Analys
US crude oil 2018 production forecast by EIA still too low
Price 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
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
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
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
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
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
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
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
Ch9: 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
Ch11: 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
Market is starting to take US/Iran headlines with a pinch of salt. Brent crude rose $2.8/b yesterday to an official close of $112.1/b. But after that it traded as low as $108.05/b before ending late night at around $109.7/b. Through the day it traded in a range of $106.87 – 112.72/b amid a flurry of news or rumors from Iran and the US. ”US temporary sanctions during negotiations” (falls alarm). ”We will bomb Iran” (not anyhow),… etc. While the market is still fluctuating to this kind of news flow, it is starting to take such headlines with a pinch of salt.
We’ll see. Maybe, maybe not. The Brent M1 contract is trading at $110.2/b this morning which very close to the average ticks through yesterday of $110.4/b.
Trump with bearish, verbal intervention whenever Brent trades above $110/b it seems. What seems to be a pattern is that Trump states something like ”very good negotiations going on with Iran”, ”New leaders in Iran are great,..”, ”Great progress in negotiations,…”, ”Deal in sight,..” etc whenever the Brent M1 contract trades above $110/b. An effort to cool the market. These hot air verbal interventions from Trump used to have a heavy bearish impact on prices, but they now seems to have less and less effect unless they are backed by reality.
As far as we can see there has been no real progress in the negotiations between the US and Iran with both sides still standing by their previous demands.
Iran is getting stronger while the cease fire lasts making a return to war for Trump yet harder. Iran is naturally in constant preparation for a return to war given Trump’s steady threats of bombing Iran again. Iran is naturally doing what ever is possible to prepare for a return to war. And every day the cease fire lasts it is better prepared. This naturally makes it more and more difficult and dangerous for the US to return to warring activity versus Iran as the consequences for energy infrastructure in the Persian Gulf will be more and more severe the longer the cease fire lasts. Israel seems to see it this way as well. That the war is not won and that current frozen state of a cease fire gives Iran opportunity to rebuild military and politically.
Global inventories are drawing down day by day. How much? In the meantime the Strait of Hormuz stays closed. There is varying measures and estimates of how much global inventories are drawing down. Our rough estimate, back of the envelope, is that global inventories are drawing down by at least some 10 mb/d or about 300 mb/d in a balance between loss of supply versus demand destruction. Other estimates we see are a monthly draw of 250-270 mb/d. The IEA only ’measured’ a draw in global observable stocks of 117 mb in April with oil on water rising 53 mb while on shore stocks fell 170 mb. But global stocks are hard to measure with large invisible, unmeasured stocks. As such a back of the envelope approach may be better.
Oil products is what the world is consuming. Oil product prices likely to rise while product stocks fall. Strategic Petroleum Reserves (SPR) are predominantly crude oil. Discharging oil from OECD SPR stocks, a sharp reduction in Chinese crude imports and a reduction in global refinery throughput of 6-7 mb/d has helped to keep crude oil markets satisfactorily supplied. But global inventories are drawing down none the less. And oil products is really what the world is consuming. So if global refinery throughput stays subdued, then demand will eventually have to match the supply of oil products. The likely path forward this summer is a steady draw down in jet fuel, diesel and gasoline. Higher prices for these. Then, if possible, higher refinery throughput and higher usage of crude in response to very profitable refinery margins. And lastly sharper draw in crude stocks and higher prices for these. But some 6 mb/d of oil products used to be exported through the Strait of Hormuz. And it may not be so easy to ramp up refinery activity across the world to compensate. Especially as Ukraine continues to damage Russian refineries as well as Russian crude production and export facilities.
Watch oil product stocks and prices as well as Brent calendar 2027. What to watch for this summer is thus oil product inventories falling and oil product premiums to crude rising. Another measure to watch is the Brent crude 2027 contract as it rises steadily day by day as the Strait of Hormuz stays closed and global oil inventories decline. The latter is close to the highest level since the start of the war and keeps rising.
The Brent M1 contract and the Brent 2027 prices and current price of jet fuel in Europe (ARA). All in USD/b
Our back of the envelope calculation of the global shortage created by the closure of the Strait of Hormuz. Note that 3.5 mb/d of discharge from SPR is also a draw. Note also that ’Forced demand loss’ of 2.5 mb/d is probably temporary and will fall back towards zero as logistics are sorted out leaving ’Price demand loss’ to do the job of balancing the market. Thus a shortfall of at least 9 mb/d created by the closure. More if SPR discharge is included and more if Forced demand loss recedes.
Brent is climbing higher. Front-month is at USD 106.3/bl this morning, close to a weekly high and a USD 9/bl jump from Mondays open. This is the move we flagged as a risk earlier in the week: the market shifting from ”a deal is around the corner” to ”this is going to take longer than we thought”.
