OPEC v. US Shale- are we setting up for Round 2?
The production caps agreed upon by OPEC and partners served to put a $50 floor under crude prices for the last few months, but their impact on prices may be starting to break down as the market digests their actual fundamental implications. With broad allowances for Nigeria, Libya, and Iran to increase production, global supply is still above 2015 levels and near record highs. As a Bloomberg analyst said today, "OPEC must concede that its production-maximizing strategy to push prices down and competitors out of the market hasn't shown the desired results. On the other hand, the radical output cut decided with Russia and other non-OPEC producers is not lifting prices substantially either".
With production persisting at high levels, it’s hard to accomplish the main goal of the deal, which was to force a dramatic drawdown of global crude stocks and bring the market back into balance this year. According to the IEA’s most recent monthly report, stocks are falling somewhat but still well above the 5-year average and hovering in record-high territory.
A recent statement from Saudi oil minister Khalid Al-Falih intimated that the caps might be extended into the second half of the year to give the deal longer to work. But it remains to be seen what the kingdom’s tolerance will be for continuing to cut extra volume to make up for increased output from other parties. Al-Falih said “It is not going to be fair or acceptable that some countries will carry the burden for all… We’ve been willing to do it for the front end but we expect our friends and partners to pick up the slack as we move forward.”
And meanwhile, back at the ranch of US shale oil production? This was happening:
To say that low prices have been painful for US oil and gas producers would be an understatement. Between January 2015 and February 2017, 119 North American E&Ps filed for some form of bankruptcy protection, representing nearly $80 billion in debt being wiped out or restructured. Texas alone saw 55 companies file during this term.
But the pressure from low prices, plus continuing improvements in technology and engineering drove efficiency up and breakevens down dramatically. Many E&Ps now talk not only about longer laterals, fewer rig days, and better IPs, but also about cheaper field services and higher netbacks due to better infrastructure. The “fat” that padded breakevens at $100 oil has been burned off in the crucible of low prices.
In the research piece accompanying the above chart, Rystad Energy projects that average wellhead breakevens may level off in 2017 because of the loss of savings from “cyclical” causes like low field service rates. But many US shale producers are reporting healthy IRRs from these basins at the current forward curve and many have been adding to hedges.
What happens next?
It’s a given that OPEC production caps will help US shale reclaim some market share lost in the downturn. This is effectively what OPEC and partners conceded by agreeing to them in the first place. US crude production has stabilized and has started growing again:
This is likely to accelerate. A Barclays survey conducted at the end of last year predicted a 27 percent spending jump by North American oil companies in 2017 over 2016. The EIA predicts average production of 9.2 million barrels per day in 2017, on the way to 9.7 million per day in 2018. This would exceed the official peak in April 2015 of 9.627 million bbl/d.
The move to watch (and we’ve got our popcorn ready) is how Saudi Arabia and Russia will respond to this increase. Previous moves were:
· Keep volumes high, drive prices lower, and try to bankrupt US producers to regain market share
· Cap production, concede market share and hope for a rebound in prices
What tools might be left in the toolbox? WSJ has reported that OPEC has been on a “listening tour”, meeting with oil traders to understand how the market reacts to their moves.
They’re also curious, according to one source quoted in the article, as to why “the US banks were so quick to reinvest in American shale producers after the bust and what would happen if prices fell again”.