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US shale oil productivity update – OPEC could choke on strongly reviving US shale oil production in 2018 if oil prices hold up in H1-17

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SEB - Prognoser på råvaror - CommodityNote: US rig count data by Baker Hughes at 19:00 CET on Friday December 16th

Crude oil comment – US shale oil productivity update – OPEC likely to choke down the road on strongly reviving US shale oil production if oil prices hold up in H1-17

The only thing which can prevent a strong rise in US shale oil rig count going forward is muted crude oil prices. The physical crude oil production effect of an additional 25 shale oil rigs into the market per month in H1-17 won’t really hit the market before H2-17 and mostly 2018. Thus price action may stay oblivious to the coming wave of US shale oil production if it disregards a potentially continued solid rise in US shale oil rigs in H1-17 on the back of OPEC cuts and associated higher prices. At the moment we can see a marginal increase in US shale production projected for January 2017. In weekly data we can see that US crude production bottomed out in September and rose 99 kb/d w/w last week.

We will not see the actual realisation of US shale oil crude production in the spot market following the rig rise in H2-16 and potentially H1-17 for quite some time. I.e. not really before H2-17 and 2018. What we can see at the moment is the reflected hedging activity from the US shale oil players who hedge on the curve for 2018 and 2019 pushing it down. Shale oil players securing their investments in newly initiated activity having been burned heavily in the previous boom and bust. That is the immediate “shadow effect” hitting the market and the crude oil curve here and now as a reflection of the rising rig count which is again an effect of higher oil prices.

According to the latest US EIA’s Drilling productivity report there were 23 shale oil rigs added per month from the start of June until November. In November alone there were 34 rigs added.

The WTI 15mth price has averaged $51.6/b since the start of June. At the time of writing it trades at $54.3/b but recently traded all the way up to $56.4/b.

Note that in the below US crude oil production scenarios we have only assumed an additional 25 rigs per month for H1-17 for Ch10 and Ch11. That is not much more than the +23 added shale oil rigs per month since June observed by the US EIA in their December drilling productivity report. Thus assuming +25 rigs per month in H1-17 is not really acceleration in rig count addition versus H2-16. However, if the crude oil price was to be significantly higher, especially the WTI 15 mth crude price, then one probably should assume a substantially higher inflow of rigs in H1-17 than what we have witnessed in H2-16.

What this all tells us is that the oil price will be highly responsive to changes in the oil market balance versus OPEC cuts or whether Libyan production will average 1 mb/d in 2017 or just 0.5 mb/d or whether global oil demand growth will be much stronger or not in 2017 or whether Russia will actually be good on its pledged cuts for H1-17 etc. Then again US shale oil rig count and thereafter production will be highly responsive to oil prices again. We have shale oil boom and bust behind us. Now we have the shale oil adaptability before us. We cannot predict all the possible uncertain events which might hit the oil market supply/demand balance in 2017 and thus impact the oil price. We can however say a lot about the responsiveness for US shale oil production and thus how the oil market dynamically will behave. Thus if OPEC gives the market elevated oil prices in H1-17, then US shale oil will give the market a serious Blue Monday in H2-17 or 2018.

What the three US crude oil production scenarios below tells us is that US crude production in 2018 is highly impacted by how many rigs are added in H1-17. If there are no more rigs in H1-17, then US crude production is good at 9.2 mb/d in 2018. However, if we just continue on the trend from H2-16 with close to 25 extra rigs per month, then US crude production jumps to 10 mb/d in 2018. Thus the 2018 global supply/demand balance is really at play in H1-17. Our numbers are of course a model. The model still fairly well shows the magnitude of sensitivities at play.

Ch1: US shale oil volume productivity growth continues to hold up at 20% per annum
Both in terms of y/y as well as 3mth/3mth annualized

US shale oil volume productivity growth continues to hold up at 20% per annum

Ch2: US shale oil volume productivity set to rise to 806 b/d per rig per month in January
Calculated for the 4 main US shale oil regions: Bakken, Eagle Ford, Nibrara and Permian

US shale oil volume productivity set to rise to 806 b/d per rig per month in January

Ch3: The US EIA again revised higher historical US shale oil productivity by 2.1% for Nov and Dec
Data back to December 2015 were also on average revised higher.

The US EIA again revised higher historical US shale oil productivity by 2.1% for Nov and Dec

Ch4: The productive effect of today’s some 400 rigs are as strong as 1200 rigs back at the start of 2013
Dark line gives historical rig count adjusted with today’s productivity versus productivity at the time.
An additional 23 rigs are assumed added both in December and in January.

