When oil prices began to collapse around two years ago, most producers (especially in North America) adopted the mentality that the decline was only likely to be short-lived and continue to spend as if there was nothing to be concerned about in the market.
Two years on and it’s pretty clear that lower prices are here to stay.
There has been no meaningful reduction in production around the world, inventories remain at record levels and now formally high-cost producers are becoming extremely efficient at extracting oil from the ground. This is becoming a huge problem for the oil market. Up to six months ago, it was assumed that lower oil prices would push high-cost producers out of the market curbing supply and sending prices back to previous levels by the end of this year.
However, North American oil patch producers have now become so efficient that they can now make a profit with oil below $60 a barrel. 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. According to Deutsche Bank, US tight oil production can now be expected to bottom and some point during the first quarter of 2017 and grow slowly after that. Previously, forecasts were expecting US tight oil production to bottom at some time during 2017 and remain flat for the rest of the year.
It seems that oil producers are already ramping up supply.
On Wednesday the US Energy Information Administration reported that domestic crude supplies rose by 2.5 million barrels in the week ended Aug 19, ahead of the 200,000/bbl expected by analysts. The American Petroleum Institute late Tuesday reported a rise of nearly 4.5 million barrels.
US oil production benefits from efficiency gains
Improving well economics are to blame for the increasing resilience of US tight oil producers to lower oil prices.
A report from Deutsche Bank’s integrated oil analysts Ryan Todd and Igor Grinman out today claims that 2017 capital efficiency for US producers has declined by $5,000 barrels of oil per day of growth since last year. In percentage terms that works out at around 21% in efficiency gains. Previously the estimate for growth was $24,000/bbl; that figure is now down to $19,000/bbl. Based on these productivity gains, Deutsche has pencilled in oil production growth of 500,000 to 600,000/bbl a day for 2017, which works out at growth of 100,000 to 200,000/bbl a day year-on-year.
Ryan Todd and Igor Grinman don’t expect the attractive cost environment to last for long, however. As companies with ramp up activity to take advantage of low costs, the duo expect oil services providers to respond to the higher demand by hiking prices. Based on this assumption they are assuming an estimate of capital efficiency growth of $21,000/bbl for 2018 — but still at levels 11%/33% better than 2016/2015.