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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

Lowest since Dec 2021. Kazakhstan likely reason for OPEC+ surprise hike in May

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Collapsing after Trump tariffs and large surprise production hike by OPEC+ in May. Brent crude collapsed yesterday following the shock of the Trump tariffs on April 2 and even more so due to the unexpected announcement from OPEC+ that they will lift production by 411 kb/d in May which is three times as much as expected. Brent fell 6.4% yesterday with a close of USD 70.14/b and traded to a low of USD 69.48/b within the day. This morning it is down another 2.7% to USD 68.2/b. That is below the recent low point in early March of USD 68.33/b. Thus, a new ”lowest since December 2021” today.

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

Kazakhstan seems to be the problem and the reason for the unexpected large hike by OPEC+ in May. Kazakhstan has consistently breached its production cap. In February it produced 1.83 mb/d crude and 2.12 mb/d including condensates. In March its production reached a new record of 2.17 mb/d. Its crude production cap however is 1.468 mb/d. In February it thus exceeded its production cap by 362 kb/d.

Those who comply are getting frustrated with those who don’t. Internal compliance is an important and difficult issue when OPEC+ is holding back production. The problem naturally grows the bigger the cuts are and the longer they last as impatience grows over time. The cuts have been large, and they have lasted for a long time. And now some cracks are appearing. But that does not mean they cannot be mended. And it does not imply either that the group is totally shifting strategy from Price to Volume. It is still a measured approach. Also, by lifting all caps across the voluntary cutters, Kazakhstan becomes less out of compliance. Thus, less cuts by Kazakhstan are needed in order to become compliant.

While not a shift from Price to Volume, the surprise hike in May is clearly a sign of weakness. The struggle over internal compliance has now led to a rupture in strategy and more production in May than what was previously planned and signaled to the market. It is thus natural to assign a higher production path from the group for 2025 than previously assumed. Do however remember how quickly the price war between Russia and Saudi Arabia ended in the spring of 2020.

Higher production by OPEC+ will be partially countered by lower production from Venezuela and Iran. The new sanctions towards Iran and Venezuela can to a large degree counter the production increase from OPEC+. But to what extent is still unclear.

Buy some oil calls. Bullish risks are never far away. Rising risks for US/Israeli attack on Iran? The US has increased its indirect attacks on Iran by fresh attacks on Syria and Yemen lately. The US has also escalated sanctions towards the country in an effort to force Iran into a new nuclear deal. The UK newspaper TheSun yesterday ran the following story: ON THE BRINK US & Iran war is ‘INEVITABLE’, France warns as Trump masses huge strike force with THIRD of America’s stealth bombers”. This is indeed a clear risk which would lead to significant losses of supply of oil in the Middle East and probably not just from Iran. So, buying some oil calls amid the current selloff is probably a prudent thing to do for oil consumers.

Brent crude is rejoining the US equity selloff by its recent collapse though for partially different reasons. New painful tariffs from Trump in combination with more oil from OPEC+ is not a great combination.

Brent crude is rejoining the US equity selloff by its recent collapse though for partially different reasons.
Source: SEB selection and highlights, Bloomberg graph and data
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Tariffs deepen economic concerns – significantly weighing on crude oil prices

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Brent crude prices initially maintained the gains from late March and traded sideways during the first two trading days in April. Yesterday evening, the price even reached its highest point since mid-February, touching USD 75.5 per barrel.

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

However, after the U.S. president addressed the public and unveiled his new package of individual tariffs, the market reacted accordingly. Overnight, Brent crude dropped by close to USD 4 per barrel, now trading at USD 71.6 per barrel.

Key takeaways from the speech include a baseline tariff rate of 10% for all countries. Additionally, individual reciprocal tariffs will be imposed on countries with which the U.S. has the largest trade deficits. Many Asian economies end up at the higher end of the scale, with China facing a significant 54% tariff. In contrast, many North and South American countries are at the lower end, with a 10% tariff rate. The EU stands at 20%, which, while not unexpected given earlier signals, is still disappointing, especially after Trump’s previous suggestion that there might be some easing.

Once again, Trump has followed through on his promise, making it clear that he is serious about rebalancing the U.S. trade position with the world. While some negotiation may still occur, the primary objective is to achieve a more balanced trade environment. A weaker U.S. dollar is likely to be an integral part of this solution.

Yet, as the flow of physical goods to the U.S. declines, the natural question arises: where will these goods go? The EU may be forced to raise tariffs on China, mirroring U.S. actions to protect its industries from an influx of discounted Chinese goods.

Initially, we will observe the effects in soft economic data, such as sentiment indices reflecting investor, industry, and consumer confidence, followed by drops in equity markets and, very likely, declining oil prices. This will eventually be followed by more tangible data showing reductions in employment, spending, investments, and overall economic activity.

Ref oil prices moving forward, we have recently adjusted our Brent crude price forecast. The widespread imposition of strict tariffs is expected to foster fears of an economic slowdown, potentially reducing oil demand. Macroeconomic uncertainty, particularly regarding tariffs, warrants caution regarding the pace of demand growth. Our updated forecast of USD 70 per barrel for 2025 and 2026, and USD 75 per barrel for 2027, reflects a more conservative outlook, influenced by stronger-than-expected U.S. supply, a more politically influenced OPEC+, and an increased focus on fragile demand.

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US DOE data:

Last week, U.S. crude oil refinery inputs averaged 15.6 million barrels per day, a decrease of 192 thousand barrels per day from the previous week. Refineries operated at 86.0% of their total operable capacity during this period. Gasoline production increased slightly, averaging 9.3 million barrels per day, while distillate (diesel) production also rose, averaging 4.7 million barrels per day.

U.S. crude oil imports averaged 6.5 million barrels per day, up by 271 thousand barrels per day from the prior week. Over the past four weeks, imports averaged 5.9 million barrels per day, reflecting a 6.3% year-on-year decline compared to the same period last year.

The focus remains on U.S. crude and product inventories, which continue to impact short-term price dynamics in both WTI and Brent crude. Total commercial petroleum inventories (excl. SPR) increased by 5.4 million barrels, a modest build, yet insufficient to trigger significant price movements.

Commercial crude oil inventories (excl. SPR) rose by 6.2 million barrels, in line with the 6-million-barrel build forecasted by the API. With this latest increase, U.S. crude oil inventories now stand at 439.8 million barrels, which is 4% below the five-year average for this time of year.

Gasoline inventories decreased by 1.6 million barrels, exactly matching the API’s reported decline of 1.6 million barrels. Diesel inventories rose by 0.3 million barrels, which is close to the API’s forecast of an 11-thousand-barrel decrease. Diesel inventories are currently 6% below the five-year average.

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Over the past four weeks, total products supplied, a proxy for U.S. demand, averaged 20.1 million barrels per day, a 1.2% decrease compared to the same period last year. Gasoline supplied averaged 8.8 million barrels per day, down 1.9% year-on-year. Diesel supplied averaged 3.8 million barrels per day, marking a 3.7% increase from the same period last year. Jet fuel demand also showed strength, rising 4.2% over the same four-week period.

USD DOE invetories
US crude inventories
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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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