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US Shale May Be The Latest Oil Shock

Commodities | Oct 01 2019

Is US shale oil the key ingredient in the latest "oil shock", putting the global oil market into surplus?

-The "oil shock" of the last decade largely emanating from US shale production
-US shale oil supply expected to surprise to the upside in 2020
-US oil prices well above median break-even for shale producers


By Eva Brocklehurst

Anxiety about world oil supply has increased following the attacks on Saudi Arabia's oil processing centre. The action brought back memories (for those old enough) of the "oil shocks" of the 1970s when the price of oil soared as geopolitical tensions in the Middle East escalated.

Is the same about to happen now? Probably not, given the latest attacks provoked only a relatively modest response in the oil price. Despite the kingdom being the world's largest supplier of crude oil, the disruption to global markets is likely to be remedied much sooner than it would have been back in the 1970s.

Moreover, the current disruption has occurred during a period of high global oil inventory, augmented by the rapid growth in US shale oil over the past decade. This is the main differentiating feature, Longview Economics Research argues.

That said, the analysts acknowledge there is a risk that similar disruptions such as what occurred in Saudi Arabia will happen again in coming months and, as always, each circumstance requires close attention.

The US remains the world's largest oil consumer and the "oil shock" of the past decade has largely been one emanating from an additional source of fuel oil – US shale. Without growth in US shale oil, Longview Economics points out the global market would have experienced an annual supply deficit of -4.1mbpd on average between 2012 and 2019.

Instead, the US has grown its shale oil supply such that the annual surplus has averaged 0.5mbpd over that period. Hence, the researchers assess that the oil price has been in a structural bear market since 2011, the time when US production of shale oil accelerated.

One of the main factors in determining the direction of oil prices over the next 12-18 months is US crude production. Official estimates expect growth of just under 1mbpd in 2020. Yet, the analysts suspect US shale supply will surprise (again) to the upside and grow by at least 1.4mbpd in 2020 (scenario 1).

This is based on the Longview Economics model of US shale production, and a number of conservative assumptions are included. Assumptions such as well completions and well productivity are unchanged from

current levels in the model.

Yet, shale oil companies are starting to tap into their DUC (drilled but uncompleted) well inventory. Current estimates suggest there are over 8000 DUC wells available for completion. Rig counts have been steadily falling over recent months, Longview Economics observes, and oil prices have dropped back to 2017 levels, while well completion rates have actually grown by over 60%.

Another factor is the price of oil is currently above break-even (even more so if DUC wells are being tapped). This means oil companies are profitable and likely to grow production.

The analysts assess oil prices (WTI price around US$65/bbl) are currently US$12 above median break-even levels in key shale basins and, in this scenario, 75% of shale oil producers are making a profit. Permian well productivity is also accelerating and has been rising consistently since early 2017, which is expected to persist as producer expenditure is constrained.

These factors all combine to enhance suspicions that US growth may be in excess of assumptions. Longview Economics asserts that shale oil companies are generating positive cash flow for the first time since 2014/15, a period when the oil price slumped.

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