The Last Barrel

The U.S. is experiencing a noticeable recovery, thanks in large part to the well-publicized production cuts by OPEC and Russia. At the group’s last meeting in September, Kuwaiti Oil Minister Issam Al Marzooq said the “market has markedly improved since the last time OPEC ministers and their allies met.”

Bloated stockpiles of fuel have been drained massively, and the producers have implemented more than 100% of their agreed cuts, according to OPEC Secretary-General Mohammad Barkindo. “We are on the right track, and there is now light at the end of the tunnel,” Al Marzooq continued. There has been a significant reduction in worldwide inventories, down to 170 MMbbl this year, but they need to be reduced further, and “this is not the time to take our foot off the accelerator.”

Although ministers gathering in Vienna made a few conflicting statements, they generally indicated that they did not see the need for concrete measures to address perceived shortcomings in their agreement, notably that the cuts may end too early.

While their accord has shown signs of success, the market could return to surplus if the group allows the deal to expire at the end of March. Russian Energy Minister Alexander Novak said “we need to keep the pace and go on with our coordinated efforts, but also need to work out a strategy for the future.” President Vladimir Putin said Russia is open to extending a deal with OPEC to restrict output until the end of 2018, but he will wait to make a decision until closer to the end of the existing pact. The comments are the strongest signal yet that the Kremlin is willing to cooperate with the cartel to lift prices, as Putin prepares to meet with King Salman Bin Abdulaziz of Saudi Arabia in Russia.

BP chips in. Three days after the OPEC summit, Janet Kong, CEO of BP’s Eastern Hemisphere crude trading business, confirmed that “rebalancing is already on the way,” but OPEC needs “to cut beyond the first quarter,” to bring inventories down and back to historically normal levels. While I understand the BP oil trading business is separate from their E&P and refining ventures, I believe Ms. Kong should be advising BP to cut its own production, to help reduce excess inventory, rather than suggesting what other companies should or should not do. One would hope, and we would tend to believe, that Ms. Kong’s attitude is not shared by most folks at BP.

State of shale. Shale drillers have posted healthy profits this year, but analysts say it will take oil prices above $50/bbl for their investments to pay off. A study by Moody’s Investors Service of 37 E&P companies, in the U.S. and Canada, determined that companies emerging from the downturn are delivering higher dividends to investors this year. Yet, margins are tight, and any improvement in their ability to sustain healthy returns will have to come from commodity price improvements. The best performers are focused on liquids-rich areas in the Marcellus/Utica and Montney shales of the northeastern U.S. and Alberta, respectively.

Companies in the Permian are also spending big and hoping for higher prices, yet investors are starting to have reservations. Despite a surge in crude prices in late September, WTI has hovered in a sub-$50/bbl range since the first of the year. However, the top 40 U.S. exploration and production companies working the shale plays are largely maintaining their aggressive 2017 drilling and completion capital spending plans, says RBN Energy trackers. In all, companies plan to spend more on new wells in 2017 than they did in 2016. Yet the stock value of companies on Standard and Poor’s E&P index is down since late 2016. Assets tied to Permian basin shale producers have fallen, according to Bloomberg.

Hedge fund managers are also downgrading operators working in North Dakota’s Bakken region, because the wells deplete so quickly, and the companies constantly require capital infusion to replace assets. In some cases, operators may struggle to cover interest payments, because crude prices are too low to justify a company’s drilling budget.

Exaggerated U.S. projections. Harold Hamm, chairman of Continental Resources says that EIA’s projections of more than 1 MMbpd of new U.S. oil production are way too optimistic, and are distorting global crude prices. He predicts that this year’s rise will likely be closer to 500,000 bpd, far less than the government’s initial forecast. During an interview with Bloomberg, Mr. Hamm said the EIA projection is just flat wrong and fails to take into account a new discipline among U.S. drillers. “We have the capability of producing a whole lot, but you have to get a return on investment,” he said. The government scenario has contributed to worries about an oversupply that puts U.S. oil at a steep discount to international crude.”

DUCs continue to build. In spite of this “new discipline,” the number of DUCs has continued to surge, according to a report by the EIA. From July to August, the Permian basin gained 133 DUCs, bringing the count up to 2,297. The situation in the Eagle Ford, up 47 DUCs, to 1,401, and in Oklahoma’s Anadarko area, where backlogged inventory increased 26 uncompleted wells, to 933, is equally ominous. In a single month, operators added 231 wells nationally, rising to 7,048 DUCs waiting on completion.

Equilibrium, for now. Drilling activity in the U.S. shale plays has leveled off, and producers are focusing on high-quality prospects to improve their bottom line. The stabilization in activity caused a 1.3% drop in production in August. The question is, can the shale industry self-regulate, if oil tops $60/bbl or more? If drawing inferences from the past to predict future events can be trusted, we all know the answer.  

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com