The productive effect of today’s some 400 rigs are as strong as 1200 rigs back at the start of 2013

Ch5: US shale oil production is set to start to rise rapidly near term as new production cross above losses in old production
New production here given by EIA rig productivity (December report) stretching out to Jan-17 multiplied by rig count from same report but assuming an additional 23 rigs added in Dec and Jan. In reality however there is a time-lag of 2-4 months before they really cross over.

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US shale oil production is set to start to rise rapidly near term as new production cross above losses in old production

 

Ch6: US EIA shale oil production just about to turn higher
Data from EIA’s drilling productivity report for December

US EIA shale oil production just about to turn higherCh7: US crude oil production in weekly data already ticking higher (+99 kb/d w/w last week)

US crude oil production in weekly data already ticking higher (+99 kb/d w/w last week)

Ch8: US WTI15mth contract at most stimulative level (shale oil investment vise) since July 2015
Playing with numbers:
Green line: Adjust historical WTI15mth crude prices with the 20% pa (roughly) volume productivity growth
Then today’s WTI15 mth price is the most investment wise stimulative level since August 2014

US WTI15mth contract at most stimulative level (shale oil investment vise) since July 2015

Ch9: US 2018 crude oil production at 9.2 mb/d – Assuming no added US shale oil rigs after Nov 2016 and zero productivity growth
Thus rig count is fixed at 401 from Dec-16 onwards with no productivity growth
However we have already seen 21 additional shale oil rigs into the market in December but they are not added to this scenario.
Only the rigs from the US EIA’s December drilling productivity report are included in this scenario.
Thus seen in the perspective of SEB’s US crude oil model it seems to us that the US EIA assumes NO additional activated shale oil rigs into the market after Nov-16 and no additional shale oil rigs into market in 2017.
We think that the US EIA should specify its assumptions and model projections for the US shale oil rig cont and productivity which goes into their model in its monthly STEO oil reports.

Oil

Oil

Ch10: US 2018 crude oil production at 10.0 mb/d – Assuming +25 shale oil rigs per month from December 2016 to June-2017 and zero productivity growth
Then no more rigs added after June 2017 with number of US shale oil rigs fixed at 576 rigs after that
Also zero volume productivity growth here onwards from December 2016 gives the following production projection

US 2018 crude oil production

US 2018 crude oil production

Ch11: US 2018 crude oil production at 10.3 mb/d – Assuming +25 shale oil rigs per month from December 2016 to June-2017 and 10% pa volume productivity growth
Then no more rigs added after June 2017 with number of US shale oil rigs fixed at 576 rigs after that
But assume that US shale oil volume productivity growth continues at 10% pa. instead of the historical (and current) 20% pa.

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Oil

Ch12: US shale oil profitability versus WTI 15 mth crude oil prices
Annual return for a three year investment.
Three years of crude oil production from a new shale oil well.
All money back after three years.
IP 1mth: 1000 b/d. Royalty pay: 20%. Discount rate: 10%, Three yr production after royalty and discount: 330,000 barrels, Wellhead to Cushing discount: $5/b, OPEX: $12/b, Total well cost: $8million,
All production within the hedgeable part of the WTI crude oil price curve.
Thus return should be possible to lock in at the initiation of the investment

US shale oil profitability versus WTI 15 mth crude oil prices

Ch13: The WTI crude oil forward curve feeling the depression from shale oil hedging in 2018 and 2019
Likely to be increasingly heavy depression if rig count continues to rise further

The WTI crude oil forward curve feeling the depression from shale oil hedging in 2018 and 2019

Ch14: As three year annual shale oil profitability hits 16% pa

As three year annual shale oil profitability hits 16% pa

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

Brent on a rollercoaster between bullish sanctions and bearish tariffs. Tariffs and demand side fears in focus today

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Brent crude rallied to a high of USD 75.29/b yesterday, but wasn’t able to hold on to it and closed the day at USD 74.49/b. Brent crude has now crossed above both the 50- and 100-day moving average with the 200dma currently at USD 76.1/b. This morning it is trading a touch lower at USD 74.3/b

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

Brent riding a rollercoaster between bullish sanctions and bearish tariffs. Biden sanctions drove Brent to USD 82.63/b in mid-January. Trump tariffs then pulled it down to USD 68.33/b in early March with escalating concerns for oil demand growth and a sharp selloff in equities. New sanctions from Trump on Iran, Venezuela and threats of such also towards Russia then drove Brent crude back up to its recent high of USD 75.29/b. Brent is currently driving a rollercoaster between new demand damaging tariffs from Trump and new supply tightening sanctions towards oil producers (Iran, Venezuela, Russia) from Trump as well.

’Liberation day’ is today putting demand concerns in focus. Today we have ’Liberation day’ in the US with new, fresh tariffs to be released by Trump. We know it will be negative for trade, economic growth and thus oil demand growth. But we don’t know how bad it will be as the effects comes a little bit down the road. Especially bad if it turns into a global trade war escalating circus.

