Supply Risks Loom, Creating Potential for Higher Oil Prices

Friday, June 24, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Iran's rapid progress

- Iran has made shocking progress in boosting oil production. Since January, when international sanctions were removed, Iran has managed to increase production by 730,000 barrels per day.
- Iranian oil production hit 3.64 million barrels per day (mb/d) in May, about 80,000 barrels per day higher than in the month of April.
- Much of Iran's increased output has gone to Europe, where Iran is fighting to retake lost market share.
- The extra supplies have prevented a sharper rally in international oil prices. But Iran's near-term progress could be reaching its limits. Without investment in new oil fields, production could stagnate.
- The IEA projects Iran will average 3.6 mb/d for 2016 - roughly where output currently stands - and only rise to 3.7 mb/d in 2017.
- Iran has a goal of attracting $100 billion in new investment, but uncertainty over oil contracts along with lingering sanctions from the U.S. government could scare away western oil companies, at least for a while. Iran may not be able to significantly boost production from today's levels for a few more years.

2. Venezuela a downside risk

- Venezuela's oil production has been in gradual decline for years, but the pace of losses is starting to increase.
- Venezuela's conventional oil fields are depleting and its massive heavy oil reserves require large-scale investments. Because the government has syphoned off revenues from the state-owned PDVSA in order to meet social and political objectives, the oil company has failed to invest in its future.
- But the financial crisis hitting Venezuela today is leading to worse losses. Oilfield service companies are cutting back on operations because of lack of payment. Electricity blackouts are cutting into refining production. Shortages of light oil have hampered diluting heavy oil production.
- Venezuela's output fell 20,000 barrels per day in May, dropping to 2.29 mb/d, the lowest monthly output in seven years. The IEA sees an annual decline of at least 100,000 barrels per day this year.
- A recent estimate from Barclays is much more pessimistic - the investment bank says that a 0.5 mb/d decline is possible this year.
- There is little chance that Venezuela will surprise on the upside, and there is a strong chance it will surprise on the downside.

3. Fewer rigs needed in shale patch

- The rig count has increased for three consecutive weeks, with 21 oil rigs added back to the oil patch so far in June.
- The weekly rig count data has put downward pressure on prices, raising fears of an upturn in U.S. oil supply. There is little chance that a handful of rigs will be able to halt the declines in U.S. oil production, losses which most analysts expect to continue for the rest of this year.
- At the same time, drillers are much more efficient than in years past, requiring fewer rigs to produce a barrel of oil.
- The average initial production rate from new oil wells increased by more than 50 percent in 2015, rising to 550 barrels per day. Those rates vary from basin to basin. In the Eagle Ford, an average rig can produce more than 1,000 barrels per day. The Permian has seen more attention lately from drillers, but IP rates are lower - about 508 barrels per day estimated for July.
- The downside to using the "average production per rig" metric is that the loss of inefficient rigs could make the figure appear more impressive. The IEA estimates that average production per well seems to have stalled in 2015, and the agency sees little chance of further productivity gains in the next year or so, barring any technological breakthrough.
- That means more rigs will be required if the U.S. is to see production increase again.

4. Iran cutting into Russia's backyard

- Iran has ratcheted up oil exports, adding more than 700,000 barrels per day. More than half of that is going to Europe - Iran's exports to the EU hit 355,000 barrels per day in May, up from 330,000 barrels per day in April.
- That is putting pressure on Iran's main rivals for the European market - Saudi Arabia and Russia.
- Russia's benchmark oil price, the Urals blend, dropped to its deepest discount to Brent crude in two years as competition in Europe stiffened. The discount widened to $2.40 per barrel, a level not seen since June 2014.
- Saudi Arabia has been forced to cut its prices for oil in Europe, which is all the more telling given that it raised prices for its oil heading to Asia.

5. $80 oil around the corner?

(Click to enlarge)

- Investment bank Raymond James is bucking the market trend, issuing bullish estimates for oil prices.
- It projects oil prices to average $80 per barrel by the end of 2017, higher than all but one of the 31 analysts surveyed by Bloomberg.
- The above chart is a bit busy, but it shows Raymond James' reasoning for its bullish sentiment: It now sees global oil supplies about 790,000 barrels per day lower in 2017 than it previously thought six months ago.
- That figure is broken down into downward revisions from the following sources: unforeseen disruptions will be 300,000 bpd worse than expected; 400,000 bpd in downward revisions from structural declines in non-OPEC countries; and also a deeper loss of 400,000 bpd from U.S. shale. That will be partially offset by a 320,000 bpd upward revision in production from the North Sea, Russia, Iran, and Kuwait.
- In short, the oil markets are set to tighten much deeper than many expect. "We continue to believe that 2017 WTI oil prices will average about $30/barrel higher than current futures strip prices would indicate," Raymond James wrote.

6. DUCs to halt U.S. production decline

- The U.S. shale industry is starting to work through the backlog of drilled but uncompleted wells (DUCs).
- Rystad Energy estimates that in the second half of 2016, well completions from DUCs will exceed the number of new wells drilled by roughly 30 percent. The DUC inventory, which tops 4,000, will be drawn down by about 800 by the end of the year.
- Production from DUCs will add about 300,000 to 350,000 bpd to U.S. output, enough to stop the production declines that have been ongoing since last year.
- Rystad Energy says that more than 90 percent of the DUCs can be completed economically at $50 per barrel.

7. Decline rates pickup

- As the global oil industry slashes investment, companies will spend less on maintenance at existing fields, ultimately leading to faster declines in output.
- According to a June estimate from Rystad Energy, the decline rate at existing oil fields in several countries - the U.S., Russia, Canada and Norway - are set to rise this year. The energy consultancy sees decline rates jumping from around 3.5 percent in 2014 to 6 percent in 2016.
- That could lead to the loss of 700,000 barrels per day from existing oil fields.
- Natural depletion from existing oil fields must be offset by output from new oil fields. But two consecutive years of overall investment declines across the entire world could hamper global oil production in the next few years.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.