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Analys

US shale oil production growth to slow sharply in 2020

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SEB - analysbrev på råvaror
SEB - Prognoser på råvaror - Commodity

Baker Hughes US oil rig count has declined by 178 rigs since the recent peak of 888 rigs in mid-November 2018 with latest count now at 710. If anything the rig count decline has accelerated since July as investors have closed their pockets for debt based production growth with no profit to show for.

US oil rig count is now drawing down by about 3.5% per month. US shale oil producers are now completing more wells than they are drilling. As a consequence the DUC inventory of Drilled but uncompleted wells which ballooned from 5400 wells in late 2016 to a peak of 8246 in March 2019 has now been drawing down since April and is now drawing down at an accelerating pace.

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

The more the rig count falls the faster will be the DUC inventory draw-down be as producers work hard to maintain the monthly rate of well completions. In the end producers will have no other choice than to reduce the monthly rate of completed wells or to increase drilling activity and that is the point in time when US shale oil production growth will start to slow sharply. We think that in the end a higher oil price is needed to drive drilling activity higher.

If we assume that the drilling rig count continues to fall by 20 rigs per month to the end of this year and then stabilizes then marginal US shale oil production growth is likely to slow sharply from March 2020 before contracting in September 2020.

The US EIA has a very simplistic method of calculating shale oil drilling productivity. The consequence is that they underestimate productivity in periods when the DUC inventory is growing (Dec-2016 to Mar-2019) and overestimate it when the DUC inventory is declining as it has been doing now since April. As a consequence they also have too high production forecasts when the DUC inventory is drawing down like it is now.

The US EIA is now probably overestimating US oil production for 2020 by some 300 k bl/d with a projection that production will average 13.17 m bl/d in 2020 (US EIA STEO report released yesterday). They did reduce their 2020 US production forecast yesterday from 13.23 m bl/d in their September STEO forecast to 13.17 m bl/d yesterday but they are probably still some 300 k bl/d too high.

US shale oil production is still growing by a marginal, annualized pace of 0.9 m bl/d (75 k bl/d/mth) now in October according to the latest US EIA DPR report in September. Thus the current very strong marginal US production growth still gives a very strong bearish impulse to the global oil market.  This bearish impulse is however going to slow sharply from March onwards next year and potentially go to neutral and turn to bullish in September next year.

Year on year production growth in the US is still going to be significant in 2020 due to base effects. The US EIA STEO report yesterday projects a US liquids production growth of 1.56 m bl/d y/y from 2019 to 2020. We think that this is probably in the ball-park some 0.3 m bl/d to high. That still leaves a very strong 1.2 m bl/d y/y average growth in 2020. The monthly production growth and thus marginal bearish impulse to the global oil market is however likely going to slow sharply from March next year. On a Jan-2020 to Jan-2021 basis the US crude oil production is probably not going to increase by more than 100 k bl/d unless drilling picks up.

In order to instigate an expansion again in US drilling rig count the shale oil players will need a higher oil price than we have now. The Permian oil price has averaged $56/bl during the oil rig draw-down since January. The WTI price has averaged $57/bl and the 18 month forward WTI price has averaged $55/bl. These prices probably need to move up to $65-70/bl in order to instigate an expansion US shale oil drilling again. Right now we have Permian = $54/bl, WTI 1mth = $53/bl and WTI 18mth = $49.9/bl. I.e. all these prices are today lower than what they have been on average during the rig count draw down since January so further draw down in US oil rig count should be expected.

Ch1: Local Permian oil price in USD/bl versus 4 weeks change in US oil rig count. The Permian oil price has averaged $56/bl during the draw-down phase and probably needs to move up by some $10/bl in order to instigate drilling rig count expansion again. Latest Permian oil price is $54/bl

Local Permian oil price in USD/bl versus 4 weeks change in US oil rig count

Ch2: The US EIA’s latest STEO report is also forecasting a sharply lower marginal, annualized production growth in US Lower 48 states (excl GOM) which is mostly shale oil production. They are forecasting a marginal, annualized production growth rate of 0.3 m bl/d/yr on average in 2020 versus an average growth rate of 0.84 m bl/d in 2019. Thus the US EIA is also forecasting a sharply slower production growth for US shale next year. However, we do think that their projections are probably too high and needs to be adjusted lower towards zero marginal production growth through 2020.

