An OPEC production cut is unlikely until U.S. production declines by about another million barrels per day (mmbpd). OPEC won’t cut because it would accomplish nothing beyond a short-term increase in price. Carefully placed comments by OPEC and Russian oil ministers about the possibility of production cuts achieve almost the same price increase as an actual cut.
Bad News About The Oil Over-Supply from IEA and EIA
The International Energy Agency (IEA) and U.S. Energy Information Administration (EIA) shook the markets yesterday with news that the world’s over-supply of oil has gotten worse rather than better in recent months. IEA data shows that the global liquids over-supply increased in the 4th quarter of 2015 to 2.24 million barrels per day (mmbpd) from 1.62 mmbpd in the 3rd quarter (Figure 1).
Figure 1. IEA world liquids market balance (supply minus demand). Source: IEA and Labyrinth Consulting Services, Inc.
Supply increased 70,000 bpd and demand decreased 550,000 bpd for a net increase in over-supply of 620,000 bpd. The sharp decline in demand is perhaps the most troubling aspect of IEA’s report. The agency forecasts tepid demand growth of only 1.17 mmbpd in 2016 compared with 1.61 mmbpd in 2015. The weak global economy is the culprit.
EIA’s monthly data showed the same trend. Over-supply in January increased to 2.01 mmbpd from 1.35 mmbpd in December, a 650,000 bpd net change (Figure 2). Supply fell by 370,000 bpd but consumption dropped by a stunning 1.02 mmbpd.
Figure 2. EIA world liquids market balance (supply minus consumption). Source: EIA and Labyrinth Consulting Services, Inc.
The January 2016 Oil Price Head-Fake
Recent comments about a possible OPEC cut were largely responsible for the late January ‘head-fake’ increase in oil prices (Figure 3). WTI futures increased 27% from $26.55 to $33.62 per barrel between January 20 and 29. As hopes for a production cut faded, prices fell 8% last week and have fallen below $28.00 as reality regains control of market expectations.
Figure 3. NYMEX WTI futures prices, October 2015-February 2016. Source: EIA, Bloomberg and Labyrinth Consulting Services, Inc.
There were, of course, other factors that boosted oil prices for that brief period. These included the usual questionably substantial suspects: a lower-than-expected build in U.S. crude oil inventories, sharp declines in U.S. land rig counts, and a weaker U.S. dollar on expectation that the Federal Reserve Board may slow planned interest-rate increases. What happens in the U.S. continues to drive oil markets.
Oil markets reflect a psychological conflict among investors between reality and hope. The reality is that the world is over-supplied with oil. The hope is that oil prices will increase without resolving that fundamental problem.
An OPEC production cut fulfills that hope. Deus ex machina.
Blame It On OPEC
Many believe that OPEC caused the global oil-price collapse by failing to rescue prices in its role as swing producer. This narrative also contends that OPEC and Saudi Arabia are producing at maximum capacity to destroy U.S. shale producers. The data do not support this narrative.
January 2016 Saudi crude oil production (9.95 mmbpd) increased slightly from December (9.90 mmbpd) but has declined since the August 2015 peak of 10.25 mmbpd (Figure 4).
Figure 4. Saudi Arabia crude oil production and change in production since January 2008. Source: EIA and Labyrinth Consulting Services, Inc.
Total OPEC crude oil production in January production was 31.61 mmbpd, almost half-a-million barrels per day less than in July (32.09 mmbpd) and only somewhat more than its 4-year average of 31.28 mmbpd.
Figure 5. Total OPEC crude oil production. Source: EIA and Labyrinth Consulting Services, Inc.
OPEC crude oil production since the Financial Crisis in 2008 has been remarkably balanced (Figure 6). Overall, increases by Iraq (+2.35 mmbpd) and Saudi Arabia (+0.6 mmbpd) have largely offset decreases by Iran (-1.0 mmpbd due to sanctions) and Libya (-1.4 mmbpd due to civil war). Renewed export by Iran with the lifting of sanctions is part of what pulls the oil market back to reality after its flights of sentiment-based hope.
