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US crude oil 2018 production forecast by EIA still too low

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SEB - Prognoser på råvaror - CommodityPrice action – Higher on Nigeria strike, Fortis pipeline outage, lower oil rig count, softer USD and positive equities
Brent crude is gaining 0.9% this morning as it climbs to $63.8/b along with a 0.2% softer USD index and positive equity gains. A part of the positive oil price drive today is the Nigerian oil union declaring a strike as they protest against unfair labour practices thus posing a risk to Nigeria’s production of 1.7 mb/d. The Fortis pipeline carrying xxx kb/d is still off-line with the operator declares force majeure as it expects repairs of the hairline will take some 2-4 weeks. The key concern is that there might be a wider problem stretching along the whole pipeline. If the reason for the current crack is the higher sulphur content in the Buzzard crude flowing in the Fortis crude stream and sulphide corrosion as a consequence of this then the outage of the pipe could be much, much longer. The pipe carries some 450 kb/d and thus a major share of the physical supply into the Brent spot market. A decline of 2 US oil rigs last week adds some support on the margin.

Crude oil comment – US crude oil 2018 production forecast by EIA still too low
Later today we’ll have the monthly update from the US EIA on shale oil drilling productivity in the US. We expect the EIA to revise its productivity as well as its production higher. Their last productivity report had data points to Dec 2017. We expect the EIA to show that the strong production growth of on average 91 kb/d/mth from July to December this year stays intact at around 90 kb/d/mth also in January and also that well completions continued to rise also in November as they have done every month since January this year.

We do not think that the EIA update later today will necessarily hit the Brent crude oil price bearishly. More likely we expect the Brent to WTI price spread to widen further on the back of such news.

The US EIA last Tuesday adjusted its 2018 forecast for US crude oil production upwards from 9.95 mb/d to an average of 10.02 mb/d thus growing 0.78 mb/d y/y to 2018. The increase in forecast of 70 kb/d was the third upwards revision in three months. We still think that the US EIA is significantly behind the curve in terms of its projections for US crude oil production for 2018. As such we expect the US EIA to continue to revise its projection for 2018 higher in the months to come until it reaches at least an average crude oil production of around 10.4 mb/d for 2018.

US shale oil production growth is currently running at some 90 kb/d/mth. That is the exit shale oil growth rate for 2017 while the average growth rate from July to December has been 91 kb/d/mth. The implied marginal, annualized production growth rate is thus currently running at 1.1 mb/d/yr. The US EIA is however assuming that US shale oil production will only grow by some 37 kb/d/mth in 2018. That is 40% lower than the current growth rate in shale oil production. From Dec-17 to Dec-18 the EIA projects that US lower 48 (ex GoM) will grow by only 440 kb/d. If we instead apply the current 90 kb/d/mth growth rate through 2018 then L48 ex GoM would grow by 1.1 mb/d from Dec-17 to Dec-18.

If we extrapolate the current shale oil production growth rate through 2018 it would lead US crude oil production to exit 2018 at 11 mb/d versus EIA’s forecast of 10.34 mb/d. If we include NGLs, Bio-fuels and refinery gains it would lift total US liquids production to close to 18 mb/d in December 2018 and drive total US liquids production growth to 1.7 mb/d y/y Dec-17 to Dec-18.

US shale oil well completions is still rising (+35 wells m/m in October), the drilled but uncompleted numbers of wells is still rising and oil prices have been on a constant trend upwards since mid-June . So if anything the current trend is for stronger US shale oil production growth month/month in the months ahead and not at all the sudden drop-off in shale oil production growth which the EIA predicts for 1Q18 where they expect a monthly average growth rate of only 23 kb/d/mth.

We think that one of the key reasons for why the US EIA has a too low production growth target for 2018 is due to the build-up in the DUC (Drilled but uncompleted wells) inventory which gives an impression of declining shale oil volume productivity. This decline in volume productivity is in our view not real. In our calculations we see US shale oil volume drilling productivity has continued to tick higher even though now mostly sideways. But at least we do not see productivity in decline as the official headline numbers indicate.

There is a lot of focus on a shift in investor focus from rewarding production growth and now instead demanding profits. This could possibly change shale oil producer behaviour and as such lead to softer US shale oil production growth than indicated above.

