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Dan Steffens

Dan Steffens

Dan Steffens is the President of Energy Prospectus Group (EPG), a networking organization based in Houston, Texas. He is a 1976 graduate of Tulsa University…

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The Real Reason Why US Oil Production Has Peaked

One of the basic assumptions or “Paradigms” that is keeping a lid on the price of oil is the belief that U.S. oil production will continue going up year­-after-year. This paradigm is second only to the fear that the tariff war between the U.S. and China will go on for years, causing a global recession. FEAR has caused oil prices to fall back into the mid-$50s, not supply / demand fundamentals. It is important that energy sector investors know what’s going on in the real world because $55 oil is not a sustainable price for the world’s most important commodity.

In the real world, upstream oil & gas companies are slashing drilling & completion budgets and the active rig count is falling week after week. Today we aren’t completing enough new wells to offset the accelerating decline rate of existing wells.

(Click to enlarge)

Raymond James recently estimated that over the last three years the U.S. decline rate for oil has doubled from 1.6 to 3.2 million barrels per day. The drilled but uncompleted well inventory (“DUC”) is back to normal, so the number of wells being drilled and the number of wells being completed is now about the same. We need over 12,000 new horizontal oil wells completed each year to hold production flat and the number of completed wells will need to go up each year.

What happens if U.S. oil production stalls or goes on decline?

This is a big question because U.S. production growth has been close to 90% of global oil supply growth over the last three years. If U.S. oil production has peaked, then global supplies will have trouble keeping up with demand growth. Global demand for products refined from crude oil goes up 1.0 to 1.5 million barrels per day year-after year. The only annual decline in demand for oil happened in 2008-2009 thanks to the Great Recession and demand quickly rebounded back to the long-term trend line in 2010. I don’t think Trump’s tariff war with China will cause another Great Recession. Related: U.S. To “Drown The World” In Oil

Let me pause here and say that I believe there is more upside for U.S. oil production. It just isn’t going to happen unless the price of oil goes a lot higher than it is today.

The U.S. Energy Information Administration (“EIA”) forecast at the beginning of this year was that the U.S. shale oil plays were just getting started and that production would increase by at least 2 million barrels of oil per day (“MMBOPD”) each year for several more years.

Thanks to the Great Recession, U.S. oil production dipped briefly below 4.0 MMBOPD in September 2008 but rebounded to over 5.3 MMBOPD within six months. The “Shale Revolution” started around 2010; saving the U.S. oil & gas industry. Jumping forward, U.S. crude oil production increased 2.4 MMBOPD from 9.7 MMBOPD in December 2017 to 12.1 MMBOPD in December 2018. EIA’s projection that oil production would go up at least 2.0 MMBOPD this year seemed reasonable back in January, but shale oil production has definitely hit a wall.

(Click to enlarge)

The chart above is taken directly from the EIA website. Note that after a 539,000 barrel per day surge in U.S. oil production from September to December of 2018 U.S. production declined in the first quarter of this year. After a nice increase in April, production pulled back again slightly in May. May is the last month for which we have actual production data. Related: Hong Kong Billionaire Loses $20 Billion In Canadian Oil Sands

The EIA appears to have figured this out, but the International Energy Agency (“IEA”) based in France is still telling the world that the U.S. can keep the world well supplied with cheap oil.

EIA’s weekly oil supply estimates are just “guesses” based on their formulas. They don’t have measuring devices on the more than a million oil wells producing in the U.S. Since the end of May (area highlighted in yellow in the chart below) EIA has been reporting that U.S. oil production has been flat. The big dip in mid-July was caused by Hurricane Berry.

(Click to enlarge)

My conclusion is that upstream companies in the U.S. are not completing enough new wells to offset the increasing decline rate. My "guess" is that U.S. oil production peaked sometime in April or May. If this is confirmed by a few more months of actual production data provided by state agencies on a 90-day lag, I think there may be a big “Paradigm Shift” that causes a lot of investors to add more energy to their portfolios.

I follow close to 100 upstream oil & gas companies. I’ve never seen the market sentiment toward the sub-sector so negative. Dozens of profitable oil companies that I follow are trading at single digit PE ratios and multiples of cash flow from operations that I never dreamed possible. This world runs on oil and there is nothing that is going to change that anytime soon. That is the real world we live in.

By Dan Steffens for Oilprice.com

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  • Anant Singh on August 25 2019 said:
    Indeed, whatever people say, the world does run on oil, and to satisfy the needs, it is necessary that more new wells are completed. A report by Grand View Research predicted a linear growth for the oilfield chemicals sector, a crucial factor for crude oil production, by 2025. However, will there still be a declining trend, that is something we need to see.
  • Victor Edwards on August 26 2019 said:
    The article has this line:

    "FEAR has caused oil prices to fall back into the mid-$50s, not supply / demand fundamentals."

    The notion that any "supply/demand fundamentals" are even related to the oil market is laughable. This is the most manipulated market that has existed in the history of manking, and if those imaginary concepts called "supply and demand" were extant in any place other than ancient textbooks, oil would be $10 a bbl.
  • Daniel Porter on August 26 2019 said:
    The headline and article don't match. There is some great info written there as well, but I noticed that they did not answer the big question. At what point (i.e. dollar value) will oil be high enough to continue U.S production? I think we have taken a McDonalds strategy where we make a little bit millions of pennies at a time. In other words, if there is money to be made, then we will keep pumping! It may not be well received in Saudi or Iran, but thats too bad. I say, lets keep drilling!
  • Tony Smith on August 26 2019 said:
    Great Article
    Talk of over supply in oil and gas is all over the meda right now.
    Natural gas is getting a hammering at the moment with prices just over $2
    whereas the EIA NATURAL GAS STORAGE DASHBOARD shows for a similar level of storage in the past the NG price has averaged about $3.
    LNG export is up
    Elec power gen from gas is up
    Storage is in deficit from 5 year average and will never catch up by withdrawal season
    Nat gas prices should be higher.
    Anyone know any gas producers like DGOC with a low PE?
  • Lee James on August 26 2019 said:
    If U.S. production has been in decline, it'll be interesting to see where additional supply comes from to meet demand -- will it be foreign or domestic? No one knows for sure, but with domestic production costs rising, I can see how foreign suppliers may kick in more.
  • Pedro Piporro on August 28 2019 said:
    While it is true that the oil market is manipulated in some corners of the world, what the US did by suddenly changing from a gradually declining producer to a quickly increasing supply producer, was upset the apple cart. The manipulators had two choices, reduce supply, to maintain the supply/demand balance needed for 100 dollar oil, or over supply the market and get the price down low enough to drive these new upstarts out of business. We all know which route they took. The other elephant in the room is how will the electric car market will affect demand. Some projections have the worldwide new car market at half electric within 10 years. Since very little electricity is generated using oil the growth in the demand for oil could decline to zero and negative growth could even happen. That would throw a monkey wrench into the manipulators plans.
  • Hugh Williams on August 29 2019 said:
    (1) Supply and demand vs the markets: From 2009 through 2013 global banks were fined over $166 billion for market fixing. The value of oil derivatives traded daily is around $2.5 trillion compared to the daily value of produced oil of around $7 billion. Free market, ha, ha, ha.

    (2) Oil production--Hydrocarbon molecules come in many forms, a million or so, and therefore the question of what is crude oil has many interpretations. My favourite nonsense fudge factor is including the expansion which comes with refining in the calculation of the amount of crude production.

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