The Last Barrel

Thanks in large part to unprecedented cooperation between OPEC and Russia, combined with favorable legislation in the U.S., the E&P industry looks primed for a modest uptick in 2018. But has enough confidence returned to the sector to drive a prolonged recovery? Will Saudi Arabia continue to withhold production at the expense of market share? How long will Russia maintain its collaboration with OPEC? And the billion-dollar question, can U.S. shale producers self-regulate? These factors will determine if 2018 will be the start of a sustained recovery or the calm before another down-cycle. 

Key drivers. In our February issue, World Oil’s editors forecasted a 12% increase in U.S. activity and a 4.6% rise in international drilling. In spite of predictions, Wood Mackenzie believes operators will remain cautious and drill fewer wells, concentrating activity in commercially attractive plays. “Competition for the best opportunities will be fierce, but the industry’s focus on reducing costs is starting to pay dividends, and we should see double-digit returns in 2018. Tight oil will enter its second phase of growth, and more than 15 Bboe will be up for grabs.” U.S. Deputy Energy Secretary Dan Brouillette added, “prospects for unrelenting expansion in American shale fields is a distinct possibility, and crude output is on track for phenomenal growth.” I hope for the industry’s sake, operators will show restraint when tapping the vast U.S. shale resource.  

Golden rule. Investment will grow slightly in 2018, with a total spend of around $400 billion, indicating that the down-cycle has bottomed out, says Tom Ellacott, head of corporate research at Wood Mac. “This is despite LNG spend collapsing 40%, as projects are completed in Australia and Russia.” The resulting gap will be filled by unconventionals and deepwater projects, where investment will be up 15% for both. “After three years of decline for deep water, this is a noteworthy shift, and we expect the GOM to be the big winner.” More than half of all oil and gas volumes will again be found in deep water. Licensing rounds in Brazil and Mexico will be the most active. Although risk tolerance will strengthen, explorers will avoid high-cost theaters with difficult logistics and hard-to-drill well profiles. The best discoveries should come from newly proven plays, as we have seen throughout the downturn.

Limited exploration investment. Exploration’s share of upstream investment has slipped below 10% since 2016. This is the new normal, with the days of $1 in every $6 spent on exploration forever in the past. “We expect global 2018 investment in conventional exploration and appraisal to be approximately $37 billion—7% less than 2017 and 60% below its 2014 peak, according to Wood Mackenzie. This unprecedented reduction in pure exploration would be alarming, but the warm/fuzzy U.S. shale security blanket is keeping the industry slumbering, for now. 

Shale output/DUC wildcards. U.S. tight oil production is forecast to surge 24% (1.2 MMbpd) in 2018, driven by a 60% increase from the Permian, if oil stays above $55/bbl. But service costs are already increasing, and less experienced crews could slow momentum. “We see break-evens rising as much as 15% in 2018, particularly in the Permian and Mid-continent,” Wood Mac said. However, the DUC stockpile continued to build at an alarming rate during the second half of 2017. In May 2017, the EIA reported 5,877 uncompleted wells nationwide and 2,114 in the Permian basin. As of Jan. 2018, the DUC backlog stood at 7,609 and 2,880 (Permian), an increase of 29% and 36% respectively. If I understand correctly, operators do not get an ROI until a well actually sells hydrocarbons (without the use of creative accounting). It begs the question, why continue to drill wells (stranding capital) that can’t
be completed? 

Saudi Arabia’s new perspective. Historically, Saudi Arabia advocated for moderation within OPEC, resisting the temptation to push for higher oil prices. However, their philosophy seems to be changing. Saudi Energy Minister Khalid Al-Falih said “producers should keep cutting for the whole year, even if it causes a small supply shortage.” The KSA faces unprecedented pressures, as Crown Prince Mohammed Bin Salman embarks on a program of economic reforms known as Vision 2030. “They are definitely not a price dove anymore,” said Mike Wittner, head of oil market research at Societe Generale. “They have to think about their social costs, and the Aramco IPO.” “If you’re trying to radically reinvent your country, then you need a certain price to make it work,” said Helima Croft, head of commodity strategy at RBC Capital Markets. The hawkish stance on prices is a sharp contrast with their attitude in previous years. The initiative for social reform and economic diversification seems to indicate that Saudi Arabia will continue to support prices, even if it means losing market share.

Service sector stress. It appears 2018 will be another difficult year for the service sector. While most producers have managed to return to profitability, the service sector is still in survival mode. Operators will continue to take advantage of an oversupply in the sector, putting additional stress on providers already decimated by three years of crippling cost reductions. The only leverage that the service industry can muster appears to be U.S. pressure pumping.

Cynically optimistic. The unlikely alliance between Saudi Arabia and Russia is likely to continue. However, “prices are vulnerable to the downside over the coming months,” said Giovanni Staunovo, an analyst at UBS Group. “The market likes OPEC and its allies’ show of unity, but we still need to see how U.S. shale companies will react to higher prices.” This situation reminds me of the Dutch boy with his finger in the dike. The question is, how long before the dam breaks and a flood of U.S. supply sends prices lower again?  

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com