It didn’t take that long for the horizontal drilling technology and hydraulic fracturing stimulation technique that unlocked huge stores of unconventional natural gas to be transferred to the oil patch, and now oily producers face as bleak a future for prices and activity as their gassy brethren, energy analysts with Raymond James & Associates Inc. said last week.
In a note to clients, analyst J. Marshall Adkins and his team said the “downside risk” to oil prices has begun sooner than they expected in part because of a “flare-up of the European debt crisis and negative economic datapoints across the globe. That said, we continue to see downside pressure for oil prices into 2013, as our oil model points to a severely oversupplied global oil market.
“While lower demand is part of the story, robust production growth in the U.S. is the monster lurking in the shadows. We expect this bogeyman to fully show himself before the end of this year. Accordingly, we believe Saudi Arabia will begin to noticeably cut production in 4Q2012, while U.S. producers will begin to curb activity in upcoming weeks. Combining the U.S.-driven resurgence in non-OPEC supply with our lackluster demand expectations, we believe that once the market’s focus shifts from demand to supply, the oil price picture will get uglier.”
Raymond James lowered its 2013 price forecast to $65/bbl for West Texas Intermediate (WTI) from a previous forecast in February of $83. The Brent forecast was cut to $80 from $95. Both of the forecasts are “well below the futures strip and consensus estimates,” said the analysts. They also cut their 10-year WTI forecast average to $80/bbl from $90.
Natural gas liquids (NGL) pricing will fall even more than crude pricing, said the Raymond James team.
“Currently NGLs comprise about a quarter of the total U.S. oil-related production and roughly one-fifth of our projected oil product supply growth. Unfortunately, the ratio between NGL pricing and crude pricing has been gradually deteriorating over the past several years. We expect that trend to continue over the next couple of years as the petrochemical industry buildouts continue to lag NGL production growth. Eventually, the petrochemical producers will catch up and NGL pricing (relative to crude) will normalize but that looks to be several years out.
“In the meantime, we believe ethane/propane will continue to exhibit a stronger relative correlation with relatively weak natural gas prices (i.e., natural gas acts as a floor for light-end NGLs) and the heavier-end NGLs…will correlate more with WTI oil prices.”
In February the Raymond James analysts cut oil price forecasts on concerns about rapidly growing U.S. supplies and the deteriorating outlook for global oil demand growth. Since then the oil market has begun to come to terms with the prospect of reduced global oil demand growth and prices have corrected by about $20/bbl, they noted.
“Unfortunately, we think there is more pain to come over the next year as the oil market fully digests the severity of U.S. oil supply growth…We are updating the production model because we now have four more months of actual data and our U.S. rig count assumptions have continued to drift lower. So, how do our numbers shake out now? Well, they’re still ugly â€“ real ugly. So far this year, U.S. supply growth is already tracking well above our original projections. Yes, that means we were not bearish enough.
“Even when we assume the U.S. rig count significantly rolls over in 2013, it will be too little, too late…”
The U.S. oil supply surge “is so severe that WTI oil prices must fall far enough over the next six to 12 months to drive the average 2013 rig count down at least 10%.”
The analysts’ initial basin production estimates in February were based on an average U.S. onshore rig count growth of 8% this year and another 6% growth in 2013. In mid April they cut their 2013 domestic rig count forecast to a 3% average annual decline — or a 10% beginning to end of year decline in 2013.
“We are now looking for average annual onshore rig growth of only 4% in 2012 and a 13% decline in 2013 — or a 25% decline from now to the end of 2013. Keep in mind that consensus expectations for 2013 still assume increasing drilling activity next year. Sorry, our oil model says that U.S. drilling activity must slow next year (unless the Strait of Hormuz is shut down).”
How can the analysts cut their forecast by nearly 780 oil rigs by the end of 2013 and not have a “meaningful” change to U.S. oil supplies next year? There are several reasons, said Adkins and his colleagues. For one thing, onshore rigs have “transitioned much more rapidly than we thought four months ago” from the gassy areas to the oily areas. They model eight oil producing plays — the Eagle Ford, Williston, Permian, Denver-Julesburg Basin (Niobrara), Cana Woodford, Granite Wash, Mississippian Lime and Barnett — and they have added 120 rigs year-to-date, more than twice their January forecast of 55 rig additions by mid June.
There also appears to be a “meaningful lag” in the past year between active drilling rigs and oil/gas supply hitting the market because of infrastructure bottlenecks (transportation, hydraulic fracturing crews, etc.) “In practice, as rigs are put down, we would expect high grading of prospects and working down the backlog of completion and pipeline work to allow production growth to continue despite falling rigs.”
In addition, actual U.S. oil supply figures reported in the past four months “are meaningfully higher than what our original model was predicting. When we input the actual data from 4Q2011, the entire U.S. oil supply curve shifts higher for 2012 and 2013. More specifically, our prior estimates for Gulf of Mexico production were simply too pessimistic, as we had anticipated Gulf of Mexico volumes would fall another 200,000 b/d in 2012 versus 2011. We now assume Gulf of Mexico production will be flattish in 2012 and 2013.”
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