Yves here. There have been two view of how the sudden plunge in oil prices would affect US oil production. The first was the classic supply and demand view, that at a lower price, fewer players will want to provide energy. The second was that of John Dizard of the Financial Times, which we picked up here, that US producers, particularly of shale gas, would not cut back until their money sources forced them to. This OilPrice article suggests that Dizard’s counterintuitive reading was not all wet.
Yet it is instructive to see how different reporters are reading the same data sources. The Financial Times in a story tonight that also looked at oil production levels, pointed to a decline in rig count and in filing new drilling permits:
Last Friday Baker Hughes, the energy services group due to be bought by rival Halliburton, published data which showed the number of rigs drilling for oil in the Eagle Ford shale of south Texas had fallen by 16 since October to 190. The number of rigs in the Bakken shale and related North Dakota formations had meanwhile dropped by 10 to 188.
Also last week Drillinginfo, a consultancy, published figures showing that the number of applications for permits to drill new wells had fallen by about 30 per cent in both the Bakken and the Eagle Ford areas last month compared with October. That may overstate the likely drop in activity, because companies will have a backlog of permits they can use, but it is clear the industry is responding to a steep drop in the oil price.
The Financial Times also points out that areas that will be hardest hit are the marginal ones, and contends that good assets in the hands of overlevered drillers will move to stronger owners. It ends on an upbeat note:
. But some analysts expect the overall impact on US oil production to be relatively modest.
“The rate of increase in production is going to slow down,” says Philip Verleger, an energy economist. “Even at $50 oil, though, US production probably plateaus, but it doesn’t start going down.”
However, keep in mind that these comparatively sunny views are based on the assumption that oil prices next year average $70. If they are sustained below that level, the picture starts to change. Note this contrasting view from Bank of America, via Ambrose Evans-Pritchard:
The Opec oil cartel no longer exists in any meaningful sense and crude prices will slump to $50 a barrel over coming months as market forces shake out the weakest producers, Bank of America has warned.
Revolutionary changes sweeping the world’s energy industry will drive down the price of liquefied natural gas (LNG), creating a “multi-year” glut and a mucher cheaper source of gas for Europe…
The bank said in its year-end report that at least 15pc of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55. The high-cost producers in the Permian basin will be the first to “feel the pain” and may soon have to cut back on production…
It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year,” said Sabine Schels, the bank’s energy expert.
Yves here. But in Soros’ classic reflexivity, wouldn’t the belief that everyone else will be rational lead many producers to not cut back, particularly since a rebound to $80 or $90 would lead to an average price somewhere in the $60 range, with much better prospects going forward? The confidence that the supply problem will sort itself out (save for the most marginal producers, who presumably will fold early) could lead to the reset taking longer than in the Bank of America scenario. As Warren Buffet said, “Only when the tide goes out do you discover who’s been swimming naked.” With the supply situation so dynamic, at this point, the tide has only begun to recede.
By Andy Tully, an editor at OilPrice. Originally published at OilPrice
The drop in oil prices caused by a supply glut hasn’t daunted US drillers.
Oil companies are still drilling in the United States at the highest rate in more than 30 years even as demand in China and Europe sags. In fact, the Houston-based oilfield-services giant Baker Hughes is reporting that the number of active US rigs saw a net increase of three to 1,575 the week ending Dec. 5.
This defies predictions that drilling, much less exploration, would decline because of OPEC’s decision on Nov. 27 not to reduce its production limit of 30 million barrels of oil per day. The move was orchestrated by Saudi Arabia and other extremely wealthy Persian Gulf oil producers despite the pleas of poorer members such as Venezuela and Libya.
The wealthier OPEC members are defending their market share and apparently challenging American shale oil producers, whose methods, including hydraulic fracturing and horizontal drilling, are more expensive than conventional extraction methods and unsustainable if prices drop too low.
It’s too early to say whether this modest increase is a signal that US producers are fighting back against OPEC. Although the American rig count reached a record 1,609 in mid-October, the number has receded in five of the past eight weeks, according to the Baker Hughes report, issued on Dec. 5. Still the count is more than 200 rigs higher than in December 2013 when 1,397 rigs were drilling.
In the week ending Dec. 5, the oilfields with the most new rigs were the Granite Wash in Texas and Oklahoma, according to the Baker Hughes report. At the same time, some rigs were removed from the Cana Woodford field in Oklahoma, Eagle Ford in Texas and Williston, spanning areas of North Dakota and Montana.
Meanwhile, Baker Hughes reports that the number of vertical gas-drilling rigs remained static at 344, down by 11 from the same week in 2013. The number of these rigs had peaked at 1,606 in 2008. And the net number of horizontal rigs for both shale oil and gas dropped by three to 1,368 after peaking at 1,372 in mid-November.
The question remains: How low can the price of shale oil drop before it becomes too expensive to extract? The conventional wisdom is that the threshold is $60 per barrel.
One consulting firm, Wood Mackenzie of Edinburgh, says American producers should be able to profit from exotic drilling techniques for the near term. It sets the threshold at $70 per barrel for West Texas Intermediate, the US benchmark, but adds that the low prices are “so far not a material threat to U.S. [shale] oil or the industries that surround it.”
And perhaps the United States and OPEC aren’t playing exactly the same game. That’s the view of one analyst, Kash Kamal, of Sucden Financial Ltd. in London. “U.S. producers are more focused on preserving profitability, while the Saudis and Iraq are interested in preserving market share,” he told Bloomberg News. “Until we see an increase in demand outlook, it will be hard to pin down prices.”