Oil and Gas

The USA Crude Oil Conundrum

The current US oil market is in the midst of a slugfest reminiscent of a Rocky fight, as competing influences face off against one another. In one corner we have rising US shale oil production, while in the opposing corner we have a precipitously falling rig count. Out of this duking duo, one is going to provide a sucker punch to prices. The question is….which?

Let’s get straight to the main event. The oil rig count has dropped precipitously. It has fallen by over 34% to 1056 from an all-time high of 1609 last October. Not only are lesser efficient vertical rigs being idled (and at lesser productive shale plays), but we have seen 347 horizontal rigs idled, down 25% from a record high of 1372:

But therein lies the rub. At first blush, it seems wholly logical that a falling rig count would translate into materially lower production. But this is not necessarily the case.

Although under different circumstances, we saw a similar scenario play out in aftermath of the oil crash in 2008-09. Even though the number of rigs declined 60% between November 2008 and June 2009, production ticked lower by a mere 5% on a weekly basis from early December 2008 into the second week of January 2009, before rebounding from there. On a monthly basis, production never actually dropped.

This time around, US production is again likely to remain stable despite the oil rig drop. Not only does improving productivity per rig mean efficiencies will buoy production going forward, but a significant backlog in well completions (of 3 – 7 months) will act as a cushion for production rates.  Combine this with a response in drilling activity to a price rebound (like, um, the +30% rally in recent weeks) and we may see a leveling off in production, but by no means a significant drop. Hark, the EIA is on board:

But for now, US production keeps rolling with the punches, edging ever higher. This is manifesting itself in higher oil inventories, which are now at 417 million barrels, the highest level since weekly records began in 1982, and the highest since 1931 according to monthly EIA data. US oil inventories seasonally tend to rise in the first quarter given lesser demand and the onset of spring refinery maintenance. What is unusual, however, is for inventories to set such a pace while already at record levels (h/t rampant production):

Meanwhile, back at the pipeline crossroads of the world (as we talked about here recently), Cushing stockpiles have now more than doubled since October to be at 42.5 million barrels. Such as swift uppercut of an increase has led to the question of how much room is left.

According to Genscape (who, like Mohammed Ali, hails from the mighty Louisville, KY), capacity is just shy of 70 million barrels. Given it has averaged a build of ~2 million barrels a week thus far this year, we could be brimming by mid-year if it keeps up this pace:

So this leaves us in quite a conundrum, and one which is prompting a vast variety of views for oil going forward. Goldman Sachs led the bearish charge last month by slashing their WTI forecast in half to the $30s, while Citi sees even further downside to $20. In recent days, economist Gary Shilling has one-upped them all by touting a $10 price target. On the flipside, OPEC Secretary-General el-Badri says that oil is heading higher from here, while my buddy the Mighty Phil Flynn is also saying that prices have bottomed out.

Only time will tell who is the victor here. But given that we will see some response from US production – be it marginal or material – the ultimate victor when prices rebound will be the ones feeling the most short-term pain now: OPEC.


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