In our view such a shift should primarily hit drilling rather than completions as the shale oil companies have a huge stack of uncompleted wells which they can convert to oil and money in 2018. They can ease back on the drilling and continue to ramp up completions. Completions have been trailing drilling for a full year now. If shale oil companies pull back on investments then this should switch around in 2018 to a situation where drilling is lower than completions while spending on completions continues at a high level and drilling at a lower. Completions in 2018 could run some 20% above the Jan to Oct average completion level of 2017.

In terms of capex spending we had news last week that Keane Group, one of the largest pure-play providers of US shale completion services yesterday announced that they will order three new frac fleets on top of their existing 26. The order is a response to robust 2018 US shale oil investments announced latest weeks. Completions are the thing for 2018 which means more shale oil production.

Ch1: US shale oil production growth is exiting 2017 at a rate of about 90 kb/d/mth (1.1 mb/d on a marginal annualized rate)
It is now growing as strongly as it did through 2012 and 2013

US shale oil production growth is exiting 2017 at a rate of about 90 kb/d/mth (1.1 mb/d on a marginal annualized rate)

Ch2: If US shale oil production grows in 2018 as it exits 2017 (~90 kb/d/mth) then total US crude production will grow by 1.1 mb/d y/y to 10.4 mb/d y/y

If US shale oil production grows in 2018 as it exits 2017 (~90 kb/d/mth) then total US crude production will grow by 1.1 mb/d y/y to 10.4 mb/d y/y

Ch3: The Production Weighting Price (PWP) of a new shale oil well with a 6 week lead has moved higher since Sep
If history is anything to go by then US shale oil action will increase in response. Drilling and or completions

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The Production Weighting Price (PWP) of a new shale oil well with a 6 week lead has moved higher since Sep

Ch4: US oil rig count moved down 4 last week but implied shale oil rigs increased by 2
US oil rig count is up by 22 over the last 5 weeks which is 17 rigs shy of the level in August

US oil rig count moved down 4 last week but implied shale oil rigs increased by 2

US oil rig count moved down 4 last week but implied shale oil rigs increased by 2

Ch5: The mirage of declining shale oil productivity created from the large build-up in DUCs (uncompleted wells)
The official US shale oil productivity was running higher than our estimate during the DUC draw down in 2016.
It is running way below our productivity estimate in 2017 during a huge build up in the DUC inventory during 2017.
As the DUC inventory eventually draws down the official productivity will again be running above our estimate

The mirage of declining shale oil productivity created from the large build-up in DUCs (uncompleted wells)

Ch6: A lot of uncompleted wells to complete in 2018!!
The DUC inventory was still BUILDING in October (the last data point)
So drilling new wells can decline a lot in 2018 while completions can increase some 20% y/y

A lot of uncompleted wells to complete in 2018

Ch7: No top-down sign that US shale oil resources are deteriorating as losses in existing production stays on scale to production level
No top-down sign as of yet of run-away losses in existing production versus production level

No top-down sign that US shale oil resources are deteriorating as losses in existing production stays on scale to production level

Ch8: US EIA crude oil production forecast likely to be lifted further up towards 10.4 mb/d
EIA lifting it forecast 3 mths in a row

US EIA crude oil production forecast likely to be lifted further up towards 10.4 mb/d

Ch9: Volume wise there are good shale oil days in both Colorado and Bakken North Dakota these days

Volume wise there are good shale oil days in both Colorado and Bakken North Dakota these days

Ch10: Annualized 1-3 mth Brent backwardation fully funded roll-yield of 10% pa

Annualized 1-3 mth Brent backwardation fully funded roll-yield of 10% pa

Ch11: The positive roll-yield in Brent continues to suck in more long spec into both Brent and WTI front end crude’

The positive roll-yield in Brent continues to suck in more long spec into both Brent and WTI front end crude

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

OPEC+ will likely unwind 500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d in one go could be in the cards