Marginal production growth

Ch3: US marginal, annualized production growth is still very strong with an annualized growth rate of 0.9 m bl/d according to the US EIA September DPR report. The estimate of 0.9 m bl/d/y for October is probably a bit on the high side. Nonetheless it is in decline. Shale oil players are probably going to start to reduce monthly well completion rates from January onwards as the DUC inventory starts to decline. That will rapidly drive the marginal production growth rate lower

US sharel production growth

Ch4: The US inventory of DUCs has now been drawing down since April and the draw down is accelerating. It will probably draw down to about 5,500 at around the end of 2020.

The US inventory of DUCs

Ch5: US shale oil well productivity has halted its historical relentless productivity growth and has pulled back a little.

US shale oil well productivity

Ch6: Official US EIA drilling rig productivity measure has risen strongly since the end of 2018. In our view this is primarily due to the accelerating draw down in the US DUC inventory which technically is leading to an overestimation in drilling productivity according to the EIA’s methodology of calculating it as [New production at time T]/[Rig count in T-2]. If a significant amount of new production stems for the DUC draw down then production will be high while the rig count number will be low thus leading to an overestimation of the rig productivity

Barrels

Ch7: US shale oil production is growing strongly but slowing and the slowing will accelerate in March 2020 onwards

 US shale oil production is growing

Ch8: US production growth is likely to slow sharply in Q2-2020 onwards as well completions are likely to decline along with the declining DUC inventory

US

Ch9: US oil rig count is falling sharply and the decline seems to accelerate. Completions of shale oil wells per month has managed to hold up due to the DUC inventory but impact is likely to be significant in Q2-2020 leading in the end to lower well completion rates

US oil rig count

Analys

A sharp weakening at the core of the oil market: The Dubai curve

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SEB - analysbrev på råvaror

Down to the lowest since early May. Brent crude has fallen sharply the latest four days. It closed at USD 64.11/b yesterday which is the lowest since early May. It is staging a 1.3% rebound this morning along with gains in both equities and industrial metals with an added touch of support from a softer USD on top.

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

What stands out the most to us this week is the collapse in the Dubai one to three months time-spread.

Dubai is medium sour crude. OPEC+ is in general medium sour crude production. Asian refineries are predominantly designed to process medium sour crude. So Dubai is the real measure of the balance between OPEC+ holding back or not versus Asian oil demand for consumption and stock building.

A sharp weakening of the front-end of the Dubai curve. The front-end of the Dubai crude curve has been holding out very solidly throughout this summer while the front-end of the Brent and WTI curves have been steadily softening. But the strength in the Dubai curve in our view was carrying the crude oil market in general. A source of strength in the crude oil market. The core of the strength.

The now finally sharp decline of the front-end of the Dubai crude curve is thus a strong shift. Weakness in the Dubai crude marker is weakness in the core of the oil market. The core which has helped to hold the oil market elevated.

Facts supports the weakening. Add in facts of Iraq lifting production from Kurdistan through Turkey. Saudi Arabia lifting production to 10 mb/d in September (normal production level) and lifting exports as well as domestic demand for oil for power for air con is fading along with summer heat. Add also in counter seasonal rise in US crude and product stocks last week. US oil stocks usually decline by 1.3 mb/week this time of year. Last week they instead rose 6.4 mb/week (+7.2 mb if including SPR). Total US commercial oil stocks are now only 2.1 mb below the 2015-19 seasonal average. US oil stocks normally decline from now to Christmas. If they instead continue to rise, then it will be strongly counter seasonal rise and will create a very strong bearish pressure on oil prices.

Will OPEC+ lift its voluntary quotas by zero, 137 kb/d, 500 kb/d or 1.5 mb/d? On Sunday of course OPEC+ will decide on how much to unwind of the remaining 1.5 mb/d of voluntary quotas for November. Will it be 137 kb/d yet again as for October? Will it be 500 kb/d as was talked about earlier this week? Or will it be a full unwind in one go of 1.5 mb/d? We think most likely now it will be at least 500 kb/d and possibly a full unwind. We discussed this in a not earlier this week: ”500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d”

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily. That core strength helped to keep flat crude oil prices elevated close to the 70-line. Now also the Dubai curve has given in.

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily.
Source: SEB calculations and graph, Bloomberg data

Brent crude oil forward curves

Brent crude oil forward curves
Source: Bloomberg

Total US commercial stocks now close to normal. Counter seasonal rise last week. Rest of year?

Total US commercial stocks now close to normal.
Source: SEB calculations and graph, Bloomberg data

Total US crude and product stocks on a steady trend higher.

Total US crude and product stocks on a steady trend higher.
Source: SEB calculations and graph, Bloomberg data
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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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SEB - analysbrev på råvaror

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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SEB - analysbrev på råvaror

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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