Focus today will naturally be on the negative side of demand. It will be hard for Brent to rally before we have the answer to what the extent these tariffs will be. Republicans lost the Supreme Court race in Wisconsin yesterday. So maybe the new Tariffs will be to the lighter side if Trump feels that he needs to tread a little bit more carefully.

OPEC+ controlling the oil market amid noise from tariffs and sanctions. In the background though sits OPEC+ with a huge surplus production capacity which it now will slice and dice out with gradual increases going forward. That is somehow drowning in the noise from sanctions and tariffs. But all in all, it is still OPEC+ who is setting the oil price these days.

US oil inventory data likely to show normal seasonal rise. Later today we’ll have US oil inventory data for last week. US API indicated last night that US crude and product stocks rose 4.4 mb last week. Close to the normal seasonal rise in week 13.

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Oil gains as sanctions bite harder than recession fears

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Higher last week and today as sanctions bite harder than recession fears. Brent crude gained 2% last week with a close on Friday of USD 73.63/b. It traded in a range of USD 71.8-74.17/b. It traded mostly higher through the week despite sharp, new selloffs in equities along with US consumer expectations falling to lowest level since 2013 (Consumer Conf. Board Expectations.) together with signals of new tariffs from the White House. Ahead this week looms the ”US Liberation Day” on April 2 when the White House will announce major changes in the country’s trade policy. Equity markets are down across the board this morning while Brent crude has traded higher and lower and is currently up 0.5% at USD 74.0/b at the moment.

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

New US sanctions towards Iran and Venezuela and threats of new sanctions towards Russia. New sanctions on Venezuela and Iran are helping to keep the market tight. Oil production in Venezuela reached 980 kb/d in February following a steady rise from 310 kb/d in mid-2020 while it used to produce 2.3 mb/d up to 2016. Trump last week allowed Chevron to import oil from Venezuela until 27 May. But he also said that any country taking oil or gas from Venezuela after 2 April will face 25% tariffs on any goods exported into the US. Trump is also threatening to sanction Russian oil further if Putin doesn’t move towards a peace solution with Ukraine.

The OPEC+ to meet on Saturday 5 April to decide whether to lift production in May or not. The OPEC+ Joint Ministerial Monitoring Committee will meet on Saturday 5 April to review market conditions, compliance by the members versus their production targets and most importantly decide whether they shall increase production further in May following first production hike in April. We find it highly likely that they will continue to lift production also in May.

OPEC(+) crashed the oil price twice to curb US shale, but it kicked back quickly. OPEC(+) has twice crashed the oil price in an effort to hurt and disable booming US shale oil production. First in 2014/15/16 and then in the spring of 2020. The first later led to the creation of OPEC+ through the Declaration of Cooperation (DoC) in the autumn of 2016. The second was in part driven by Covid-19 as well as a quarrel between Russia and Saudi Arabia over market strategy. But the fundamental reason for that quarrel and the crash in the oil price was US shale oil producers taking more and more market share.

The experience by OPEC+ through both of these two events was that US shale oil quickly kicked back even bigger and better yielding very little for OPEC+ to cheer about.

OPEC+ has harvested an elevated oil price but is left with a large spare capacity. The group has held back large production volumes since Spring 2020. It yielded the group USD 100/b in 2022 (with some help from the war in Ukraine), USD 81/b on average in 2023/24 and USD 75/b so far this year. The group is however left with a large spare capacity with little room to place it back into the market without crashing the price. It needs non-OPEC+ in general and US shale oil especially to yield room for it to re-enter. 

A quick crash and painful blow to US shale oil is no longer the strategy. The strategy this time is clearly very different from the previous two times. It is no longer about trying to give US shale oil producers a quick, painful blow in the hope that the sector will stay down for an extended period. It is instead a lengthier process of finding the pain-point of US shale oil players (and other non-OPEC+ producers) through a gradual increase in production by OPEC+ and a gradual decline in the oil price down to the point where non-OPEC+ in general and US liquids production especially will gradually tick lower and yield room to the reentry of OPEC+ spare capacity. It does not look like a plan for a crash and a rush, but instead a tedious process where OPEC+ will gradually force its volumes back into the market.

Where is the price pain-point for US shale oil players? The Brent crude oil price dropped from USD 84/b over the year to September last year to USD 74/b on average since 1 September. The values for US WTI were USD 79/b and USD 71/b respectively. A drop of USD 9/b for both crudes. There has however been no visible reaction in the US drilling rig count following the USD 9/b fall. The US drilling rig count has stayed unchanged at around 480 rigs since mid-2024 with the latest count at 484 operating rigs. While US liquids production growth is slowing, it is still set to grow by 580 kb/d in 2025 and 445 kb/d in 2026 (US EIA).