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Down to mid-60ies as Iraq lifts production while Saudi may be tired of voluntary cut frugality. The Brent December contract dropped 1.6% yesterday to USD 66.03/b. This morning it is down another 0.3% to USD 65.8/b. The drop in the price came on the back of the combined news that Iraq has resumed 190 kb/d of production in Kurdistan with exports through Turkey while OPEC+ delegates send signals that the group will unwind the remaining 1.65 mb/d (less the 137 kb/d in October) of voluntary cuts at a pace of 500 kb/d per month pace.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Signals of accelerated unwind and Iraqi increase may be connected. Russia, Kazakhstan and Iraq were main offenders versus the voluntary quotas they had agreed to follow. Russia had a production ’debt’ (cumulative overproduction versus quota) of close to 90 mb in March this year while Kazakhstan had a ’debt’ of about 60 mb and the same for Iraq. This apparently made Saudi Arabia angry this spring. Why should Saudi Arabia hold back if the other voluntary cutters were just freeriding? Thus the sudden rapid unwinding of voluntary cuts. That is at least one angle of explanations for the accelerated unwinding.

If the offenders with production debts then refrained from lifting production as the voluntary cuts were rapidly unwinded, then they could ’pay back’ their ’debts’ as they would under-produce versus the new and steadily higher quotas.

Forget about Kazakhstan. Its production was just too far above the quotas with no hope that the country would hold back production due to cross-ownership of oil assets by international oil companies. But Russia and Iraq should be able to do it.

Iraqi cumulative overproduction versus quotas could reach 85-90 mb in October. Iraq has however steadily continued to overproduce by 3-5 mb per month. In July its new and gradually higher quota came close to equal with a cumulative overproduction of only 0.6 mb that month. In August again however its production had an overshoot of 100 kb/d or 3.1 mb for the month. Its cumulative production debt had then risen to close to 80 mb. We don’t know for September yet. But looking at October we now know that its production will likely average close to 4.5 mb/d due to the revival of 190 kb/d of production in Kurdistan. Its quota however will only be 4.24 mb/d. Its overproduction in October will thus likely be around 250 kb/d above its quota  with its production debt rising another 7-8 mb to a total of close to 90 mb.

Again, why should Saudi Arabia be frugal while Iraq is freeriding. Better to get rid of the voluntary quotas as quickly as possible and then start all over with clean sheets.

Unwinding the remaining 1.513 mb/d in one go in October? If OPEC+ unwinds the remaining 1.513 mb/d of voluntary cuts in one big go in October, then Iraq’s quota will be around 4.4 mb/d for October versus its likely production of close to 4.5 mb/d for the coming month..

OPEC+ should thus unwind the remaining 1.513 mb/d (1.65 – 0.137 mb/d) in one go for October in order for the quota of Iraq to be able to keep track with Iraq’s actual production increase.

October 5 will show how it plays out. But a quota unwind of at least 500 kb/d for Oct seems likely. An overall increase of at least 500 kb/d in the voluntary quota for October looks likely. But it could be the whole 1.513 mb/d in one go. If the increase in the quota is ’only’ 500 kb/d then Iraqi cumulative production will still rise by 5.7 mb to a total of 85 mb in October.

Iraqi production debt versus quotas will likely rise by 5.7 mb in October if OPEC+ only lifts the overall quota by 500 kb/d in October. Here assuming historical production debt did not rise in September. That Iraq lifts its production by 190 kb/d in October to 4.47 mb/d (August level + 190 kb/d) and that OPEC+ unwinds 500 kb/d of the remining quotas in October when they decide on this on 5 October.

Iraqi production debt versus quotas
Source: SEB calculations, assumptions and graph, Bloomberg actual production data to August
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Analys

Modest draws, flat demand, and diesel back in focus

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U.S. commercial crude inventories posted a marginal draw last week, falling by 0.6 million barrels to 414.8 million barrels. Inventories remain 4% below the five-year seasonal average, but the draw is far smaller than last week’s massive 9.3-million-barrel decline. Higher crude imports (+803,000 bl d WoW) and steady refinery runs (93% utilization) helped keep the crude balance relatively neutral.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

Yet another drawdown indicates commercial crude inventories continue to trend below the 2015–2022 seasonal norm (~440 million barrels), though at 414.8 million barrels, levels are now almost exactly in line with both the 2023 and 2024 trajectory, suggesting stable YoY conditions (see page 3 attached).

Gasoline inventories dropped by 1.1 million barrels and are now 2% below the five-year average. The decline was broad-based, with both finished gasoline and blending components falling, indicating lower output and resilient end-user demand as we enter the shoulder season post-summer (see page 6 attached).

