It has been more than two months since OPEC+ decided to extend the output limit agreement and no desired results can be observed in the global oil market. In June-July, Brent prices fluctuated within a range of $45-50 per barrel and managed to break a psychologically critical 50-dollar ceiling only by the end of the last month.
According to the OPEC monthly report, in June global oil supply increased by 0.66 mb/d from the previous month and reached 96.6 mb/d. The increase was mainly (0.39 mb/d) provided by the production growth in the OPEC’s countries (Libya, Nigeria, Angola, Iraq and Saudi Arabia) which reached 32.6 mb/d in spite of a decline in Venezuela. Representatives of Ecuador directly stated that due to the difficult economic situation they could no longer fulfill its obligations under the agreement.
According to a preliminary estimate by Reuters, OPEC oil production in July rose by 90 tb/d to 33 mb/d. Thus, taking into consideration the current production level, the supply deficit will be only 500 tb/d. At the same time, export deliveries rose to 26.1 mb/d, an increase of 370 tb/day from the previous month. In view of a decline in OPEC members’ discipline, more market participants start to believe in the imminent collapse of the agreement further adding “bearish” sentiment.
At the same time, commercial oil reserves of OECD countries in May dropped by 12.9 million barrels to 3 billion barrels, which is 37 million less y-o-y. This is the fourth consecutive month of reserves reduction. However, this level is still 234 million barrels higher than the five-year average.
Significant reductions in commercial reserves of US stocks of crude oil provided positive influence on the market situation. In July, they were shrinking for four consecutive weeks by 21 million barrels in total. Nevertheless, the stocks level is still 72 million barrels higher than the five-year average. These reductions were caused not only by the automobile season, but also by the increase of US oil export in July by 6.5 million barrels, which added pressure on world oil prices.
Americans do not give up
The discord within OPEC took place against a backdrop of the continuous increase in the production of American shale oil. At the end of July, US production reached 9.4 mb/d, the highest level since September 2015.
At the same time, some experts saw signals of American companies’ activity slowdown. According to Baker Hughes, in June the number of drilling rigs increased by 23 units, in July – only 10, reaching 766 units.
Source: Baker Hughes, EIA
Thus, signals of significant oil reserves reduction, as well as some slowdown in the activity of American producers, led to the revival of “bullish” sentiment in the market.
But what is this? Is it speculative fluctuations on the base of weekly data small changes, or the US producers “surrendered” under the pressure of moderate prices?
Wellhead breakeven prices in key US oilfields
Source: Rystad Energy
It is well-known, that due to the high cost of shale deposits exploitation, the activity of American producers largely depends on oil prices. Over the past three years, the wellhead breakeven price fell by 50-60% and in 2016 it reached $29-39 per barrel in key shale formations. The cost reduction was achieved due to improved drilling technology, lower specific production and oilfield services costs as well as operator concentration in the oilfield sweetspots. However, the actual WTI breakeven price, including infrastructure costs, royalties, taxes, transportation costs and other extras, is still $10-15 higher for the oil company than the wellhead breakeven price. Thus, even the current price of around $50 per barrel does not cover costs in many spots.
According to some experts, the continuing production growth, despite of the moderate oil prices, is related to the hedging made at higher prices in the previous year – around $55-60 per barrel. Currently, the share of hedged deals for the beginning of 2018 is very small.
Specific feature of shale oil exploration is that projects are have on average a five-year life span. A bulk of profit is earned in the first year of operations, afterwards, the production falls by approximately 70%. Thus, experts expect that the decline of new drillings will occur in the coming months, but the oil output will not decrease in the short term due to the still high potential of already drilled but uncompleted wells (DUCs).
As another argument for the future weakening of shale activity, some experts call the technical features of American refineries. The fact is that they are designed for processing heavy, high-sulfur oil, which is mainly imported. However, US shale oil is highly valued in the market, because it is light, contains few sulfur compounds, so it is very profitable to export it. This will also be facilitated by the US administration, which plans to increase oil exports to 1 mb/d from the current 844 tb/d.
In this regard, one of the largest US ocean ports Corpus Christi received a preliminary Congress approval of $350 million for dredging project. That would allow serving tankers with more than a million-barrel tonnage. Two more pipelines, the EPIC and South Texas Gateway, are slated to open in 2019, brining more oil to the Gulf of Mexico cost. In late July, President Trump announced the beginning of the 108 tb/d capacity oil pipeline construction from the US to Mexico.
In addition, it is necessary to pay attention to the growth of DUCs in shale deposits. Over the past three years, their number has doubled and in June 2017 has exceeded 6,000 units, which potentially can add hundreds of thousands of barrels of oil per day to the market. Although at present, due to low prices, some of the DUCs launching is suspended, under favorable prices these wells will turn out to be a “nightmare” for OPEC members. According to EIA, US oil production in 2017 will be 9.3 mb/day, and even more in 2018 – 9.9 mb/day.
Conclusion: the battle of the Titans continues
Thus, it becomes obvious: even despite of the shale producers activity slowdown signals, the threat of American oil expansion continues to hang over the global market. The struggle of two oppositely directed factors – the efforts of OPEC and the US – does not allow achieving a balance. In the current situation of “vicious circle”, the experts recommend OPEC two options. The first one is to continue to adhere to the production-cut agreement and hope that the recovery of demand will be faster than the US shale production growth. In favor of scenario speaks Saudi Arabia’s intention to cut energy exports in August by about 1 mb/d, statements of the alliance members about possible extension of the agreement beyond the Q1 of 2018, and OPEC’s intention to terminate membership of the countries, which do not fulfill their obligations under the agreement.
The second line of action is offered by Goldman Sachs experts: continue to cut production to stabilize reserves, and then announce plans to increase production. This could make forward oil prices to become lower than spot, as a result US companies will be forced to cut investments in oil production.
Both variants reflect the experts’ opinion on the persistence of irreconcilable, antagonistic relations between these two oil forces in the future. Nevertheless, having learnt a bitter lesson of the 2014 crisis, some shale producers voice their opinion about the need for discipline in the matter of increasing production volumes, as their sharp spikes and declines, following by oil price movements, create greater risks and instability for investors, workers, local authorities and all related infrastructure. Thus, perhaps there is a third way: direct or indirect coordination of actions between the US and OPEC+. But this is still in the realm of impossible.
Rating Agency of the Regional Financial Center of Almaty
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