US Shale Surge Puts Damper on OPEC Strategy

US shale production forecast to reach about 4.87 million bpd in March 2017

The Organization of Petroleum Exporting Countries (OPEC) reached a milestone agreement on November 30th, 2016, to reduce oil output to 32.5 million barrels per day (bpd) from levels of around 33.24 million bpd, driving a spike in crude prices since then. Benchmark oil prices have since gained more than 10% to breach the $50 per barrel barrier and the share prices of energy companies around the globe jumped alongside a basket of major currencies of large oil exporting nations. OPEC stated that it will reduce output by about 1.2 million bpd from January 2017 in a bid to eliminate the global oil glut and prop up oil prices to about $55 to $60 per barrel over the next six months.

Despite OPEC’s production cuts in a bid to prop up the sagging oil prices, it appears that US shale drillers are standing ready to fill the supply gap to reap the benefits of higher oil prices. The rising US shale production has put a damper on global oil prices; data from the US Energy Information Administration (EIA) showed that US production was about 8.9 million barrels per day (bpd) in 2016 and is expected to climb to 9 million bpd in 2017 and 9.3 million bpd in 2018. While most of the world’s leading oil producers have agreed to slow down in 2017, US production is expected to grow. Since September 2016, US output has been rising at an average rate of 93,000 bpd, and is now back above 9 million bpd, according to Bloomberg.

Oil prices tumbled on February 24th, 2017, after EIA data showed US crude stockpiles rose for a seventh straight week. EIA data showed stocks rose 564,000 barrels to 518.7 million barrels in the week ended February 17th, 2017, higher than the levels of 478.2 million bpd in December 2016, and much higher than 468.7 million bpd in January 2016.

Moreover, crude oil prices trimmed gains when Baker Hughes data as of February 24th, 2017, showed another pickup in US drilling activity. US rotary rig count was up by 3 to 754 during the week, about 252 rigs or 50.2% higher than the rig count for the same period last year. The number of rotary rigs drilling for oil was up 5 at 602. There are 202 more rigs targeting oil than last year.

Exploration and production (E&P) companies have added 77 rigs in 2017 until February 24th, 2017, while US shale production is forecast to reach about 4.87 million bpd in March 2017, according to the EIA’s latest Drilling Productivity Report. Estimates of just how much shale will be added over 2017 range from as high as 900,000 bpd to a more modest 400,000 bpd, as per Bloomberg. Moreover, falling borrowing costs and increased hedging opportunities following the latest price rally has benefitted E&Ps looking to gain access to capital and expand production in 2017.

OPEC reaches record compliance

Keeping with its promise, OPEC has achieved record compliance with the production cuts deal, and the biggest laggards, the United Arab Emirates and Iraq, have pledged to catch up with their targets. The IEA estimated OPEC’s average compliance at a record 90% in January 2017. Saudi Arabia, OPEC’s largest producer which raised oil production to record levels in 2016, promised to reduce output by 486,000 bpd to 10.05 million bpd. Saudi has delivered on its promise to cut production, and said that its output had fallen below 10 million bpd to levels last seen in February 2015 and that it expects to make even deeper cuts in February 2017.

US shale firms hedge oil price risks

The rise in benchmark oil prices has spurring US shale oil companies to hedge their oil price risk for 2017 and 2018. US shale companies are making use of higher crude oil prices to lock-in cash flows for 2017. The rush in hedging activity by locking in future cash flows and sales prices could translate into higher US oil production in 2017, thereby offsetting the impact of the first output cut by the OPEC.

Given this scenario, it remains to be seen whether OPEC and Russia will continue to curb output when the deal ends in six months when their main objectives have not been met and US shale producers are likely the main beneficiaries.

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