Analyst Commodities, SEB
During April, rest-of-year Brent remained remarkably stable around USD 90/bl. A stability which rested on one single assumption: the SoH reopens around 1 May. That assumption is now slowly falling apart.
As we highlighted yesterday: every week of delay beyond 1 May adds (theoretically) ish USD 5/bl to the rest-of-year average, as global inventories draw 100 million barrels per week. i.e., a mid-May reopening implies rest-of-year Brent closer to USD 100/bl, and anything pushing into June or July takes us meaningfully higher.
What’s changed in the last 48 hours:
#1: The US military has formally warned that clearing suspected sea mines from SoH could take up to six months. That is a completely different timescale from what the financial market is pricing. Even a political deal tomorrow does not immediately reopen the strait.
#2: Trump has shifted his tone from urgency to ”strategic patience”. In yesterday’s press conference: ”Don’t rush me… I want a great deal.” The market is reading this as a president no longer feeling pressured by timelines, with the naval blockade running in the background.
#3: So far, the military activity is escalating, not de-escalating. Axios reports Iran is laying more mines in SoH. The US 3rd carrier strike group (USS George H.W. Bush) is arriving with two countermine vessels. Trump yesterday ordered the US Navy to destroy any Iranian boats caught laying mines. While CNN reports that the Pentagon is actively drawing up plans to strike Iranian SoH capabilities and individual Iranian military leaders if the ceasefire collapses. i.e., NOT a attitude consistent with an imminent deal!
Spot crude and product prices eased off the early-April highs on a combination of system rerouting and deal optimism. Both now weakening. Goldman estimates April Gulf output is reduced by 14.5 mbl/d, or 57% of pre-war supply, a number that keeps getting worse the longer this drags on.
Demand-side adaptation is ongoing: S. Korea has cut its Middle East crude dependence from 69% to 56% by pulling more from the Americas and Africa, and Japan is kicking off a second round of SPR releases from 1 May. But SPRs are finite.
Ref. to the negotiations, we should not bet on speed. The current Iranian leadership is dominated by genuine hardliners willing to absorb economic pain and run the clock to extract concessions. That is not a setup for a rapid resolution. US/Israeli media briefings keep framing the delay as ”internal Iranian divisions”, the reality is more complicated and points toward weeks and months, not days.
Our point is that the complexity is large, and higher prices have only just started (given a scenario where the negotiations drag out in time). The market spent April leaning on the USD 90/bl rest-of-year assumption; that case is diminishing by the hour. If ”early May reopening” is replaced by ”June, July or later” over the next week or two, both crude and products have meaningful room to reprice higher from here. There is a high risk being short energy and betting on any immediate political resolution(!).
Down on Friday. Up on Monday. The Brent June crude oil contract traded down 5.1% last week to a close of $90.38/b. It reached a high of $103.87/b last Monday and a low of $86.09/b on Friday as Iran announced that the Strait of Hormuz was fully open for transit. That quickly changed over the weekend as the US upheld its blockade of Iranian oil exports while Iran naturally responded by closing the SoH again. The US blew a hole in the engine room of the Iranian ship TOUSKA and took custody of the ship on Sunday. Brent crude is up 5.6% this morning to $95.4/b.
The cease-fire is expiring tomorrow. The US has said it will send a delegation for a second round of negotiations in Islamabad in Pakistan. But Iran has for now rejected a second round of talks as it views US demands as unrealistic and excessive while the US is also blocking the Strait of Hormuz.
While Brent is up 5% this morning, the financial market is still very optimistic that progress will be made. That talks will continue and that the SoH will fully open by the start of May which is consistent with a rest-of-year average Brent crude oil price of around $90/b with the market now trading that balance at around $88/b.
Financial optimism vs. physical deterioration. We have a divergence where the financial market is trading negotiations, improvements and resolution while at the same time the physical market is deteriorating day by day. Physical oil flows remain constrained by disrupted flows, longer voyage times and elevated freight and insurance costs.
Financial markets are betting that a US/Iranian resolution will save us in time from violent shortages down the road. But every day that the SoH remains closed is bringing us closer to a potentially very painful point of shortages and much higher prices.
The US blockade is also a weapon of leverage against its European and Asian allies. When Iran closed the SoH it held the world economy as a hostage against the US. The US blockade of the SoH is of course blocking Iranian oil exports. But it is also an action of disruption directed towards Europe and Asia. The US has called for the rest of the world to engaged in the war with Iran: ”If you want oil from the Persian Gulf, then go and get it”. A risk is that the US plays brinkmanship with the global oil market directed towards its European and Asian allies and maybe even towards China to force them to engage and take part. Maybe unthinkable. But unthinkable has become the norm with Trump in the White House.
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
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