We pointed out in late 2014, citing the work of the Financial Times’ John Dizard, that it was access to money, and not fundamentals, that would (as in could in theory) constrain US shale gas production. As you can see below, that has yet to happen. And OPEC hasn’t turned off the spigot either. From a 2014 post:
In the new normal of lower energy prices, developers are apparently playing a game of chicken, hoping that competitors will cut production first. Dizard again:
Particularly in the gas and natural gas liquids drilling directed sector, every operator (and their financier) is waiting for every other operator to stop or slow their drilling programmes, so there can be some recovery in the supply-demand balance. I have been hearing a lot of buzz about cutbacks in drilling budgets for 2015, but we will not really know until the companies begin to report in January and February. Then we will find out if they really are cutting back, using their profits on in-the-money hedge programmes to keep their debt under control, and taking impairment charges on properties that did not really pay off.
One gas-orientated industry man in Houston I know thinks that the banks are going to call a halt to the madness of permanent negative operating cash flows. “What is the timing of their borrowing base renegotiations (with the banks)? That is the most important thing; can they borrow more money?” If not, he believes drilling and producing on uneconomic terms will slow or stop, and with the high depletion rates of unconventional reserves, such as shale gas, supplies will fall and gas prices will rise.
In other words, if the industry doesn’t discipline itself, the money sources will. Or will it?
If the bankers reduce the borrowing base for the E&P companies, there could be a lot of private equity or high-yield investors with covenant-light deals to offer who might take their place. Not to mention cash-rich majors who would like to take the billions they can no longer put into Russia or Venezuela, who would not mind picking up more North American properties on the cheap.
Although Dizard does not discuss the downside directly, he sets forth a fact pattern that could lead to some ugly ends. US shale gas production needs to get to $6 per mBtu or more for players who aren’t very leveraged to get to break-even cash flow; they hope to make more two to three years after that on presumably higher prices.
But if super low interest rates keep money flowing into the shale bubble, another set of issues emerges: US production is set to considerably outstrip domestic uses:
So much gas is being developed in the Marcellus and Utica resources of the northeastern US that it really cannot be absorbed by the US market. Suzanne Minter, manager of oil and gas consulting at Bentek in Denver points out: “Over the next five years, daily production in the US is forecast to grow by more than 16bn cubic feet per day, with about 10bcf of that coming from the northeast. Of that, at least 8.5bcf has to be exported. Domestic demand does not grow enough.”
That means a lot of infrastructure like pipelines and storage facilities needs to be built. But that requires regulatory approvals and possibly government intervention. And even then, with US shale gas production projected by the IEA to peak in 2020 and fall slowly over the next decade, this extraction boom is nowhere near as durable as development of conventional oil has proven to be.
But in the stone ages of investing, 18 months was the limits of equity analyst forecasts, and the next quarter seems to be the limits of Mr. Market’s attention. But it is taxpayers that will wind up holding the bag for shale gas infrastructure, particularly if a lot of proves not to be as productive as billed after 2030.
By Nick Cunningham, a Vermont-based writer on energy and environmental issues. You can follow him on Twitter at @nickcunningham1. Originally published at OilPrice
WTI and Brent continued to tumble on Thursday, dropping to their lowest levels since the announcement of the OPEC deal back in November. Brent actually dipped below $49 per barrel, raising fears of another downturn. Both WTI and Brent were off by nearly 4 percent during midday trading on Thursday.
Oil traders have been patient, hoping that despite the rapid rebound in U.S. shale production, the OPEC cuts would take a substantial volume of oil off the market and correct the supply/demand imbalance. But it has been a painful and protracted process.
U.S. crude oil inventories hit a record high of 535 million barrels as recently as the end of March. Several consecutive weeks of drawdowns in April again raised hopes that the market is heading towards balance, but the most recent data release from the EIA on May 3 disappointed yet again, and it was apparently the last straw for some. Market analysts predicted a drop in oil inventories by about 2.3 million barrels, but the EIA said stocks only fell by 930,000 barrels. WTI sank to $46 per barrel and Brent fell into the $40s for the first time in 2017.
Worse, gasoline stocks increased slightly, offering more evidence that motorists are not willing to burn through all the refined products that the downstream sector is producing. Even if refiners suck more crude out of storage, consumers won’t sufficiently burn through all of the additional refined product.
But the most bearish part of the report came from the upstream figures, which once again showed dramatic growth in U.S. oil production. In the last week in April, the industry added another 28,000 bpd, taking U.S. output up to 9.293 million barrels per day (mb/d), up more than 200,000 bpd since the beginning of March, and up more than 450,000 bpd since the start of the year. Output is now the highest since the summer of 2015, and if current trends continue, the industry could break all-time production records before we know it.
U.S. oil production “continues to grow hand over fist, and the market will remain well oversupplied given the lack of” demand for gasoline and diesel, Roberto Friedlander, head of energy trading at Seaport Global Securities, told CNBC.
It is growing more difficult by the day to make the case that oil prices will post strong gains this year. A WSJ survey of 14 investment banks finds an average projected Brent oil prices for this year at $57 per barrel, an estimate that is starting to look a bit overly optimistic.
“Crude inventories fell, because they always do at this time of year,” Stephen Schork, president of Schork Group Inc., told Bloomberg. “This is the 11th straight-weekly gain in production and heading for a modern-day record by the end of the year. I don’t see any way you can spin this as bullish.”
Adding to the supply glut is the fact that Libya has restored large chunks of its production, taking output back above 700,000 bpd. Libya’s National Oil Company is also targeting another 500,000 bpd of gains this year, although that will be easier said than done.
Things are not all bad. On the plus side, hedge funds and other money managers have reduced their bullish bets on crude oil, which is to say, they are not overextended on the upside in the way that they were the last time oil prices fell. That means there is less pent up pressure that could suddenly force prices down further. “We’ve had some pretty sharp price corrections already so it does reduce the risk of length liquidation. I do think as long as OPEC maintains the cuts, the price will get some stability,” Petromatrix analyst Olivier Jakob said to CNBC.
And although it gets lost in the mix, especially when prices start getting volatile, the market is still marching slowly in the right direction. Inventories are declining globally, and many analysts still see more balance later this year.
Moreover, the markets tend to put too much emphasis on one indicator over another. OPEC was given enormous credit in the initial rally up to $50 last November, but some argue that the large OPEC cuts, which are likely to be extended through the end of the year, are now being discounted as everyone shifts their focus to the shale comeback. “U.S. production continues to rise largely in response to supply discipline being shown by OPEC and Russia,” Tim Evans, an energy analyst at Citi Futures Perspective, said in a Bloomberg interview. “It was a mistake during the first part of the year to ignore rising U.S. production and focus exclusively on the OPEC cuts. It’s a mistake now to just focus on U.S. production and assume that guarantees we’ll have an ongoing abundance of supply.”
But the problem with that argument is that to a large degree the OPEC extension has already been priced into the markets. That leaves little upside to an extension but a massive risk to the downside if OPEC fails to extend.