If anyone is cheering the news of an OPEC deal it is U.S. shale producers. The OPEC agreement sent oil prices shooting up this week, with WTI and Brent quickly surging above $50 per barrel.
Saudi Arabia has agreed to swallow the pain by lowering its oil production, reducing the global surplus to the benefit of everyone else. But it also managed to convince some of its intractable peers to chip in some production cuts, including Iraq, which had previously resisted any cuts. OPEC was even able to bring Russia on board for 300,000 barrels per day in reductions, even though Russia is not an OPEC member.
The result is significant by any measure. OPEC is planning to cut 1.2 million barrels per day beginning in January and non-OPEC producers could add another 600,000 barrels per day in reductions. The global supply-demand balance will likely flip from surplus to deficit when the deal is implemented, and Goldman Sachs sees oil prices rising to $60 per barrel in the first half of next year.
Surely there were champagne corks being popped in Texas as OPEC announced its decision. The share prices of more than 50 U.S. oil and gas companies shot up by more than 10 percent on Wednesday. The S&P 500 Energy Sector Index gained 5 percent, rising to its highest level since mid-2015.
The rebound in oil prices could lead to a revival in U.S. shale production. The U.S. has already lost about 1 million barrels per day (mb/d) since hitting a peak in April 2015, with output now down to about 8.6 mb/d. But production has stabilized in recent months, and the rig count has even rebounded substantially since hitting a low point at just over 400 in May of this year, rising by about 50 percent. Those early signs of stabilization in the shale patch occurred when oil prices were below $50 per barrel. Higher oil prices will accelerate the rebound.
Although major shale regions like the Bakken and the Eagle Ford are still losing production, the Permian Basin in West Texas has allowed the shale industry to survive, and even thrive in some cases. “Assuming OPEC makes good on an apparent production-cut deal, U.S. oil production growth is all but guaranteed to return in 2017,” Joseph Triepke, founder of Infill Thinking, an oil-research firm, told Bloomberg. “All U.S. tight-oil plays will benefit, but none more than the Permian, where we estimate as many as 150 rigs could be reactivated next year.”
Of course, breakeven prices in the shale patch can vary widely from place to place, but in the best locations, there is money to be made even at today’s low prices. North Dakota officials say that Dunn County, which is situated in Bakken country, can produce oil at $15 per barrel, according to Reuters. That puts it on par with the production costs in famously low-cost Iran, and almost as cheap as Iraq. However, because Bakken producers need to pay higher transport costs (thus, the urgency the industry sees in the construction of the Dakota Access Pipeline), which often involves shipping crude by rail, breakeven prices can run higher for many companies. Related: U.S. To Be The Third Largest Natural Gas Exporter By 2020
In contrast, the Permian Basin is where the real action is today. Production never really stopped growing in West Texas, even during the downturn. Now the Permian is setting new output records seemingly every month – the EIA projects production will climb to a new record of 2.06 million barrels per day in December, up 27,000 barrels per day from November. Breakeven prices for much of the Delaware Basin in the Permian are around $30 per barrel.
The OPEC deal could accelerate spending, drilling, and production across the U.S. If oil prices rise well into the $50s per barrel, production could be profitable in virtually all of the major shale basins, including the Eagle Ford, which has fallen on hard times over the past two years. Even some large-scale projects from the oil majors, such as multi-billion dollar offshore projects, could move forward now that OPEC has cut output.
But here is where things get complicated. A strong rebound in shale drilling could doom the very price rally that sparked the revival. Goldman Sachs predicts that oil prices above $55 per barrel will bring back some 800,000 barrels per day in shale production compared to a scenario in which oil prices traded at just $45 per barrel. That would put a cap on oil prices – Goldman reiterated its projection for WTI for the second half of 2017 at $50 per barrel, arguing that a surge in shale production will bring prices back down.
By Nick Cunningham of Oilprice.com
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Also have to consider how many producers are now stuck with hedges in the 40-50 range, and they have limited their ability to actually benefit from price increases. They will be kicking themselves next year, especailly if those service costs do start to rise at all, their profits they thought they guaranteed themselves with hedging could quickly turn into more losses.
Cartels never last. But it does create return on investment issues with those investing capital in extracting higher priced oil, such as the shale based producers. We'll have to see if banks and traders will be buying/selling futures contracts for oil, given the gyrations the cartel can cause in the market, which allow producers to guarantee their profits before they invest a lot of capital in extracting oil. I bet they do.