Exactly How Rising U.S. Production is Affecting You
Since last Friday’s close, crude oil prices have dropped just over 4%. The reason is simple: concern over rising U.S. shale oil production.
Indeed, ever since the November 30 meeting in Vienna where OPEC promised to cut oil production, the U.S. response has been the focus of global markets.
What happens here may well decide whether OPEC’s Vienna Accord is successful or not.
Oil is Still Too Low for (Most) U.S. Producers
Of course, an increase in U.S. oil production was guaranteed by the spike in prices that followed the November 30 OPEC decision to cut/cap production – the Vienna Accord. Through December 28, WTI (the benchmark crude rate traded in New York) had increased 19.5% for the month. The 45% improvement for the year was the best since 2009.
And as of close yesterday, the benchmark is up 98.2% since its low for the year ($26.21 on February 11).
In a broader perspective, however, as of open this morning, WTI remains 31.5% below its price in mid-November of 2014, just before the OPEC decision to defend market that sent oil prices crashing.
All of which sets the stage for what’s really happening in U.S. production.
At the current range of $52 to $54 a barrel – the price I had initially predicted back in September for close of year levels – you can expect changes in American production volume.
That is especially the case with shale and tight oil, which has transformed the U.S. from relying on imports to having genuine expectations of energy independence.
Barely seven years ago, the widely shared assumption was that more than 70% of daily crude oil needs would have to be imported into the U.S. by 2020. These days, that import figure is closer to 40%, with any increases in the amount of oil brought down to refinery margins, not domestic oil demand.
The production/import balance, therefore, is a much more nuanced one than had been the case when imports ruled the market.
And today’s oil price sits in the center of a massive tug-of-war.
Soaring U.S. Production Could Scuttle the OPEC Oil Deal
If American production increases markedly, it will put pressure on OPEC’s continued abidance to the Accord. That agreement, in turn, serves as the foundation for OPEC’s deals with Russia and other non-cartel producers.
Should U.S. extractions begin to accelerate, the entire fabric of the Vienna Accord begins to unravel. The U.S. is not party to the Accord and had no involvement in the Vienna meetings in which it was hammered out.
But what happens here may well determine international pricing dynamics going forward. Oil prices are currently below the level necessary to make most fields in the U.S. profitable, especially shale/tight production that requires something closer to $63-$65 a barrel on average.
This is accentuated when you consider that operating companies receive a “wellhead” price – what’s paid when the oil first leaves the ground. That price is well below the market price and reflects the initial transfer of the oil.
Nonetheless, the ability to hedge contract prices into the future will prompt some additional production even at levels below “breakeven” prices. And that has OPEC worried.
The Accord only went into effect this month and needs to remain in place until at least the third quarter of this year to have any genuine effect. There’s also the matter of compliance to consider.
By Mid-Year, Things Will Look Very Different
As I have noted here in Oil & Energy Investor, the aggregate level of production actually experienced will be higher than the total of monthly production quotas by OPEC members. In other words, the countries most desperate for export revenues will exceed their quotas.
To avoid returning to the vicious zero-sum contest experienced over the past two years, in which one country lowering production just meant lost market (and money) to another country, production must not intensify from sources not involved in the Accord or its subsequent application to non-OPEC nations.
And that brings us back to the elephant in the room – U.S. production.
The present volatility in NYMEX oil prices remains manageable so long as the market price remains at or below the average breakeven point. Some additional volume is justified, especially if general demand levels continue to rise.
Technical advances have reduced field costs by an average of 17% over the past 18 months, while the recent overall improvement in the price level allowed companies to once again issue debt or equity to meet expenses.
However, this will continue to be an environment in which selected producers will be faring much better than the sector as a whole. This will continue at least through mid-year. By that time, if my latest estimates of $63-$65 a barrel hold for second quarter, a different picture will be emerging.
But even then, an opening production situation still requires access to operating capital, so not all boats will be lifted. Instead, a specific set of companies are emerging that comprise the better investment opportunities moving forward.
I’ll have more to say on this soon. Stay tuned.