The energy market took notice earlier this year when the U.S. Department of Energy observed that shale oil production in Texas’ Permian basin, one of the biggest and most profitable shale oil deposits, had slowed down.
Shale oil wells have a short life span compared to traditional oil wells, but the news from the Energy Department’s statistical arm, the Energy Information Administration, still was a surprise. The EIA first said in June that daily oil production per average rig from new wells in the Permian slipped from the previous month, a trend that continues. Net oil production from the Permian remains up.
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Considering U.S. shale oil production turned the U.S. into a petroleum powerhouse, spooking the Organization of Petroleum Exporting Countries into waging a price war these past few years, does this mean the days of low oil prices and plentiful production are over? No, oil market watchers say. But it could be the oil supply glut that the price war brought on may be winding down.
Low prices keep production in check. Rob Haworth, senior investment strategist with U.S. Bank Wealth Management in Seattle, says U.S. oil production is likely to remain subdued unless prices stay above $50 a barrel. For much of this year, West Texas intermediate futures prices have pooled mostly under $50.
While the drop in the Permian caught the market’s attention, Haworth says production in the lower 48 states in general is falling because there are fewer oil rigs. “We’ve seen a slowdown in investment and to some extent some lower productivity per well, so we should be seeing a slowdown in production at this point,” he says. “Prices for crude oil have been in the mid $40s, which is typically not thought of as an economic price to drill wells.”
Capital expenditures for shale oil producers fell about 30 percent in 2015 and 40 percent in 2016, says Stewart Glickman, an energy equity analyst for CFRA in New York. In fact, 2017 is the first year that shale oil companies have had positive capex spending. “When you had two substantial negative years like that back to back, it takes a really significant percentage increase to get you back to square one, and we’re not there yet,” he says.
Some of the decline is geological too, Glickman says. Although slower than before, new well production continues to more than offset existing production. Unless oil companies add more oil rigs, incremental growth will decline, he says. That could mean “the worst is over for oil prices,” Glickman says. Crude oil prices fell to multi-decade lows in 2015 and 2016.
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Yet Rob Thummel, managing director and portfolio manager at Tortoise Capital Advisors in Leawood, Kansas, says a lot is misunderstood about the production slippage. He traced some of the concerns to second-quarter earnings calls from a few companies that had higher-than-expected natural gas production in the Permian. That led to questions about the Permian’s true potential, but he says there’s no reason for concern. “Nothing’s changed in our mind about the absolute production volumes of oil,” he says. “They’re just going to produce more oil and natural gas and natural gas liquids in total.”
Shale oil is here to stay. The EIA expects total U.S. shale oil production to grow by about 600,000 to 650,000 barrels this year, which Tortoise has been forecasting all along, Thummel says. Earlier in the year, however, overstated data led the market to anticipate much higher production growth, about 1 million barrels more than last year, he says. That unrealistic expectation likely exacerbated the concerns over oil output.
Morgan Stanley analysts also are unperturbed by slowing Permian production. They say technological improvements and the way oil is extracted can easily keep the basin one of the U.S.’s top producers for years to come.
Analysts are waiting to see if OPEC takes any action in response to slipping U.S. production. OPEC has cut its own production lately, which has helped ease the global oil glut. If OPEC sees an opportunity to add barrels back into global production, that could weigh on prices, Haworth says. On the other hand, if deferred crude oil futures contracts rise above $60, that may give shale oil producers an incentive to find more projects in the Permian and elsewhere.
No matter what happens in the Permian and whether OPEC removes its production caps or not, Haworth expects crude oil prices to range between $45 and $55 a barrel for the fourth quarter, a forecast that Glickman also shares. Now that U.S. producers have become much more cost-efficient, OPEC has less influence over prices.
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“When OPEC engaged in a price war, they discovered that they have less power than they thought they did,” Glickman says. “So, the only way oil prices go higher is for U.S. shale production to start disappointing. But I don’t think we’re at [that] point yet.”
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Will Slowing Shale Production Lift Oil Prices? originally appeared on usnews.com