Figure 6. OPEC crude oil production compared to January 2008 production levels (minus Indonesia). Source: EIA and Labyrinth Consulting Services, Inc.
Although it appears unlikely that Libya will resolve its civil unrest any time soon, renewed Libyan production and export is a sobering factor to ponder.
OPEC and Saudi Arabia increased production aggressively from March through August of 2015. Since then, however, production has declined to near average levels for 2012-2016.
The United States and Non-OPEC Are The Problem
OPEC did not cause the oil over-supply in early 2014. Over-production by the United States and other non-OPEC countries caused the problem. This is still the case.
The U.S. is responsible for more than 70% of the increase in non-OPEC liquids production since January 2014 (Figure 7). Brazil and Canada along with China and Russia account for the rest.
Figure 7. Non-OPEC liquids production compared to January 2014 production levels. Source: EIA and Labyrinth Consulting Services, Inc.
Until the structure of non-OPEC production decreases, there is little that OPEC can do to remedy low prices. Cuts by OPEC might temporarily increase prices but this would lead to more over-production outside of OPEC that would further collapse world oil prices later on.
Why U.S. Production Has Not Declined More
U.S. crude oil production has only declined by approximately 570,000 bpd from its peak of 9.69 mmbpd in April 2014 to 9.13 mmbpd in January 2016-about 60,000 bpd each month (Figure 8).
Figure 8. U.S. crude oil production and forecast. Source: EIA and Labyrinth Consulting Services, Inc.
EIA forecasts that production will fall another 820,000 bpd (about 100 kbpd each month) to 8.31 mmbpd by September 2016 before increasing again. The forecast provides hope that the oil market may balance later in 2016 or in 2017 but history to date suggests that it is probably optimistic.
Tight oil production in the U.S. has not declined nearly as much as many anticipated based on falling rig counts. Most explanations invoke increases in drilling and completion efficiency but I believe the truth lies in the continued availability of external capital to fund drilling of an ever-increasing number of producing wells until quite recently.
In the Bakken, Eagle Ford and Permian basin plays, the number of producing wells has declined or flattened in the last reporting months of October or November 2015. The plays are different and so are the patterns for production decline. Nevertheless, the decrease in new producing wells suggests that either capital is less available or that companies are choosing to drill and complete fewer wells.
Reporting in the Bakken is better than in the other plays. Bakken production only declined 51,000 bpd between the December 2014 and November 2015, the last reported data from the North Dakota Department of Mineral Resources (Figure 9).
Figure 9. Bakken production and number of producing wells. Source: North Dakota Dept. of Mineral Resources and Labyrinth Consulting Services, Inc.
Over the same period, the horizontal rig count fell by 111, from 173 to 62 rigs. Yet, the number of producing wells increased by 943, from 12,134 to 13,077 (the number of wells waiting on completion (WOC) increased by 219 from 750 to 969).
As long as more wells were added each month, production continued to increase. The number of producing wells only began to decline in October 2015. Each completed well cost approximately $8 million so capital spending did not decrease until then despite fairy tales about ever-increasing efficiency.
The resilience of tight oil production in the Bakken, therefore, reflected the continued availability of external capital to fund more drilling and completion. The impact of reduced capital is apparently a recent phenomenon in the Bakken.
The Eagle Ford and Permian basin plays show similar patterns of flattening rates of well completions in recent months. Eagle Ford production has declined 183,000 bpd since March 2015 while Permian basin production may just be peaking.
It is too early to draw concrete conclusions from the tight oil play data presented here but, in a way, that is the point. Production has only begun to decline because external capital was available until late 2015 despite low oil prices. If companies are forced to rely increasingly on cash flow for new drilling then, U.S. production should decline sharply. If, on the other hand, the recent $2 billion in equity raised by Permian basin operators becomes more the norm in 2016 then, production declines will be more modest.
This article is for information and discussion purposes only and does not form a recommendation
to invest or otherwise. The value of an investment may fall. The investments referred to in this
article may not be suitable for all investors, and if in doubt, an investor should seek advice from
a qualified investment adviser. More