U.S. Demand Responds while Production is Resilient to Decline … Are Current Prices Sustainable?

U.S. Demand Responds while Production is Resilient to Decline … Are Current Prices Sustainable?

7th August 2015

After last week’s modest decline of onshore rigs, the number of active onshore oil and gas rigs increased by 6 this week.  The onshore rig count now stands at 846, down 1,030 (55%) from a November 2014 high of 1,876, but up 16 from the June 2015 low of 830.  With worries about China demand and Iran perhaps getting back in the market quicker than expected, prices resumed their fall again this week, hitting US$44.20 per barrel for WTI, and US$48.78 for Brent, down 25% (ironically) from the same point in June when the rig count hit its low for the year.

However, data shows that U.S. liquids production is now in decline, while U.S. demand continues to show a positive, albeit still modest, reaction to lower crude oil price.  Nonetheless, it still looks like a tough time for the industry (though not, perhaps, consumers) through at least 2016 unless the financial pressures starting to build on key producers, including Saudi Arabia, causes economic pragmatism to trump raw economic fundamentals.

U.S. Drilling Activity.....

After a modest decrease in rig count last week, rig count increased this week indicating that E&P operators continue to focus their efforts on maintaining flat production. Market signals, and the price decrease of 25% since June, are clearly directing operators to show more discipline with their drilling activities and wait for global production to decline before adding rigs. However, second quarter results from key operators indicate that U.S. liquid production remains relatively flat with a 1% decline Qtr. on Qtr. 2015.

Source: Operator 2015 Earnings Results and GCA Analysis

Across the three major unconventional oil basins, rigs increased by 7, with the Eagle Ford unchanged, Permian up 6, and Williston up 1 week-on-week.  Rig activity over the past week included the increase of 8 horizontal rigs.

U.S. Supply and Demand…..

Total U.S. oil stocks continue to be above their five-year highs while U.S. oil production is starting to decline.  While price drifted downwards, oil inventories continued their trend with another large decease last week of 4.4 million barrels, including a withdrawal of 0.5 million barrels from stocks at the Nymex delivery point of Cushing, Oklahoma.

U.S. crude oil refinery inputs averaged 17.1 million barrels per day, 313,000 barrels per day more than the previous week’s average and a level not achieved since the EIA started its records in 1990.  Refineries are now operated at 96.1% of their operating capacity.  U.S. crude imports averaged 7.2 million barrels per day, down by 365,000 barrels per day from the previous week, which contributed to the large withdrawal from crude stocks.  Over the past four weeks, crude oil imports have averaged 7.5 million barrels per day, 0.4% below the same four-week period last year.

The volume of crude processed by U.S. refineries last week hit a record 17.1 million barrels per day (bpd), 680,000 bpd above the prior-year level and almost 1.5 million bpd above the 10-year seasonal average.

Source: EIA Weekly Update and GCA Analysis

Global Production News....

Reuters reported that West African crude oil exports to Asia are expected to fall to 1.84 million barrels per day in August, an overall decline of 13% from July and highlighting the nature of buyers in the oversupplied market.

The EIA drilling productivity report estimates that recent annual decline rates for existing production are 47% for the Bakken, 55% for the Eagle Ford and 22% for the Permian, although that decline should not be confused with declines in the play overall as new wells are still being added.  However, even if there were to be no further drilling (which will not be the case), it is questionable that a decline in shale production at these rates would be sufficient to bolster flagging oil price with the return of Iran to the global market.  A survey last week by Reuters revealed July crude production by the Organization of the Petroleum Exporting Countries hit the highest monthly level since survey records began in 1997.

Mexico’s national oil company, Petróleos Mexicanos, is also cutting back on drilling rigs to bring its costs down.  The oil company is renegotiating the rates on rigs that it wants to keep under contract as it slashes $4 billion from this year’s investment budget and prepares for more austerity next year, officials at Pemex said.

U.S. crude may temporarily rise above global benchmark Brent next year as Middle East output expands while the nation’s supply boom fades, according to Bank of America Corp.  West Texas Intermediate futures, which have been at a discount to Brent for most of the past five years, may need to strengthen to attract imports as U.S. output falters, the bank said in a report dated July 31.  Output from the Bakken and Eagle Ford shale oil formations is “rolling over in response to lower prices,” Iran plans to expand exports following last month’s nuclear accord and other OPEC members are also raising production, the bank said.

Iranian Minister of Petroleum Bijan Zangeneh says Iran is planning to open a new chapter in cooperation with the French energy giant, Total, for the development of Iranian oil fields.

GCA Analysis…..

Economic fundamentals shape the business of energy and forecasters frequently make the mistake of assuming the medium term will look similar to the recent past whereas experience suggests it will look very different.  Both supply and demand sides of the oil market are subject to lags between price changes and adjustments in production and consumption.  Changes are already underway, and U.S. consumption this year is set to grow as a result of the fall in prices and continued economic recovery.

The opposite effect can be seen between 2010 and 2014 when OPEC held the price of crude above US$80 per barrel, causing consumer demand to falter.  During that same period, U.S. production nearly doubled, growing from 5 million barrels per day in 2009 to a peak of 9.7 million barrels per day in April 2015. 

Source: EIA July 2015 Update and GCA Analysis 

According to the IEA, non-OPEC production growth is expected to slow from 2.4 million barrels per day in 2014 and 1 million barrels per day in 2015 to zero in 2016, a direct result of the price crash in early 2015. U.S. unconventional liquids production has already started to fall and, assuming a continuation of the current pricing environment, can be expected to continue this trend through 2016. 

Source: EIA July 2015 Update and GCA Analysis 

What has surprised the market is how significantly the North America industry has been able to respond to the price decline with improved well performance and cost reductions.  However, even this segment of the market is not immune to fundamentals and it be would reasonable to assume that the declines that have started will continue, and probably accelerate if prices stay at US$50 WTI levels.  The message from Q2 2015 company results is a focus on dividends and capital efficiency; deep cuts have been made to capital expenditure and it is likely more will follow.  This impact is going to start to be felt from 2016.  Despite everything, US$60 WTI is not enough to keep the supply-side of the market fulfilled.

On the political front, the question is how long the big producers can continue to manage their budgets (and domestic demands).  Recently published numbers suggest that to balance their 2015 budgets many countries require prices north of US$100 per barrel, and more than one country is looking at tapping the bond markets.  Even with changes over the 2016-2018 period, there is still a big gap between these needs and current prices.  And then there is Iran, and both the physical supply and political positioning impact this will have.

This all points to a continuing period where supply and demand are going to be scoring points off each other, and prices will oscillate.  When the dust settles, economic fundamentals suggest the price should be above US$60 per barrel, though how much higher is less clear.  Particularly if, in the interim, the use of gas, including for use as a transportation fuel, adds to a downward trend in demand for oil-derived fuels.  Alternatively, there could be an outbreak of economic pragmatism and fundamentals once more get kicked, like the can, down the road.

Authors

U.S. Demand Responds while Production is Resilient to Decline … Are Current Prices Sustainable?

P Kevin Galvin

Principal Advisor, Field Development Planning - kevin.galvin@gaffney-cline.com
U.S. Demand Responds while Production is Resilient to Decline … Are Current Prices Sustainable?

Bob George

Regional Director: Americas - bob.george@gaffney-cline.com

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