OPEC Deal and U.S. Shale Oil – 12/19/16

Even if crude oil prices rise on the agreement between OPEC and other nations to cut production, a rebound in U.S. shale output could keep prices low.

After OPEC’s largest producer, Saudi Arabia, rejected initial calls for production cuts in the wake of the initial price collapse and decided in November 2014 to let low prices force out high-cost producers — such as U.S. shale drillers — it can be jarring to see how much their tune has changed.

Saudi officials now seem to dedicated to pumping as much optimism into the markets as possible. Responses range from promises of more cuts in a do-whatever-it-takes approach to the Saudi Energy Minister Khalid al-Falih saying he doesn’t expect a big supply response from American shale producers in 2017 despite expecting the opposite in 2014 when the glut began. Unfortunately for OPEC, reality is working to undermine such reasoning.

To stay optimistic, most scenarios for future oil prices have to exclude the U.S. shale producers. The producers, who nearly doubled U.S. oil production in a matter of years according to the EIA, will inevitably make a comeback. A possible quick return during 2017 is debated, but there is a strong case for it coming sooner rather than later, especially if prices rise above $60 a barrel.

Source: EIA

For one thing, Bloomberg data shows that the number of active rigs drilling for crude in America has already begun to climb.

Baker Hughes Inc. has recently observed the largest weekly addition of oil rigs since July 2015 with rigs targeting crude in the U.S. rising by 21 to 498, the most since January.

At the current rate, Goldman Saches analysts projections show shale output on track to achieve 0.8 million barrels a day of annual production growth at a price of $55 a barrel for benchmark West Texas benchmark. The Macquarie Group holds a similar view with crude output in the continental U.S. possibly rising by about 500,000 barrels a day by the end of 2017 if the price of WTI climbs to $60 a barrel.

For comparison, the OPEC cuts to output, with full compliance, are expected to amount to 1.2 million with an additional 0.6 million in cuts from non-OPEC nations.

The cost curve for U.S. shale has fallen dramatically to make such high U.S. output possible.

Despite low prices, U.S. production has largely stabilized over the last six months as production growth in the low-cost Permian Basin has made up for some of the declines in the Bakken and Eagle Ford regions.

So long as U.S. shale oil production can be ramped up to make up for any OPEC cuts, don’t expect the OPEC deal to make a meaningful impact on oil prices

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