Peaking oil production

July 12, 2017 08:17 AM
Daily Energy Market Analysis

Crude oil prices are getting a wake-up call after a lowering of the U.S. oil production outlook--a report of a major drop in U.S. oil supply and a warning by S&P to oil majors cut to back more and reduce debt levels or face downgrades. 

The Energy Information Administration (EIA) is lowering the outlook for U.S. crude oil production because of a revised oil price forecast that is $2 to $4 per barrel lower for late 2017 and during 2018 than the prior forecast that will make it less profitable for some U.S. producers to drill for oil. The EIA said that U.S. crude production will average 9.9 million barrels a day, down from a previous forecast of 10.1 million barrels a day in what I predict will be the first of more production downgrades in the future. 

As I have written before, the rush to add oil rigs by oil companies at a frantic pace seemed not to consider the well head profitability as well as the logistics for producing this shale oil. While the oil market has been so fixated on rising oil rig counts, the increase in uncompleted oil wells should have been raising some concern. What we are now seeing is a pullback in shale oil production that will hold back U.S. oil output of shale until the economics start to make more sense. That may take a while as the logistical issues of bringing drilled but uncompleted wells back online will not give us the amount of oil production that the market has been expecting.

The EIA does forecast production to average 9.9 million b/d in 2018, which would mark the highest annual average production in U.S. history, surpassing the previous record of 9.6 million b/d set in 1970. Even though U.S. oil production may break a record in a few years, the fact that the EIA is counting on the U.S. to account for 90% of the globe's production growth in the coming years, this reduction in production should be worrisome. OPEC cuts are expected to be extended and reports that both Libya and Nigeria will agree to a production quota puts the fate of global oil prices in the hands of U.S. producers. This fate looks shaky as U.S. shale producers are already pulling back and reports of investment capital for shale is drying up. 

We can’t look to big oil to suddenly make up the difference. Not only have their cuts in investments lowered their proven oil reserves and their new discoveries of oil, but a major ratings agency wants them to cut more. S&P global ratings of oil majors could see their credit ratings cut again if they fail to cut costs and reduce their growing debt loads in the next year. The report said that big oil failed to take advantage of the oil boom years when they were making record profits and instead invested too heavily on high-cost and high-risk projects while raising dividends to shareholders leaving them unprepared for the oil downturn. 

Shale oil producers should take note as the recent surge in rig counts was done with little preparation for an oil price downturn. S&P has already downgraded Exxon Mobil, Royal Dutch Shell, Total, BP. 

This news comes as the American Petroleum Institute reports a massive 8.133-million-barrel drop in U.S. crude supply. We also saw another whopper drop in Cushing, Okla., of 2.028 million barrels. This comes after last week’s big drop that the market ignored because of a rise in U.S. oil production and the storm.

After the EIA report on U.S. oil output and Tropical storm Cindy now a distant memory, this report should not be ignored as long as the EIA confirms the data at 9.30 central time. The EIA also showed gas down 801k and distillates up 2.079 million barrels.

OPEC Production was up last month but offset by the fact that NON-OPEC production was down. Crude production hit 32.61 led by increases in production by Saudi Arabia that is slightly above its targeted production and Libya and Nigeria a that will soon get quotas.  

The EIA Short-term Energy Outlook Highlights Gasoline/Refined Products: “The price U.S. consumers are expected to pay for gasoline this summer has been revised down as lower crude oil costs provide a break at the pump... The price of crude oil, which accounts for about half the retail price of gasoline, has declined in recent months on rising U.S. crude oil production and high petroleum inventories.” 

Natural Gas: “U.S. natural gas production is expected increase through the rest of this year and during 2018 in response to higher natural gas prices and growing liquefied natural gas exports The United States will become a net exporter of natural gas this year, and U.S. liquefied natural gas exports in 2018 are expected are expected to increase 45%  from this year’s levels. U.S. natural gas inventories at the start of the upcoming heating season this November are expected to be lower than last year, but still 2% above the five-year average.” 

Electricity: “Forecast milder temperatures for this summer compared with last summer will reduce the need for air conditioning, resulting in the average U.S. household consuming 5% less electricity from June through August.”

Coal: “Higher coal-fired generation and more exports are expected to be major contributors to an increase in U.S. coal production this year, with coal output in western states rising the most.”

Renewables: “U.S. electricity generation from renewables is expected to increase 12% this year and then remain steady in 2018 due mainly to a drop in hydropower next year. U.S. ethanol production is on track to reach a record high this year of just over 1 million barrels per day, and then decline slightly in 2018.”

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.