US shale oil average cost-break-even at sub USD 50/b (BNEF). Industry says it is USD 65/b. BNEF last autumn estimated that all US shale oil production fields had a cost-break-even below USD 60/b with a volume weighted average just below USD 50/b while conventional US onshore oil had a break-even of USD 65/b. A recent US Dallas Fed report which surveyed US oil producers did however yield a response that the US oil industry on average needed USD 65/b to break even. That is more than USD 15/b higher than the volume weighted average of the BNEF estimates.

The WTI 13-to-24-month strip is at USD 64/b. Probably the part of the curve controlling activity. As such it needs to move lower to curb US shale oil activity. The WTI price is currently at USD 69.7/b. But the US shale oil industry today works on a ”12-month drilling first, then fracking after” production cycle. When it considers whether to drill more or less or not, it is typically on a deferred 12-month forward price basis. The average WTI price for months 13 to 24 is today USD 64/b. The price signal from this part of the curve is thus already down at the pain-point highlighted by the US shale oil industry. In order to yield zero growth and possibly contraction in US shale oil production, this part of the curve needs to move below that point.

The real pain-point is where we’ll see US drilling rig count starting to decline. We still don’t know whether the actual average pain-point is around USD 50/b as BNEF estimate it is or whether it is closer to USD 65/b which the US shale oil bosses say it is. The actual pain-point is where we’ll see further decline in US drilling rig count. And there has been no visible change in the rig count since mid-2024. The WTI 13-to-24-month prices need to fall further to reveal where the US shale oil industry’ actual pain-point is. And then a little bit more in order to slow production growth further and likely into some decline to make room for reactivation of OPEC+ spare capacity.

The WTI forward price curve. The average of 13 to 24 month is now USD 64.3/b.

The WTI forward price curve. The average of 13 to 24 month is now USD 64.3/b.
Source: SEB graph and highlights, Bloomberg data

The average 13-to-24-month prices on the WTI price curve going back to primo January 2022. Recently dropping below USD 65/b for some extended period.

The average 13-to-24-month prices on the WTI price curve going back to primo January 2022. Recently dropping below USD 65/b for some extended period.
Source: SEB graph and highlights, Bloomberg data
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Brent Edges Lower After Resisting Equity Slump – Sanctions, Saudi Pricing in Focus

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Brent has defied bearish equities for three days but is losing its stamina today. Brent gained 0.3% yesterday with a close of USD 74.03/b, the highest close since 27 February and almost at the high of the day. It traded as low as USD 73.23/b. Brent has now defied the equity selloff three days in a row by instead ticking steadily higher. A sign of current spot tightness. This morning however it is losing some of its stamina and is down 0.5% at USD 73.7/b along with negative equities and yet higher gold prices.

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

The new US Iran sanctions is creating frictions in getting its oil to market and helps keeping oil market tight. Part of the current tightness is due to the new US sanctions on Iran which. Ships containing 17 mb of its oil now sits idle east of Malaysia waiting (Bloomberg) for ship-to-ship transfers with China teapot refineries the normal final destination. But the latest US sanctions has probably made these refineries much more cautious. More friction before Iranian oil is reaching its final destination if at all. Tighter market.

Lower Saudi OSPs for May is expected. A signal of a softer market ahead as OPEC+ lifts production. Saudi Aramco is expected to reduce it official selling price (OSPs) for Arab Light to Asia for May deliveries by USD 2/b. A measure to make its oil more competitive in relative to other crudes suppliers. It is also a sign of a softer market ahead. Naturally so since OPEC+ is set to lift production in April and also most likely in May. If Saudi Aramco reduces its OSPs to Asia for May across its segments of crudes, then it is a signal it is expecting softer oil market conditions. But news today is only discussing Arab Light while the main tightness int the market today is centered around medium sour crude segment. A lowering of the OSPs for the heavier and more sour grades will thus be a more forceful bearish signal.

Front-end backwardation may ease as the Brent May contract rolls off early next week. The Brent May future will roll off early next week. It will be interesting to see how that affects the front-end 1-3mth backwardation as it is shifted out into summer where a softer market is expected.

Brent is boring like crazy with 30dma annualized volatility of just 21%. Waiting for something to happen.

Brent is boring like crazy with 30dma annualized volatility of just 21%. Waiting for something to happen.
Source: SEB graph and calculations, Bloomberg data

Brent crude has defied three days of bearish equity markets and ticked higher instead. Caving in a bit this morning with yet another day of bearish equities and bullish gold.

Brent crude has defied three days of bearish equity markets and ticked higher instead. Caving in a bit this morning with yet another day of bearish equities and bullish gold.
Source: Bloomberg graph with SEB highlights.
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