On the diesel side, distillate inventories declined by 1.7 million barrels, snapping a two-week streak of strong builds. At 125 million barrels, diesel inventories are once again 8% below the five-year average and trending near the low end of the historical range.

In total, commercial petroleum inventories (excl. SPR) slipped by 0.5 million barrels on the week to ish 1,281.5 million barrels. While essentially flat, this ends a two-week streak of meaningful builds, reflecting a return to a slightly tighter situation.

On the demand side, the DOE’s ‘products supplied’ metric (see page 6 attached), a proxy for implied consumption, softened slightly. Total demand for crude oil over the past four weeks averaged 20.5 million barrels per day, up just 0.9% YoY.

Summing up: This week’s report shows a re-tightening in diesel supply and modest draws across the board, while demand growth is beginning to flatten. Inventories remain structurally low, but the tone is less bullish than in recent weeks.

US DOE oil inventories
US crude inventories
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Analys

Are Ukraine’s attacks on Russian energy infrastructure working?

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Brent crude rose 1.6% yesterday. After trading in a range of USD 66.1 – 68.09/b it settled at USD 67.63/b. A level which we are well accustomed to see Brent crude flipping around since late August. This morning it is trading 0.5% higher at USD 68/b. The market was expecting an increase of 230 kb/d in Iraqi crude exports from Kurdistan through Turkey to the Cheyhan port but that has so far failed to materialize. This probably helped to drive Brent crude higher yesterday. Indications last evening that US crude oil inventories likely fell 3.8 mb last week (indicative numbers by API) probably also added some strength to Brent crude late in the session. The market continues to await the much heralded global surplus materializing as rising crude and product inventories in OECD countries in general and the US specifically.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The oil market is starting to focus increasingly on the successful Ukrainian attacks on Russian oil infrastructure. Especially the attacks on Russian refineries. Refineries are highly complex and much harder to repair than simple crude oil facilities like export pipelines, ports and hubs. It can take months and months to repair complex refineries. It is thus mainly Russian oil products which will be hurt by this. First oil product exports will go down, thereafter Russia will have to ration oil product consumption domestically. Russian crude exports may not be hurt as much. Its crude exports could actually go up as its capacity to process crude goes down. SEB’s Emerging Market strategist Erik Meyersson wrote about the Ukrainian campaign this morning: ”Are Ukraine’s attacks on Russian energy infrastructure working?”. Phillips P O’Brian published an interesting not on this as well yesterday: ”An Update On The Ukrainian Campaign Against Russian Refineries”. It is a pay-for article, but it is well worth reading. Amongst other things it highlights the strategic focus of Ukraine towards Russia’s energy infrastructure. A Ukrainian on the matter also put out a visual representation of the attacks on twitter. We have not verified the data representation. It needs to be interpreted with caution in terms of magnitude of impact and current outage.

Complex Russian oil refineries are sitting ducks in the new, modern long-range drone war. Ukraine is building a range of new weapons as well according to O’Brian. The problem with attacks on Russian refineries is thus on the rise. This will likely be an escalating problem for Russia. And oil products around the world may rise versus the crude oil price while the crude oil price itself may not rise all that much due to this.

Russian clean oil product exports as presented by SEB’s Erik Meyersson in his note this morning.

Russian clean oil product exports
Source: SEB, Kepler, Macrobond

The ICE Gasoil crack and the 3.5% fuel oil crack has been strengthening. The 3.5% crack should have weakened along with rising exports of sour crude from OPEC+, but it hasn’t. Rather it has moved higher instead. The higher cracks could in part be due to the Ukrainian attacks on Russian oil refineries.

The ICE Gasoil crack and the 3.5% fuel oil crack has been strengthening. The 3.5% crack should have weakened along with rising exports of sour crude from OPEC+, but it hasn't. Rather it has moved higher instead. The higher cracks could in part be due to the Ukrainian attacks on Russian oil refineries.
Source: SEB graph and calculations, Bloomberg data

Ukrainian inhabitants graphical representation of Ukrainian attacks on Russian oil refineries on Twitter. Highlighting date of attacks, size of refineries and distance from Ukraine. We have not verified the detailed information. And you cannot derive the amount of outage as a consequence of this.

Ukrainian inhabitants graphical representation of Ukrainian attacks on Russian oil refineries on Twitter.
Source: Twitter. Not verified
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