Crude's message in a bottle

April 6, 2018 08:05 AM

U.S. crude oil production is at a record high but supplies of oil keep falling. Have you stopped to wonder why? Well, there are many reasons, such as record demand, but a larger issue has to do with shale oil. Yesterday’s oil prices initially rallied on a report that Saudi Arabia was raising crude prices for customers showing that they are confident about demand and not worried about losing market share. It later fell on a report by Genscape that supply in Cushing, Okla., rose 1.57 million barrels since last Friday. Yet, warning signs about shale, both in production with bottlenecks in the Permian shale basin and reports of high decline rates, are raising concerns that the world may be putting too much faith in shale to keep the world supplied with oil. 

Let’s talk bottlenecks first. Reuters is reporting that while the Permian Basin in Texas is leading the way in U.S. oil production, the increase in production, is causing major bottlenecks as pipelines transporting the crude have filled up more quickly than expected. This has caused a drop-in price and could pose a threat to investment and future production. Pipelines have filled to near-capacity and with few new pipeline projects scheduled for this year, producers may be forced to slow drilling, or even shut down active production. 

Reuters reports that production in the Permian Basin has hit a record 3.08 million barrels a day in March, nearly one-third of overall U.S. production of 10.4 million bpd, according to the Energy Information Administration (EIA). Now with Prime land already drilled, it seems that Permian drillers are branching out into relatively less-profitable areas of the region according to John Zanner, energy analyst for RBN Energy. “As these fringe areas begin to get exploited, we are seeing more and more crude that needs to find a pipeline to Cushing or the Gulf Coast,” he said.

Yet, this is just part of the problem. In the rush to produce shale are we going to be able to sustain U.S. production growth over the long run just relying on the Permian? Even if we had pipelines to get the oil out, there are concerns that we may be seeing signs of weakening Permian production promise.

Blue Quadrant Capital Management writes in Seeking Alpha that production decline rate in the Permian has “accelerated quite notably during the past 12 months. As we well know, shale wells have a very high initial decline rate. In many cases, the production output reported by a new well in the first month can decline by 60% in the following 12 months, before flattening out somewhat. The annualized monthly decline rate is currently at around 2.34mn bpd or 75% of total current production. A year ago, this ratio was just 62%”.

This is a problem because the U.S. and world has put all their eggs in the Permian production basket. As Blue Quadrant points out America will essentially account for almost all the expected growth in global oil supply in 2018 and 2019.  If they fail to deliver the world will be left short of oil.

According to the EIA’s Short-Term Energy Outlook publication, production growth from North America will essentially account for almost all the expected growth in global oil supply in 2018 and 2019. Most of that growth is in the Permian and if these decline rates keep up the world may be short of oil in a few years. Blue Quadrant says this raises the risk of a "black swan" event in the global oil market if productivity or production trends in the Permian unexpectedly deteriorate.

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.