Last year’s OPEC deal to cut production managed to lift oil prices and stabilize them around US$50 for most of the first quarter this year. The higher price of oil led to quite the Permania, with a lot of the available capital and subsequent production focused on the most lucrative of the U.S. shale basins, but investors backing the Permian adventurers are threatening its top spot.
The Permian continues to lead production gains of U.S. crude output, which is exceeding the wildest projections for recovery. However, a group of investors in Permian-focused drillers have reduced their positions in the largest U.S. oil field, in what could be a sign of concern that the unstoppable rise in production could sink oil prices and unravel the resurgence U.S. shale has been enjoying since OPEC decided to play the market-fixer again and collectively reduce output.
These investors are some prominent hedge funds that are waiting to see if Permian-focused firms would be disciplined enough to avoid overdoing the drilling to the point of sinking oil prices so low that production would become unprofitable. The hedge funds are also concerned that rising service costs and crazy-high land prices in the Permian are not fully factored into the highly optimistic forecasts for the future of this star U.S. shale play.
According to Reuters data and analysis, eight hedge funds—with combined assets totaling US$286 billion and with hefty energy holdings—reduced their positions in ten of the top pure Permian players or Permian-focused drillers by more than US$400 million in the first quarter this year.
The value of the holdings of those funds in the 10 Permian drillers fell by 14 percent in the first quarter, to stand at a total of US$2.66 billion, compared to US$3.08 billion in the fourth quarter last year, Reuters data show.
“We’ll have to see if these U.S. producers have the discipline to not go crazy and keep prices where they keep making money,” Gary Bradshaw, portfolio manager at Dallas-based investment firm Hodges Capital Management, told Reuters. Hodges Capital, however, has kept its holdings in Permian players, which include Diamondback Energy, RSP Permian Inc, and Callon Petroleum. Related: Saudis Overtake U.S. In Recoverable Oil Resources
The strong recovery of shale drilling is also accompanied by expectations of cost inflation, with a projected increase in service costs by around 20 percent this year.
According to Michael Roomberg, portfolio manager of the Miller/Howard Drill Bit to Burner Tip Fund, who spoke to Reuters:
“Margins will continue to be squeezed by a 15 to 20 percent increase in service costs in the Permian basin.”
According to research by IHS Markit from last month, “despite the continued economic attractiveness of the Permian Basin, rising service sector costs will raise per-well capex by more than 15 percent during 2017.”
“Costs will continue to place upward pressure on break-evens averaging $5 per barrel in the Permian,” said Imre Kugler, senior consultant at IHS Markit.
“The economics for the Permian are still impressive at $41-per-barrel (weighted average) for a $55-per-barrel WTI price-projection, but costs are rising, mostly for service sector-related costs of drilling and completion, proppant, sand and a tightening rig market as utilization rates increase,” Kugler noted.
Costs may be on the rise, but the Permian is expected to continue pumping more oil by the week. According to the latest Drilling Productivity Report by the EIA, the Permian’s crude oil production in July is set to rise to 2.470 million bpd, up by 65,000 bpd from June. To compare, the Permian’s output in January this year was 2.127 million bpd—the basin’s production will have increased in July by more than 300,000 bpd since the beginning of this year.
Total U.S. crude oil production is now seen averaging 9.3 million bpd this year, compared to 8.9 million bpd last year, the EIA said in its latest Short-Term Energy Outlook. The 2018 forecast of 10.0 million bpd exceeds the U.S. record production level of 9.6 million bpd set in 1970. Related: Bank Of America: Expect $30 Oil
At the end of May, consultancy Rystad Energy predicted that U.S. production grows so fast that it could reach an all-time high of 10 million bpd before the end of this year.
U.S. oil production is set to rise, and the Permian will continue to be the main contributor to the increase. Despite concerns over rising costs, the Permian is still the U.S. oil region with the best well economics and lowest break-evens.
By Tsvetana Paraskova for Oilprice.com
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