US shale oil production has surged this year, underlining the short-cycle nature of the resource, but what goes up can come down. Shale oil production is much more responsive to price than the majority of conventional drilling and there are early indicators that recent output gains are already topping out.
Such has been the jump in production that the US Energy Information Administration (EIA) now predicts total US liquids supply this year of 17.83 million b/d, more than 1 million b/d higher than it forecast for 2018 a year ago, largely as a result of increased shale oil drilling.
The jump in US output, higher production from Saudi Arabia and Russia, Washington’s granting of sanctions waivers to key importers of Iranian crude and an increasingly gloomy economic outlook, have all served to take the heat out of the oil market.
The result has been the liquidation of long positions by hedge funds and traders, a drop in oil prices, and a softening of the market’s backwardated structure.
However, while US oil production may now be quicker to take advantage of high returns, that same short-cycle responsiveness also works in the opposite direction.
Coming in from the cold
Prior to the late-2000s, the oil majors at least saw the future as being offshore in ever deeper water and harsher environments. This would require big capital, long-lead times and expertise only they possessed.
The prospect of the marginal barrel taking around five years to come into production meant a reinforcement of the long-term cyclical nature of the oil market.
Given the potential for both demand and supply-side shocks, the only stabilising factor was the holding of spare capacity, a role taken on in theory by OPEC, but in practice by Saudi Arabia, and to a lesser extent commercial and strategic reserves, fostered by the International Energy Agency and supported by the governments of countries dependent on oil imports.
Independent US drillers, however, had other ideas. Shale, or Light Tight Oil (LTO) to give it its broader title, fundamentally altered this dynamic.
LTO meant new wells could be brought into production in weeks rather than years. Non-OPEC production capacity could even be stored in the form of uncompleted wells (DUCs) to be brought on-stream when prices or company requirements warranted. The marginal barrel had come onshore, and taken up residence in the shale plays of the US.
Short versus long-cycle…