U.S. producers appeared to have won another battle for global oil dominance after the Organization of the Petroleum Exporting Countries (OPEC) on Thursday extended global oil production reductions through at least mid-2018.
At its 173rd meeting in Vienna, OPEC and its allies, including Russia, agreed to extend 1.8 million b/d of volume cuts through 2018, although a mid-year review is planned. The deal is designed to tighten worldwide oil supply and thus raise prices.
However, several U.S. energy analysts think the extension only gives more confidence to operators working in the Lower 48 and the Gulf of Mexico to increase output.
OPEC should be concerned about U.S. tight oil growth, said Barclays Capital analysts Michael Cohen and Warren Russell.
U.S. producers have already reaped the benefits of OPEC’s initial decision to cut production, and they will continue to do so with the extension of the OPEC/non-OPEC deal,” said the Barclays analysts.
They pointed to the Thursday release of the U.S. Energy Information Administration’s 914 data for September, which indicated domestic crude oil production increased nearly 300,000 b/d from August and is more than 900,000 b/d above September 2016 levels.
“At current prices, producers will likely continue to put rigs back to work and drive output higher,” said the Barclays analysts. “We forecast U.S. production to grow by another 1 million b/d before 2018 end, but there is clear upside risk to this forecast if current oil prices persist.”
As in the OPEC meeting held last June, Saudi’s oil minister and OPEC Chairman Khalid Al-Falih’s comments on Thursday “suggest he may misunderstand what U.S. producers are capable of at current price levels.
“He suggested that drilling will be higher in 2018, but production decline rates will also be higher, so growth next year would not be much different than 2017. Unfortunately, a prolonged ramp-up in 2017 meant that we are only now starting to see the full affects of this year’s drilling activity on production levels.”
As U.S. activity accelerates, Barclays analysts expect domestic production growth “will be stronger in 2018 on average than in 2017.”
Goldman Sachs also warned on U.S. productivity. Analyst Damien Courvalin said OPEC’s assessment of the medium-term supply response to higher prices is too conservative, with forward prices above the industry’s marginal cost.
Although an exact exit strategy was not formalized, the OPEC agreement “will further defuse long-term supply uncertainty in our view,” said Courvalin. He noted the third quarter results by U.S. exploration and production companies, as well as the oil majors confirmed “persistent declines in breakevens.
“This leads us to reiterate our long-held view that long-dated implied volatility remains too rich in the face of growing certainty on the sources of future supply,” Courvalin said.
Ultimately, how operators not members of OPEC react to higher prices may settle the “inventory nuance” as OPEC’s assessment was “more conservative” than the one by Goldman.
Specifically, Saudi’s al-Falih said U.S. shale growth in 2018 would be “no different” than in 2017.
“We estimate instead that shale production is fast accelerating and that the moderate ramp up in shale through August was a function of the inherent spud to production delays (lengthened by pad drilling) and to a lesser extent transient bottlenecks,” Courvalin said.
Goldman’s view is “consistent with the EIA September U.S. crude production data,” which indicated what Courvalin called a “spectacular” 290,000 b/d mom increase despite the impact of Hurricane Harvey in late August into September.
Meanwhile, the U.S. horizontal oil rig count for the three-week period ending Nov. 22 increased by 19, as West Texas Intermediate prices climbed above $50/bbl, Courvalin noted.
Still, the OPEC extension “adds confidence in higher oil prices,” according to Sanford Bernstein’s team led by Oswald Clint and Bob Brackett.
In part on the OPEC news, Bernstein raised its oil price forecast for 2018, tempered by a prediction for higher U.S. supply.
“Specifically, we raise our Brent forecast to $56/bbl in 2018 and expect prices to keep climbing over the medium term under our U-shaped price recovery,” said Clint and Brackett. The price calculation, 12% higher than a previous Bernstein forecast, should “likely add some new U.S. volumes.”
U.S. unconventional well productivity year-to-date is up 10-15%, according to Bernstein. Analysts also expect to see more natural gas liquids produced for U.S. ethane crackers next year, meaning domestic supply could increase even more. Bernstein calculated the additional gain in U.S. supply for 2018 at around 400,000 b/d.
During the OPEC meeting, Russia expressed concerns that significantly higher oil prices would entice other operators, i.e. U.S. producers, to increase output “and work against market balancing,” which would divert attention from a necessary longer term strategy, said Societe Generale analyst David Schenck.
“By extending the accord four months ahead of its initial expiration, OPEC has strongly reiterated its intent to supporting prices above $60/bbl and providing the market with a degree of certainty -- supportive to selling put options,” Schenck said.
“Conversely, the June review clause serves as a very explicit forewarning that OPEC will neither subsidize U.S. shale nor give up more market share by allowing prices to rise significantly -- itself supportive of call option selling. Stated differently, perhaps now is the time to sell the OPEC strangle.”