Despite the 19% fall in the price of the WTI front month between the beginning of July and August 2, oil market fundamentals remain intact, and supply continues to fall, that’s the view of Deutsche Bank’s commodities research analysts Michael Hsueh and Grant Sporre.
In a research note sent out to clients at the end of last week, Michael and Grant point out that even though the price of WTI has collapsed over the past month onshore production is still declining; product demand has grown by 316,000 barrel a day year-on-year and refinery run growth has increased by 165kb/d. Further, inventory surpluses for both gasoline and distillate peaked in April and have since declined. This decrease in inventories is being fuelled by contracting crack spreads, indicating a market coming to terms with surpluses.
But against this positive backdrop, the number of active oil-directed rigs has increased across the United States since June, and Deutsche’s analysts believe that the current WTI weakness can be traced to these rig additions.
Oil fundamentals remain intact but…..
Around 68% of the rig additions since June have been horizontal rigs, predominantly located in the Permian Basin (60%), which possesses the greatest depth of resource economics at $60/bbl and below, according to Wood Mackenzie. Indeed, Scott Sheffield, the outgoing chief of Pioneer Natural Resources claims that Pioneer’s pre-tax production costs have fallen to $2.25 a barrel in the Permian, making the company’s oil wells economic even with oil prices below $40/bbl.
The consequences of this development are that modelled onshore US tight oil production can now be expected to bottom and some point during the first quarter of 2017 and grow slowly after that according to Deutsche’s analysis. Wall Street was previously forecasting that US tight oil production would bottom at some point during 2017 and remain flat as shale producers continue to cut costs and carefully select only the most economic wells for production.
Unfortunately, as Permain production ramps up again and production becomes more efficient, it’s going to take much longer for the market to rebalance, as Michael and Grant explain:
“The proper narrative of the past two months may be that a WTI price of USD 50/bbl…incentivized an excessive increase to drilling activity and that a lower price is needed to bring US supply growth back towards a rate that is consistent with reducing the inventory surplus in 2017. This will be a familiar refrain, which originates from the demonstrated capacity of US supply to grow in excess of world oil demand growth. The theme will not likely disappear until either the US resource base is depleted (roughly 19 years given 50 bn boe economic at or below USD 60/bbl and a production rate of 7 mmb/d versus estimated July production of 4.7 mmb/d) or the sector is starved of sufficient capital to execute expansion plans. The latter would appear unlikely especially if further productivity gains can be sustainably founded on process improvement rather than high-grading of acreage as this would mean that fewer rigs and less capital needs to be deployed to achieve any given rate of production growth. Companies such as Pioneer Natural Resources, Noble Energy, Occidental Petroleum, and Devon Energy claim that improvements to completion methods can go further.”