US Shale Set To Kill Oil-Price Rally

Demand-driven price rallies are more sustainable, but that’s not what we have today.

By Nick Cunningham,

The resurgence of U.S. shale will undermine the OPEC-fueled price rally, capping oil prices at roughly $50 per barrel through 2017. That is the conclusion from the EIA’s latest Short-Term Energy Outlook, which forecasts WTI to average $50.66 per barrel and Brent to average just $51.66 per barrel next year.

The agency also cast doubt on OPEC’s ability to follow through on its deal.

The extent to which the announced plans will be carried out and actually reduce supply below levels that would have occurred in their absence remains uncertain.

But even if they do, any price rally above $50 per barrel will merely spark a revival in U.S. shale drilling, which will “encourage a return to supply growth in U.S. tight oil more quickly than currently expected.” In other words, the OPEC deal won’t fuel the sustained rally that oil bulls have hoped for.

In fact, the oil bust could persist for another year, according to the EIA. Rising U.S. oil production next year will postpone the projected withdrawals in oil inventories, pushing drawdowns off until 2018. In fact, the EIA actually projects inventories to climb once again, rising by 0.8 million barrels per day (mb/d) in the first half of 2017. For the entire year, inventories could build at an average rate of 0.4 mb/d. In other words, the EIA does not expect the global supply/demand equation to come into balance until the end of next year, a much more pessimistic prediction than the markets have come to expect, especially following the OPEC agreement.

One prevailing theory about the state of the oil market before the OPEC deal came from the IEA, which forecast a convergence of supply and demand by the middle of 2017. The OPEC deal was supposed to accelerate that adjustment, tightening the market and moving up the “balance” to early 2017.

But the EIA is much less bullish. That is because of the expected rebound in shale production.

The U.S. shale industry has succeeded in lowering the cost of drilling, as rock bottom oil prices forced efficiencies throughout the supply chain over the past two years. Even at today’s prices, a lot of shale drilling is profitable, especially in the booming Permian Basin. The agency expects overall production to be essentially flat, but supply would grow if prices increased from current levels.

The EIA found that a group of 91 publicly-traded international oil companies reported a collective profit in the third quarter of this year, the first quarterly profit since the end of 2014. The 91 companies earned a combined $2.3 billion in the third quarter, up sharply from a $54.1 billion loss in the third quarter of 2015, despite Brent prices dropping from $51 per barrel to $47 per barrel over the same time period (see chart).

That demonstrates the remarkable reduction in drilling costs, although it also captures the fact that the industry has written off so many assets over the past two years (which lower quarterly earnings figures) that there are fewer assets to write off these days. The damage is done and companies are starting to emerge from the wreckage.

The upside for oil prices is that demand could be stronger than previously expected next year. The EIA revised up its demand forecast for crude oil, which is set to grow by 1.4 mb/d this year and an additional 1.6 mb/d in 2017. But those numbers are debatable – the IEA has a more bearish take on demand, predicting growth of just 1.2 mb/d this year and next.

Higher oil prices, should they occur, could also have a self-defeating effect on demand. As Michael K. Farr, President of Farr, Miller & Washington, writes in CNBC, the price rally will be due to restricting supply and not necessarily because demand warrants higher prices. “In a tepid economy, like our current one, supply-driven price increases act as a tax and slow discretionary consumption. As gas prices rise for consumers, there is less money left over for discretionary spending and savings.”

Demand-driven price rallies are much more sustainable, but that is not what we have today. Add to that the fact that the dollar has strengthened significantly and the Federal Reserve is set to hike interest rates this month, trends that act as a drag on any price rally.

So, despite the euphoria surrounding the OPEC deal, we could be right back where we started – a slowly adjusting oil market that is still a bit oversupplied, at least for much of next year. By Nick Cunningham,

Texas is feeling it, but it’s not just the oil bust. Read… Texans Close their Wallets, Houston’s Economy Gets Crushed

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  14 comments for “US Shale Set To Kill Oil-Price Rally

  1. glut is huggeeee says:

    everybody pumpin like crazy not just the frackers,venuzuelans, Iranians,Russians,africans,iraqis,they all need the cash,opec knows that but they’re desperate and out of options ,earl is all they have,bigger question is where they gonna park all that crude still lyin around everywhere,

    • Gerald Stehura says:

      All this talk about oil and fracking and OPEC but not a word about our collapsing ecosystem. The question is: should we have a sustainable oil price to sustain US frackers or should we limit CO2 in the atmosphere to 350 ppm to sustain human society on Planet Earth? The choice is ours.

