Last year, a blog post on the IMF Blog claimed that the oil market was facing a “new normal” as “shale oil production has permanently added to supply at lower prices” and going forward “demand will be curtailed by slower growth in emerging markets and global efforts to cut down on carbon emissions.”
This wasn’t the first time a new normal for oil was declared, nor was it the last. Barron’s claimed that oil was heading to $20 a barrel at the beginning of 2016, and then Forbes issued a similar forecast at the end of the year.
But for all the talk of oil’s new normal, over the past few months the market has stabilized and shale, which is touted as the swing producer, that will keep prices low and supply high, has failed to live up to expectations.
Oil Market Stabilizing
The price of Brent crude has broken above $60/bbl for the first time in more than two years during the past few weeks. Driving the price are better than expected demand/supply fundamentals.
As I reported at the end of October, Opec’s in-house analysts now expected demand for Opec’s oil to reach 33.1 million barrels a day in 2018, up by roughly 200,000 b/d from September’s forecast. Opec’s crude production reached 32.7 million b/d last month, up by 88,500 b/d compared with August. Meanwhile, according to the Financial Times, oil demand growth has grown by a total 1.5 million b/d this year thanks to global GDP growth, which has reached 3.6%. Next year, demand growth is expected to shrink slightly, but still, come in at a significant 1.4 million b/d. Sanford Bernstein analysts Neil Beveridge and Oswald Clint report that the current level of demand growth — 1.6% — is 50 basis points higher than the long-term average of 1.1% recorded over the past two decades.
As oil demand growth accelerates, producers are still holding back on supply growth. The freeze is particularly acute in the US shale industry. Indeed, analysts at Morgan Stanley noted in a recent report that:
“Over the last 12 weeks, the US oil-directed rig count has fallen by 5%, from 768 in mid-August to 729 rigs currently – a decline of 14 rigs per month. Not all these rigs are focused on US shale. Rigs in shale basins have fallen more slowly, by ~24 rigs over this period. Yet, that number of active drilling rigs is unlikely to deliver sufficient production in 2018, and certainly not if the recent downward trend continues.”
With this being the case, it’s no surprise that over the last 30 weeks, US crude inventories have drawn at their fastest rate in 35 years, and global destocking has averaged 130 million barrels per day during the past four months, reducing five-year average to 171 million barrels in August, against 338 million at the start of the year.
The End Of Shale: Onshore Production Growth Collapses
It is becoming apparent that shale oil is not the disruptor that the majority of analysts believed it would be two years ago. The oil price crash has had a devastating impact on the industry, and even shale, with its low-cost, flexible production has not been able to cope.
The limits of shale production have also constricted the industry’s growth. In July, London-based investment manager Horseman Capital Management Ltd. noted government data that showed US shale wells were petering out at a quickening rate. In a research note titled “The End Of The Texas Tea Party,” Horseman’s Russell Clark noted:
“Permian producers have struggled to stay ahead of the legacy decline of the field. Currently Permian is losing 150,000 barrels a day of oil production to decline. Drillers in the Permian have only managed to produce new oil at a greater level then the current decline rate for a total of 10 months out of 126 months since the EIA began recording this data in 2007. Furthermore, the decline rate looks to be accelerating.”
Clark goes on to opine:
“I suspect that the drillers are finding that frac-hits (new wells interfering with legacy wells) are causing decline rates to accelerate, hence the reduction in operating wells. The implication is that increasing new production from current levels will be difficult, while legacy decline rates will continue to rise.”
These thoughts were later echoed by industry consultant Wood Mackenzie Ltd., which declared in a blog post:
“Technology gains in the past few years have propelled Permian well performance to new levels. However, industry is set up to develop the Permian region’s shale zones at an unparalleled level, testing the geological limits of the play. It is very likely that the upcoming level of activity will introduce a new set of issues, particularly reservoir deliverability.”
And during the past few weeks, a letter from Goehring Rozencwajg natural resource investors summed up the whole situation:
“Between September 2016 and February 2017, US crude production grew by 100,000 barrels per day per month, but since then US production has ground to a near standstill. Between February and July, US production has only grown by 33,000 barrels per day per month – a slowdown of 67%… The slowdown in US onshore production growth is even more puzzling given the huge increase in drilling that took place over that time. The Baker Hughes oil rig count is up 130% since bottoming in May of last year. In spite of a surging rig-count, onshore production growth is now showing signs of significant deceleration.”
It seems as if more cuts are coming:
“Furthermore, we have seen several companies lower their full-year 2017 production guidance. We believe that more reductions are coming. Of the companies that we track, 14% have reduced their 2017 production guidance. In aggregate, these companies had guided to 67,000 b/d of oil production growth at the start of the year and have since reduced this figure by 40% to 42,000 b/d today. Our analysis tells us these reductions are only the beginning. In a very interesting development, another 20% of our survey have left their production guidance unchanged, but have increased their capital spending guidance by 10%.”
So if shale isn’t the disruptor everyone believed it to be, what’s next for oil prices?
What’s Next For Oil Prices?
It seems higher prices are the only answer to the world’s oil problem. Shale wells can meet rising demand for the time being but oil demand will continue to grow. As Caterpillar President Tom Pellette recently noted, “the world population is growing we still have 15% of the world population of 7.5 billion people that don’t have access to electricity and particularly in developing parts of the world, there will be a continued need for fossil fuels. In fact, the prediction is that the absolute usage…will continue to grow 2040 and beyond.”
As US shale wells are quite literally worked to exhaustion, offshore production and OPEC will once again become relevant. The problem is, through the oil price slump, big producers have slashed investment, setting the market up for a supply crunch.
“There has been an enormous, enormous underinvestment in productive capacity worldwide. It’s breathtaking how big that underinvestment has been.” —Loews conglomerate.