U.S. shale took the world by surprise over the last five years as U.S. production grew to new heights, defying laws of pricing and oil price breakevens as the industry managed to lower the cost of oil.
U.S. oil production had peaked in 1970 at 9.6 million barrels per day (mbpd) and in 2005 it fell to 5.2 mbpd, declining for 35 straight years. Crude Oil imports reached 10.1 mbpd in 2005, just 50% of total U.S. consumption. The U.S. economy was highly dependent on oil imports from countries like Venezuela and Saudi Arabia.
Fracking changed the industry forever. This technology had been around since 1940s. It is a way by which to promote higher production rates from conventional oil and gas wells. It involves pumping water, chemicals and sand down an oil and gas well under high pressure to break open the areas in the reservoir where deposits are held. Long story short, vast improvement in technologies like horizontal drilling and fracking, despite falling oil prices, have today seen the U.S. get back to production of about 12.6 mbpd. For the first time since 1978, the U.S. recorded a surplus in petroleum trade of $252 million in September 2019. From being an oil importer, a nation dependent on oil-producing regions, it is now a net oil exporter a decade later.
US Crude Oil Exports took off like mad in only the past few years after a 40 year long export ban. It's this factor which can now make or break an EIA Report from week to week, which is why we track those physical vessel movements. We hope we explained it well. Thanks. pic.twitter.com/ziOEbofCrm— TankerTrackers.com, Inc.⚓️�� (@TankerTrackers) November 6, 2019
This swing in balance has had and will continue to have massive implications for foreign policy for the U.S. OPEC, namely Saudi Arabia, is no longer the swing producer, as they call it. Over the past few years, especially during the 2014/2015 lows, OPEC and the world was taken aback as to how efficient the U.S. shale producers were, to be able to stay in business even as prices fell below $45/bbl WTI. OPEC decided to take barrels out of the market to support the oil price, and to their detriment, they lost market share as U.S. shale kept pumping and growing.
Thanks to a very lucrative High Yield Energy market, U.S. shale companies were able to borrow as much at cheap rates by issuing bonds and using that to pump that money back into the system. Cash flow discipline was never maintained. They kept borrowing to produce even at negative cash flow rates. Just look at the performance of SPDR S&P Oil & Gas Exploration & Production ETF (XOP) . After years of being promised better capital discipline, investors have now had it with U.S. E&P companies. Now it's crunch time.
64% of U.S. shale companies have to pay their debt back in seven years ~ $71 billion (source: Rystad Energy). As the debt matures, company managements will be forced to be even more capital disciplined, focusing on repaying their debt rather than boosting production. After all these years, they have no choice but to focus on balance sheet repair as the bond and credit markets are closed to them.
The Baker Hughes U.S. Rig Count has been falling since the middle of November 2018. There is usually a time lag between WTI Oil prices and the Rig Count of about ~ 3-6 months. As prices peaked in October 2018 around $86/bbl Brent, oil has been on a downward trending path since then. This is reflected in the U.S. Oil Rig Count now down about 20% since its highs. The thing with U.S. shale is that it faces huge decline rates. As fast as it can pump oil, the same well can also deplete production quite fast if it is not pumped regularly. This requires capital. Most U.S. shale basins have a decline rate of 70% in year one, and 35% in year two. The only way to combat this decline is to drill and complete more wells.
According to Rystad Energy, if U.S. shale producers keep completion activity flat, U.S. shale will see growth rates of +470k bpd per year from fourth-quarter 2019 to fourth-quarter 2022. Bear in mind these rates vs. growth rates of +900k bpd in 2019. Taking into account decline rates plus drilled uncompleted wells that can still be used, Rystad estimates that U.S. production will average +235k bpd from fourth-quarter 2019 to fourth-quarter 2022, putting U.S. oil production at 13.6 mbpd by end of 2022 -- ~ 8% growth over just two.
There is a lack of conventional oil supply projects coming on stream just at a time when U.S. shale is plateauing and slowing production. We also have OPEC+ with a deep cut agreement of 1.2-1.5 mbpd in place till March this year. As much as OPEC and Russia have been trying to balance the market, supply is not the problem, it's demand.
The global economy had started slowing in 2018, exacerbated by the U.S./China Trade War. There was almost a dollar liquidity crisis that required the U.S. Fed to inject $400 billion in liquidity into the system over a few weeks, expanding their balance sheet when they were just normalizing it last year. The Fed cut rates by 75 bps and increased their balance sheet.
Demand is something that cannot be forecast as a science. One has to take a view of the economic cycle and make a call. This is where most economists and governmental organizations lose out, as they only report when it happens and then extrapolate the current state.
If the Trade War Phase 1 deal is reached, the global economy will start to recover, taking the price of oil higher at a time when we are entering the peak winter heating period and supply is taken off the market.