International Commentary: Déjà Vu: Shale to Kill oil prices once again
The US shale industry is in danger of killing of the very rally that it had hoped to take advantage of.
Shale production is up more than 700,000 bpd since bottoming out in September 2016, rising steadily to 9.33 MM bopd in June, according to the latest weekly estimates from the EIA. The International Energy Agency says that US oil production could end 2017 up 920,000 barrels per day (bpd) from a year earlier. Most analysts expect the production gains to continue into next year – the IEA says shale could grow by another 780,000 bpd.
Those figures, if they came to pass, would likely prevent any rally in oil prices. But the industry might not get that far because they could push down prices this year, which could potentially choke off their ambitious production plans.
“The growth outlooks proposed by many oily E&Ps appear tenuous at best and not resilient to prolonged weak oil prices,"Mizuho Securities USA analysts Timothy Rezvan and James Lizzul wrote in a research note. Many shale companies are already in the middle of their drilling campaigns, which could mean that a certain amount of growth is already locked in. But they could suspend future growth plans if prices continue to fall.
Bloomberg reported that the Bakken would see a lot of wells fall below profitability with WTI at US$45 per barrel. Less attractive parts of the Eagle Ford and the Niobrara also become less viable. The SCOOP play in Oklahoma and parts of the Permian start to come under serious pressure at US$40 per barrel. “The Permian keeps going," James Williams, President of WTRG Economics, told Bloomberg. “It doesn’t collapse, but I don’t think at US$40 it grows."UBS AG analysts said that US$45 oil “slows most US shale plays.”
There are other problems for US shale. Although shale drillers have boasted about declining breakeven prices and cost savings, drilling productivity is starting to decline. Drilling costs are actually on the rise again because the market for oilfield services (rigs, equipment and fracking crews) is growing tighter. Shale companies also gambled earlier this year on higher prices, declining to secure hedges for their 2018 production at the same volume as they have in the past. That leaves many companies exposed to lower prices, a situation that could ultimately force them to throttle back on drilling.
Those problems are running headlong into a market that looks like it is once again oversupplied. The futures market has made a dramatic shift towards contango in recent weeks, a situation in which near-term contracts trade at a discount to deliveries further off. A contango reflects concerns about near-term oversupply. The contango is especially concerning given that OPEC’s best hope was to induce backwardation into the futures market. Backwardation is the opposite of contango, a downward sloping curve that has crude for immediate delivery trading at a premium. That would allow inventories to drain because it would become costly to buy and store crude.
The market is now at the steepest contango since November. It might not be a coincidence then that oil traders are once again turning to floating storage. Reuters reports that a growing number of old oil tankers have been contracted out to store oil in Southeast Asia. The contango allows traders to pay for storage and sell their oil at a higher price at a later date. "Too much unsold oil is headed to Asia," Oystein Berentsen, MD for oil trading company Strong Petroleum, said in a Reuters interview.
Contango, backwardation and floating storage may sound like a bunch of arcane industry jargon, but the basic point is that oil is getting stored on tankers because there is too much of it on the market at the moment.
“There were all those expectations that inventories would go down and that would lead to a tighter market this year and in following years,” Olivier Jakob, MD of consultancy Petromatrix GmbH, told Bloomberg. “Right now it has been delayed and the expectations of a re-balancing are starting to evaporate.”
In short, there are growing signs that the oil market is still woefully oversupplied. Ultimately, that could put a damper on US shale. Reuters says that eight prominent hedge funds have recently cut their investments in ten top shale companies, reducing their exposure by US$400 million. The reason seems to be growing concerns that oil prices will tank because of too much drilling. The moves by the hedge funds are even more eye-opening because they pared back their positions in companies that are drilling in the Permian, the most attractive shale basin in the country.
If the margins in the Permian are no longer looking that great, then the shale boom could really be in trouble.