Shale Oil Growth Headed For Slowdown, But When?
January 28, 2019
The shale oil revolution will remain in the spotlight in 2019 and promises to once again be one of the most crucial factors driving global oil markets. Rapid growth in U.S. oil production is single-handedly satisfying worldwide oil demand – and then some – forcing the OPEC cartel and its non-OPEC allies, led by Russia, to make price-supportive supply cuts to keep the market balanced.
But how sustainable is the current state of play? How long can shale producers expect Saudi-led OPEC to effectively subsidize their operations and seize a greater share of the global oil market through growing exports?
Based on recent comments coming out of Riyadh, this arrangement appears to be the new normal. Shale earned the respect of OPEC as a low-cost source of supply during the 2014 oil price collapse and subsequent price war initiated by the cartel, which American producers not only survived but came out of stronger and more efficient.
Saudi Arabia is still the world’s only true “swing producer,” able to increase or decrease output by millions of barrels a day on short notice. But it has come to accept the importance of shale in global oil markets, as Riyadh fears that investments in other conventional oil projects – those outside of shale such as offshore and oil sands – have not sufficiently recovered over the past five years since the price crash.
Saudi Arabia now sees shale as an integral part of oil market stability and an important tool to reduce the volatility that has roiled prices over the past year, whipsawing them from over $85 a barrel in October to under $50 last month. President Donald Trump’s close relations with Riyadh, at a time when the kingdom remains under pressure for its role in the killing of Saudi journalist and U.S. citizen Jamal Khashoggi, may also factor into the kingdom’s favorable view of shale these days.
Saudi Energy Minister Khalid al-Falih recently called OPEC’s new 1.2 million barrels a day supply cut deal with Russia “a lifeline to US shale producers.” Al-Falih said he receives calls from U.S. oil executives urging him to “do something” when oil prices fall and they see investors hitting the exits. “They want us to do all of the work and they want to take the benefit, but that’s, you know, that’s life,” al-Falih said.
American oil executives can sleep soundly at night knowing they have an ally in Saudi Arabia. On the flip side, Riyadh probably sees the shale sector maturing and expects it won’t have to surrender more big chunks of oil market share as U.S. output growth eventually slows. That may be a smart bet. A slowdown could happen relatively soon, perhaps in late 2019.
Average U.S. oil production grew by 1.6 million barrels a day in 2018, with another 600,000 barrels a day added in the form of natural gas liquids. Shale has consistently surprised to the upside, keeping OPEC off guard as it tries to manage global supply-demand balances. But those days are likely numbered. OPEC this year expects U.S. oil production to grow by 1.7 million barrels a day – an ambitious forecast given that American producers have cut capital expenditure plans in response to price volatility.
Even the U.S. Energy Information Administration (EIA), with its detailed data on well productivity, is not as optimistic as OPEC. The EIA estimates U.S. oil output will average 12.1 million barrels a day this year, up 1.2 million barrels a day from an average of 10.9 million barrels a day in 2018. In 2020, the growth rate will slow further according to EIA – with output averaging 12.9 million barrels a day. The Paris-based International Energy Agency (IEA) also sees U.S. oil output growth slowing to 1.3 million barrels a day this year.
Make no mistake, the United States will bolster its position as the world’s largest oil producer this year and remains on course to become a net exporter sometime in late 2020. But there are reasons to think that shale oil production forecasts may be revised downward later this year.
Since oil prices fell in the fourth quarter of 2018 and the oil market outlook for 2019 appeared more bearish, shale budgets for this year have been cut significantly to compensate for the anticipated loss of revenues. It will take some time for the effects of those cuts to be felt on actual production volumes.
It is true that more pipelines will be brought online this year that will reduce bottlenecks and help producers get more of their oil to market – at better prices – than in the past. It’s also true that there is a large inventory of “drilled but uncompleted wells” (DUCs) that producers could bring onstream that could add to output and would not be caught by typical drilling data like rig counts. These are wild cards that could prompt another surprise in shale oil production figures.
But a more holistic, big picture view shows a maturing industry where limitations are to be expected. It happens naturally in all nascent industries as they expand.
Shale has proven to be a low-cost source of supply, but it doesn’t exactly break the bank at $50 a barrel, which is the current price for U.S. benchmark West Texas Intermediate crude. JP Morgan recently said shale explorers need $54 a barrel to eke out profits due to rising costs for oil services such as drilling and fracking equipment and labor. Many shale producers were generating negative free cash flow before prices went south.
Investors are demanding better financial returns from shale producers, and these demands helped drive a wave of corporate consolidation in the sector last year. Major oil companies have gotten into the act, too, and are now significant contributors to the shale story.
As more production and acreage ends up in the hands of bigger players, projected growth rates are expected to come down. Unlike small, free-wheeling independents, big established oil companies don’t pursue growth for the sake of growth – they exist to return cash to investors through dividends or stock buybacks. Over time, this maturation of shale will moderate its pace of growth.