- Bloomberg – Oil Explorers Expand U.S. Drilling by Most in Almost Five Years
U.S. oil explorers increased the number of drilling rigs this week by the most in almost half a decade as domestic crude production roared toward unprecedented highs. Working rigs drilling for American crude rose by 26, bringing the total to 791, the biggest one-week increase since April 2013, according to Baker Hughes data released Friday. Despite the worst weekly drop in crude prices in almost a year, prices remained close to $60 a barrel, high enough to entice drillers to boost production and use financial instruments to lock in future profits.
- Bloomberg – Crude Tumbles as Record U.S. Output Stokes Oversupply Anxieties
Weekly output tops 10 million barrels a day for the first timeFutures slid 2.5 percent in New York. Crude output from American wells jumped to 10.25 million barrels a day last week, vaulting the U.S. into the elite of world producers alongside Saudi Arabia and Russia. With production set to climb even higher later this year, the Saudi- and Russia-led alliance of other major suppliers will come under renewed pressure to reconsider self-imposed output caps aimed at eroding a glut.
- Reuters – How soaring U.S. oil exports to China are transforming the global oil game
The transformation is reflected in figures released in recent days that shows the U.S. now produces more oil than top exporter Saudi Arabia and means the Americans are likely to take over the No.1 producer spot from Russia by the end of the year. The growth has surprised even the official U.S. Energy Information Administration, which this week raised its 2018 crude output forecast to 10.59 million bpd, up by 300,000 bpd from their last forecast just a week before. When U.S. oil exports appeared in 2016, the first cargoes went to free trade agreement partners South Korea and Japan. Few expected China to become a major buyer. Data in Thomson Reuters Eikon shows U.S. crude shipments to China went from nothing before 2016 to a record 400,000 barrels per day (bpd) in January, worth almost $1 billion. Additionally, half a million tonnes of U.S. liquefied natural gas (LNG) worth almost $300 million, headed to China from the U.S. in January
Summary
U.S. shale is back in the spotlight. Just as risk markets stumbled, a gut punch of new supply sent crude oil prices tumbling. U.S. oil production surged above 10 million barrels a day and the biggest increase in shale drilling activity in 3 years promises another surge in production later this year. Crude oil inventories are nearly flat on the year despite over a year of OPEC production cuts. Markets adjusted by halving the backwardation we’ve seen in forward curves for Brent and WTI, and narrowing the Brent-WTI spread.
Comment
Crude oil fell out of bed last week, echoing a similarly sharp decline from roughly a year ago. A combination of risk market jitters, rising inventory numbers and a surge in the Baker Hughes rig count sent WTI crude oil back below $60 by Friday afternoon.
Friday’s announcement that the Baker Hughes rig count had surged higher for a second consecutive week came at a vulnerable time for markets. Several months of crude oil prices north of $60 lit a fire in the Permian Basin. This is the biggest two-week jump in rig activity since the OPEC production cuts were first announced in November 2016. Reuters reported it was the biggest increase in three years.
OPEC finds itself confronting a very uncomfortable reality. Assets in the Permian Basin are increasing in the well funded and capable hands of oil majors. Exxon unveiled plans to increase production in the Permian region three-fold by 2025 to 500,000 barrels a day. U.S. shale oil is becoming more influential in international markets with deliveries to 60 different countries in the two years since exports were reopened.
The chart below shows U.S. crude oil inventories during each year since 2009. 2017 is shown in yellow, 2018 in orange (to the left). The yellow 2017 line shows how inventories finally pulled off record highs in the second half of 2017. But despite over a year of production cuts and some remarkable achievements in compliance, OPEC has failed to reverse the huge jump in U.S. inventories from the spring of 2015.
With drilling activity in the Permian Basin surging now, U.S. oil production will surge in 6-9 months. OPEC and Russia have said they would consider extending production cuts into the second half of the year. This leaves OPEC and its collaborators with a very thorny question. Can they afford to increase production just as another wave of U.S. shale oil arrives? Or will they cede more market share to U.S. producers in hopes of keeping prices higher?
Rapidly shifting views of the supply situation later this year has finally put a dent in the backwardation we’ve highlighted in both Brent and WTI crude oil. The chart below shows the forward curves for WTI and Brent at the start of each month since September 2017. Pipeline disruptions and positive demand surprises sent crude sharply into backwardation beginning in September. Last week’s repricing pulled prices lower across the entire curve and saw the backwardation cut nearly in half.
Oil’s decline has also narrowed the spread between Brent and WTI crude oil. We’ve noted how excess supplies in Cushing and pipeline logistics drove the Brent-WTI spread to its widest level in years. As of Friday, the Brent-WTI spread is back to its 5-year average around $3.20.
Conclusion
Just as risk markets were falling out of bed last week, energy markets had to digest some changes in the global supply pictures. U.S. oil production exceeded 10 million barrels per day, on pace to challenge Russia as the top global producer. U.S. shale activity saw its biggest two-week increase in three years, which will translate to a surge in production later this fall. OPEC may have seen the drawdown in U.S. inventories run out of steam. The message out of U.S. shale producers has been discipline and returns. The energy sector is racing to whether this discipline will stick, and how much new production was hedged in January’s rally.