Can U.S. Shale Oil Offset OPEC Production Cuts?
In an earlier article - Why OPEC’s Announced Cuts Are A Really Big Deal - I addressed some of the skepticism around the recent production cuts enacted by OPEC. Today I want to consider in more depth the notion that U.S. oil producers might swiftly negate the impact of these production cuts.
To review, in November OPEC announced that it would enact 1.2 million barrels per day (bpd) of production cuts on January 1st. OPEC also announced that certain major non-OPEC members – most notably Russia – would cooperate with the production cuts, pushing the total amount of targeted cuts to 1.8 million bpd.
Some analysts cite two factors that could render OPEC’s cuts ineffective. The first is simply that OPEC members will cheat, as they have historically done. Certainly some members may overproduce their quotas, but OPEC is going to monitor global crude inventories. Those inventories had already begun to come down from record highs prior to the OPEC announcement, partly in response to declining U.S. shale oil production.
Further, a new Reuters survey has determined that OPEC’s compliance with the cuts in January was 82%. Tanker-tracker Petro-Logistics has estimated that crude oil shipments from OPEC countries were down by 900,000 bpd in January. So, early indications are that even if some cheating does occur, substantial cuts have taken place.
But the second factor cited by skeptics is beyond OPEC’s control, and that is that U.S. shale oil producers will simply ramp up production as oil prices rise, negating the OPEC cuts. That’s a reasonable concern, so let’s delve a bit deeper.
At the height of the shale boom, U.S. producers were adding more than a million bpd of oil production each year. At that growth rate, the production cuts could indeed be offset in a couple of years. But a look at the relationship between the number of oil rigs drilling for oil and oil production at first glance implies that a rapid turnaround is unlikely:
Between about 2000 and 2008, U.S. oil rigs doubled from around 200 to 400, but oil production hardly responded (though that was before the spread of modern shale drilling technology.) The rig count plunged in 2008 along with oil prices, but once oil rallied the rig count began a steep climb. Production did eventually respond, but there was a lag of more than a year between the start of the rig rush and a meaningful increase in oil production.
However, if you look at the last six months of the above graph, you will notice that the rig count began to climb again after bottoming last May. Meanwhile, oil production, which had been steadily falling since about mid-2015 reversed course and began to climb in October 2016.
This rapid turnaround is likely a result of a backlog of drilled but uncompleted wells (DUCs), which can be brought online faster than a new well can be planned, drilled, and completed. Data from the Energy Information Administration shows an uptick in completions over the past year in the four oil-dominant regions of the Bakken, Eagle Ford, Niobrara, and Permian Basin, where the DUC inventory in December stood at 4,509 wells. This uptick in completions helps explain why recent oil production responded more quickly than during the previous rig surge that began in 2009.
Considering this data, how soon might the U.S. manage to offset 1.8 million bpd of production cuts? If the impressive production gains since early October could be maintained, it would amount to ~1.5 million bpd over the course of a year. It’s going to be very important in coming months to see if these fast gains were a short-term response to $50 oil, or if they are sustainable.
My opinion is that the DUCs that are being completed with oil prices at $50/bbl will be among those with the highest production rates. After all, higher production rates are what enables a well to be economic to produce at lower prices. Thus it is likely that the most promising wells are being completed first, and that completion of additional DUCs is unlikely in my view to maintain that production growth for an extended period of time.
However, if by mid-year U.S. producers have added another half million bpd, OPEC may once again find themselves facing the difficult decision of responding with another round of production cuts.
Link to Original Article: Can U.S. Shale Oil Offset OPEC Production Cuts?