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US Oil Production Could Provide A Few Surprises

US Oil Production Could Provide A Few Surprises

Sign

The current US oil market is in the midst of a slugfest reminiscent of a Rocky fight, as competing influences face off against one another. In one corner we have rising US shale oil production, while in the opposing corner we have a precipitously falling rig count. Out of this duking duo, one is going to provide a sucker punch to prices. The question is….which?

Let’s get straight to the main event. The oil rig count has dropped precipitously. It has fallen by over 34% to 1056 from an all-time high of 1609 last October. Not only are lesser efficient vertical rigs being idled (and at lesser productive shale plays), but we have seen 347 horizontal rigs idled, down 25% from a record high of 1372:

BHIRigCount

But therein lies the rub. At first blush, it seems wholly logical that a falling rig count would translate into materially lower production. But this is not necessarily the case. Related: Why Oil Prices Must Go Up

Although under different circumstances, we saw a similar scenario play out in the aftermath of the oil crash in 2008-09. Even though the number of rigs declined 60% between November 2008 and June 2009, production ticked lower by a mere 5% on a weekly basis from early December 2008 into the second week of January 2009, before rebounding from there. On a monthly basis, production never actually dropped.

This time around, US production is again likely to remain stable despite the oil rig drop. Not only does improving productivity per rig mean efficiencies will buoy production going forward, but a significant backlog in well completions (of 3 – 7 months) will act as a cushion for production rates. Combine this with a response in drilling activity to a price rebound (like, um, the +30% rally in recent weeks) and we may see a leveling off in production, but by no means a significant drop. Hark, the EIA is on board:

EIARigChart

But for now, US production keeps rolling with the punches, edging ever higher. This is manifesting itself in higher oil inventories, which are now at 417 million barrels, the highest level since weekly records began in 1982, and the highest since 1931 according to monthly EIA data. US oil inventories seasonally tend to rise in the first quarter given lesser demand and the onset of spring refinery maintenance. What is unusual, however, is for inventories to set such a pace while already at record levels (h/t rampant production):

USInventory

Meanwhile, back at the pipeline crossroads of the world (as we talked about here recently), Cushing stockpiles have now more than doubled since October to be at 42.5 million barrels. Such as swift uppercut of an increase has led to the question of how much room is left. Related: Will Texas Survive The Downturn?

According to Genscape (who, like Mohammed Ali, hails from the mighty Louisville, KY), capacity is just shy of 70 million barrels. Given it has averaged a build of ~2 million barrels a week thus far this year, we could be brimming by mid-year if it keeps up this pace:

CushingOilInventories

So this leaves us in quite a conundrum, and one which is prompting a vast variety of views for oil going forward. Goldman Sachs led the bearish charge last month by slashing their WTI forecast in half to the $30s, while Citi sees even further downside to $20. In recent days, economist Gary Shilling has one-upped them all by touting a $10 price target. On the flipside, OPEC Secretary-General el-Badri says that oil is heading higher from here, while my buddy the Mighty Phil Flynn is also saying that prices have bottomed out.

Only time will tell who is the victor here. But given that we will see some response from US production – be it marginal or material – the ultimate victor when prices rebound will be the ones feeling the most short-term pain now: OPEC.

By Matt Smith of http://www.energyburrito.com  

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  • Jerry Spetseris on February 18 2015 said:
    Although Mr. Smith poses a question instead of asserting a conclusion, I think his data point to a build in production at a rate that is not offset by a fall in rig count. In fact the two are weekly correlated. Mr. Smith uses the term "production" in a way seeming to mean oil production. But many shale wells are classified as gas wells even though most of the production at normal temperature and pressure is in barrels of condensate (API gravity >50). Thus the BOE production is growing at a rate even greater than Mr. Smith indicates. EIA analysis of shale well completion backlog of 3-7 months appears solid based on the checking of well records I have recently performed in Texas. Whether or not operators schedule a frac and complete the wells will depend on both oil (and condensate) price and ability to borrow (presumably without relinquishing equity) driven by company cash flow needs. If oil and condensate stocks build at the rate seen in data over the past month, and the data suggests they will, prices will have to fall since U.S. storage is constrained. Only capitulation in the face of falling prices will drive operators to idle rigs and possibly forego completion of the backlog of drilled wells. That along with company failures or sale will result in a decline in production growth with an ultimate decrease in production (as natural decline takes hold) since it doesn't appear that global demand will increase anytime soon. That's my story and I'm sticking to it!
  • Matt Smith on February 20 2015 said:
    It's fair point that I was posing a question as opposed to a conclusion - my feeling is it is too early to declare the recent lows as a bottom. Appreciated your insights - thanks!
  • Mike Foster on February 20 2015 said:
    Matt,

    What are your thoughts regarding the gas rig count in the Marcellus? The Utica (Ohio) rig count is dropping but the Marceulls (PA) rig count hasn't budged from 54 in weeks.
  • Matt Smith on February 22 2015 said:
    Hi Mike,

    Drilling productivity continues to improve at Marcellus, combined with low break-evens. I expect gas rigs to continue to flat-line, while production continues to rise. We should see it rise by another couple of Bcf this year, with capacity additions later this year to facilitate this - http://www.eia.gov/petroleum/drilling/pdf/marcellus.pdf

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