    • alexisisback says:

      * Every one including Norway
      ** Oct 6, 2016 – For the first time, the Norwegian government this year is drawing more money from its vast oil fund than it is putting in to support its economy.

      But What About CHINA – with historic high purchases and ever increasing stored reserves.
      estimated by some over 400 million barrels
      they have brought the price up some say single handedly

      There is more storage available in China than China will ever divulge and the market has no idea.

  2. Tyler from Grand Rapids says:


    Any chance you have a weighted$ vs barrel cost? I feel like that would be very interesting given the dollars rally this year.

    Appreciate it and best regards

  3. nick kelly says:

    Plus the fact that two of the parties to the deal are desperate for cash, i.e food Russia and even more desperate Venezuela.
    When revolution looms, cheating is a virtue.

  4. mynamett says:

    Shale oil and tar sand are net energy negative. It means it contributes very few energy BTU toward economical growth. This is reason why Venezuela is having hyperinflation. Tar sand have an EROEI of one, it means they use all the energy to produce energy and don’t have any energy left to sell on the international market.

  5. As long as the loans keep coming, there will be drilling by (increasingly) underwater drilling companies.

    Somewhere in the background, there are loan guarantees, maybe from the Feds, a defacto nationalization of the oil business. Only national governments can borrow — run deficits — endlessly and not go into liquidation. Businesses have to make money at some point, or at least pretend.

    How far underwater the drillers are is hard to tell because their balance sheets are opaque. But all commodity ‘producers’ have costs which tend to be inelastic … times the tens of thousands of wells being drilled in this country and int coastal waters times the expense of high tech inputs and the productivity of the enterprise relentlessly declines. That means each driller dollar lifts less oil of lower quality. Barrel price does not reflect driller productivity but rather the borrowing capacity of end users as well as solvency of credit issuers, themselves.

    Demand is irrelevant; because of the ubiquity of television it can be assumed to be infinite. The ability to give form to that demand — to consume — is different: it is directly proportioned to the availability of credit, at an affordable cost going forward into the future. Even as ‘they aren’t making any more oil’ … they aren’t making any more people with money, either.

    Oil shortages are coming if they aren’t already here. They don’t make anyone richer, either.

    • sinbad says:

      I totally agree with your post, except for the last paragraph.
      Offshore oil costs $60 a barrel to produce, and the oil companies lose money on every barrel they sell.
      There is lots of cheap oil and gas to be had, just not in America, which has consumed the largest reserves on the planet at a staggering rate.

  6. night-train says:

    Some plays are better than others. Some areas in a particular play are better than others. Some tight oil plays can be profitable at $50/bbl. Many more are not. Drilling costs are down, but these wells and the type of fracking required are still very expensive. So, well economics are still iffy.

    But, one fact is indisputable. E&P companies have laid off large numbers of personnel. And the type of lay offs and early retirements are telling. When engineers and geoscientists have been laid off in significant numbers, the companies aren’t expecting a meaningful uptick for several years.

  7. che says:

    a very mainstream view. truth is, on FCF level shale does not break before $50-55, and the costs are going to go way up when prices do.

  8. DV says:

    I would argue differently. The oil pice is unlikely to go up significantly (higher than $55/bl for Brent, albeit for different reasons – one is still high “visible” inventory (visible is simply because those inventories existed before in the SA storage, but then were thrown into the market and moved to the US/Cinese storage – this is one of the reasons why Saudis went for production reduction deal), the other is strong dollar. As far as shale drilling, I have a feeling that the increase in drilling will be at best enough to arrest the fall in shale production. In addition the costs are likely to go up markedly together with the drilling costs. Oilfield service companies are no longer able or willing to drill at a loss. So the prices for oilfield services will have to go up 25-30%. So “increase in investment” also probably accounts for cost increases and the real investment may as well fell again.

    As to profit over loss issue – I do not think that it really makes sense to look at that, as most of it comes from impairment write-down/write-ups.

    So overall, it does not look like $50 is going to revive shale.

  9. AeroFX says:

    Russia has just stated their Oil companies are not required to cut. OPEC is dead – Russia says govt will not order oil companies to cut output: RIA

    Via CNBC

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