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Oil Price

An Unexpected Bullish Factor For Oil

U.S. shale drilling activity is set to slow this year as companies respond to lower oil prices. However, a lower WTI price is not the only reason for the deceleration. A series of lingering operational issues that have long been papered over by relentless drilling are starting to become increasingly apparent, while pressure from Wall Street is also forcing a reckoning.  

“We think perceptions of whether US supply growth is slowing or not will be the key driver of oil market sentiment in 2019,” Standard Chartered analysts wrote in a note. “In our view there is a large gap between the generally downbeat views of the US oil industry itself and its investors, and the upbeat tone of much media coverage and many analysts.”

The investment bank expects non-OPEC supply growth is set to slow to just 1.518 million barrels per day (mb/d) this year and 0.754 mb/d in 2020, notably down from 2.46 mb/d in 2017 (figures include NGLs and biofuels). The U.S. is the major driver of this growth.

Pressure from Wall Street is forcing a sea change in the shale industry. The days of reckless drilling with no regard to profits are starting to become a thing of the past. Shareholders are demanding returns, and have penalized companies that have not only increased spending programs but even simply tried to maintain them.

Shareholders are pressuring companies to restrain themselves, which could translate into drilling curtailments. “Faced with such a sharp equity market downgrade even in the face of roughly constant revenue and higher dividends, the industry has started to cut back plans for capex as well as drilling and completion,” Ashford and Horsnell warned in their report.

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Notably, even in the Permian – often described as the best shale play in the world – drilling has slowed. The rig count in the Permian is down 15 from a peak in November and is back down to levels last seen in July 2018. Even the latest uptick is not evidence of a rebound. “Activity has been up and down for four weeks now, the decreases being noticeably steeper than the increases,” Commerzbank wrote in a note. “Drilling activity is currently on a downward trend, which argues against any pronounced rise in US oil production.”

And this is occurring in the best shale basin in the country. Outside of the Permian, the contraction is more pronounced.

Yet, these variables could be chalked up merely to cyclical factors. Oil prices are rebounding, which, in time, could lead to a drilling resurgence.

More worrying, however, is a collection of operational problems that have long dogged the shale industry but are only now becoming increasingly difficult to ignore. Shale wells suffer from steep decline rates, which isn’t exactly breaking news. But because the production base is so large at this point, the volume of decline, month-on-month, is becoming painfully large.

In addition, initial well productivity for new wells has also declined, according to Standard Chartered. This is of greater concern since it suggests the industry has run out of new ways to cover for the precipitous decline endemic to shale production.

For instance, Standard Chartered estimates that the U.S. shale industry needed 281 well completions in February 2018 just to offset declining output. That figure ballooned to 443 well completions in February 2019.

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Most of those additional wells are needed to offset the decline rates because the production base is so much larger. That alone is a problem – the drilling treadmill gets faster and faster and it becomes harder to keep up.

But Standard Chartered says that of the 443 well completions needed to offset decline in February, an estimated 60 wells are needed because of lower initial well productivity compared to last year. That points to a deeper problem. The best acreage is spoken for, and drillers are increasingly forced to the periphery.

What does all of this mean? The math ultimately suggests the overall U.S. oil production growth will slow. “We think the number of completions is unlikely to be substantially higher than the 443 target; net output growth will come from far fewer wells, and therefore m/m growth is likely to fall substantially during 2019,” Standard Chartered concluded.

In short, a drilling slowdown should provide a “positive backdrop” for the global crude oil market. Most traders and media have focused on the huge annual increases in U.S. shale as one of the principal bearish factors keeping prices in check. However, this year could prove disappointing.

By Nick Cunningham of Oilprice.com

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