seem unwilling to reduce the pressure on the market, unlike the crude oil market which is seeing large declines in output.

Gasoline: Gasoline data remained relatively flat this week. Finished gasoline stocks grew by 464,000 barrels to 24.876 million barrels this past week. Component stocks grew slightly as well up 71,000 barrels to 216.919 million barrels a sign that refinery capacity remains level from last week. Finished gasoline production jumped to the highest levels in six weeks. Gains of 304,000 b/d brought total output for the week to 9.811 million b/d. Product supplied jumped to a six-week high as well up 414,000 b/d to 20.242 million b/d.

Gas prices continue to rise. Average regular price grew across the board to $2.240 up $0.078 from last week. The gains were double what they were last weekend. Average diesel price jumped $0.068 to $2.266. The gap continues to close between the two prices as diesel prices show faster growth.

Monday, May 2, 2016

Exxon-Mobil Disappoints in the First Quarter

Amidst the excitement that surrounds the earning season, it is necessary for investors to take a fundamental turn on their analysis. As crude oil prices stage a rebound, the financials of energy companies should start to show more earnings potential for the rest of 2016. The year-to-date gain for the WTI spot price has grown to 11.3 percent with a three-month rebound nearing 20 percent. First quarter earnings might not reflect this recent growth, but an acute fundamental analysis can inform investors on which firm will be in the best position to rebound. Exxon-Mobil may be one of these companies that will shape up into a premium investment with the potential for increasing dividends and share appreciation. With bankruptcies in the oil and gas exploration and production increasing 380 percent since 2014 according to Wall Street Journal, fine-tuning one's analysis is the necessary response in these risky periods.

Last week, Exxon-Mobil reported a net income of $1.8 billion in the first quarter of 2016. The EPS was recorded at $0.43 per share down from $0.67 last quarter and $1.17 last year. The press release blamed "the impacts of sharply lower commodity prices and weaker refining margins" for the decline in this quarter's earnings as the upstream operations division recorded a loss of $76 million with a loss of $832 million in the U.S. accounting for a large chunk of the drop. The dramatic drop in upstream performance is almost painful to watch as this section, which once contributed to 51.9 percent of net income, is now a drag on the rest of the firm. Downstream operations continue to maintain their position in the business just under a majority of the income while the chemical division takes over accounting for 62 percent of income generated by operations. At first glance, this fact seems troubling as investors are certainly paying for Exxon's superiority in the oil and gas industry to support share appreciation and a solid dividend, but suddenly, this chemical division, which only support 17.8 percent of net income a year ago, has taken over a majority of the value of the company. But that shouldn't scare away investors. Instead, optimists could see the chemicals gains as a type of hedge against a bearish oil and gas market. Over the past four quarters, each of these divisions has rotated into the best earner position depending on market circumstances. While it makes Exxon unpredictable and difficult to accurately evaluate, its versatility should be nothing but positive for the investor (who himself should understand the importance of diversification). I'd like to see more data put forth from Exxon so that analysts could construct an assessment of each operation as its own business. Not only would this report speak to the sheer size of the company but also to its dynamic approach to a slacking market.

Just before the first quarter earnings report was put out by Exxon-Mobil, a development on the credit market made leverage ratios of particular interest this time around. Standards and Poor's downgraded the oil major from an AAA credit rating to an AA+ rating citing worries about debt. The agency had this to say, "The company's debt level has more than doubled in recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow," according to RT. When looking at leverage ratios, it's clear that the low oil price environment has hurt operating cash flow growth and the ability to manage debt. Even though capital expenditures have been halved since the first quarter of 2015, operating cash flow still fell from $8.0 billion to $4.8 billion over the past year. As a result, cash flow to debt ratios over the past two years have fallen from a peak of 1.73 to 0.63 this quarter. Based on the trend in late 2014 and early 2015, Exxon employed a strategy to protect their leverage and excellent credit rating by boosting cash flow even though it was falling with smaller revenue. Unfortunately, management allowed debt to increase too much eventually taking over cash flow capabilities. Still, a cash flow to debt ratio of 0.63 is not horrible especially considering the state of the oil and gas industry. However, Exxon has allowed their cash assets to dwindle despite increases in debt. In the first quarter of 2016, the cash to debt ratio was recorded at a mere 0.11 less than half of what it was two years ago. The reduction in short-term liquidity probably played into S&P's decision to downgrade Exxon's credit rating as the oil major has done nothing but add more to total debt over the past two years with liabilities to be realizing soon. If the oil major gets caught in an oil price scenario that turns out more bearish than desired, current liabilities could begin to bite into the free cash flow and, at the worst, shareholder's dividends.

That brings us to Exxon-Mobil's most valuable assets, its crude oil and natural gas exploration and production operations. Despite a realized loss of $76 million in this division, the extraction rate continued to grow by 2.3 percent for crude oil and 1.1 percent for natural gas. The quiet increases in production came after larger jumps of 6.4 percent and 11.3 percent respectively in the last quarter of 2015. Based on these numbers, it's possible that Exxon played the bullish oil price scenario going into 2016 with large increases in drilling, especially natural gas production where an 11.3 percent jump reversed losses of -14.4 percent and -6.0 percent in the previous quarters. As equities and crude oil prices fell apart in January, the firm left their operations exposed to losses with a lack of proper hedging. Based on average realization data, Exxon-Mobil only got $27.11 for each barrel of oil and $1.60 for each mbtu of natural gas prices that were 21 percent and 11 percent lower than the quarter before. The effect was clear as negative realization accounted for most of the losses in upstream operations which dragged on overall net income. The loss should be corrected with the rebound of oil prices, but the numbers still call into question their increasingly weaker financial position. As forecasters continue to push back their projections of higher oil prices, Exxon needs to find a way to maximize their return on every extra barrel that comes out of the ground. Strategies geared towards meeting this objective include playing the futures market with better hedging or cutting high-cost barrels off in exchange for low-cost extraction. No matter what path is taken, a change is needed if investors are to believe that dividend increases are possible in the face of potential solvency problems.

Compared to historical quarterly reports, the first of four in 2016 was a tad disappointing when coupled with the credit downgrade. Exxon's status as an AAA rated company heralded the firm's securities as premium grade investments that investors simply couldn't ignore. A downgrade may have done little to the firm's ability to raise money, but the news hurt the general opinion surrounding its stock. Losses in upstream operations only augmented the pool of questions that need to be asked of the leadership at Exxon-Mobil. Does this report confirm that their operations are reliant on oil prices? If the answer is anything but no, it dramatically affects the earnings potential of the upstream assets. With energy firms declaring bankruptcy at high rates, investors don't want to see their investments exposure their position to volatile prices. If cyclicality can't be avoided, then Exxon-Mobil needs to restructure their operations so that it can successfully thrive in a market with low demand and high supply. A question might also be asked of the leadership in charge of setting production levels. Were the output increases in the fourth quarter of 2015 a product of mismanagement? Bad forecasting? In either case, the executives need to sit down and formulate plans based on different scenarios so that a volatile output does become a liability. The cost of switching operations on and off can become dangerous if the realized price for each barrel is averaging out to a loss. These are just a few of the small details that management must pay attention to in every day of operations.

Exxon-Mobil still reigns supreme in the oil and gas industry, but this earnings report has shown that oil prices can shake the energy giant. Their securities still remain of the highest quality relative to their industry, but among large-cap blue chips, their position could be threatened soon if the firm does not tighten up their operations.

Exxon's first quarter data and press release can be found here.