Rig-crazy time for crude

January 31, 2017 09:02 AM
Daily Energy Markets Report

The largest oil rig count since November, 2015 has some people making crazy predictions that the jump in rigs will somehow replace OPEC production cuts. While over time the jump in shale oil rigs will add to U.S. production and may even exceed expectations, the thought that it can replace the recent OPEC/non-OPEC production cuts or even meet them barrel for barrel is just not correct.

While some look at the initial output from shale oil rigs as evidence that production will overtake oil OPEC production cuts and perhaps meet OPEC cuts barrel for barrel fails to take in the decline rate or flush rate from a shale oil rig. Initially a shale rig on average may produce seaway 1000 to 1500 barrels a day after initially drilled, there is a flush rate that in a matter of days or weeks could reduce that output to maybe 100 or 200 barrels of oil per day. So, to keep the upward trajectory, the U.S. shale patch would have to continue to adds rigs to continue the upward trend of production.

Per Petrologistics, OPEC production cuts this month will total about 900,000 barrels per day since July. Data by from the Energy Information Administration released this month in their last "Short Term Energy Outlook” is predicting that U.S. crude oil production averaged an estimated 8.9 million barrels per day (b/d) in 2016 and is forecast to average 9.0 million b/d in 2017 and 9.3 million b/d in 2018. So, they are predicting only an increase of say 300,000 barrels. Goldman Sachs estimates that year-on-year U.S. oil, "production will rise by 290,000 bpd in 2017" if a backlog on rigs that are still to become operational is accounted for. Still far below the 900,000 barrels that are being cut. Some say that OPEC has only cut 750,000 barrels a day so far but even so that would have to double the EIA and Goldman Sachs oil production figures to get to the amount of the OPEC cut.

U.S. oil production has risen by about 6% in July when the rig count bottomed out and later after OPEC defied almost everyone but me and made a deal to cut production. So, even if you straight-line the current pace of growth, U.S. shale may be able to add production of 600,000 bpd by mid-2017 but if OPEC continues to keep output at current levels, you will see a decline in global inventories as demand growth rebounds. While we have seen a dip in demand recently, it seems to be temporary. 

The Energy Information Admintation predicts that U.S. shale output in February will rise by 41,000 barrels a day, not even enough to make a dent in OPEC production gain and a rate that would have to be maintained for almost a year if indeed the shale producers are going to catch up with the OPEC cuts. The other rigs that many shale producers have are financially strapped. Some are drilling to break even and some are drilling at a loss. While may shale operations may be profitable above $50 a barrel, if we fall below that area we may see the rigs fall off as fast as that went up as we did back in 2016.

The surge in gasoline supply will be cut as record U.S. demand and record U.S. exports will cut into that over supply. In fact, per JD power last year, we had record car sales. In 2016, a total of 1,178,133 new vehicles were sold, a record for a calendar year. This year 17.6 million cars are expected to be sold and would be another record.

Early on many analysts missed the significance of shale oil production and now they are overestimating its production rates. I am not saying that U.S. shale oil production may slow the upside on oil, it won’t stop it. We still feel oil is near the low for the year shale or no shale.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.