Oil Price
When last October Hamas attacked Israel, oil prices jumped higher, as always happens when armed conflict breaks out in the Middle East. Just a week or so later, however, prices had retreated.
Even as the war spread and lit up surrounding countries, oil prices remained stubbornly range-bound, with analysts predicting that it would take an actual supply disruption for traders to start caring about geopolitical risk.
All this was made possible by one factor: U.S. oil production. That expanded surprisingly strongly last year. And many traders and analysts alike seem to assume that this year will be the same. But will it?
Earlier this month, Saudi Arabia ordered Aramco to stop work on The Kingdom’s oil production capacity expansion. That work would have raised Aramco’s maximum production capacity from 12 million bpd to 13 million bpd. It turned out, however, that Riyadh had reconsidered the plan. Bloomberg was quick to note the role of U.S. shale as the Saudis’ “nemesis for much of the past decade.”
The suggestion appears to assume that U.S. shale production will continue growing at last year’s robust rate, which surprised most industry watchers who had expected production to reflect drillers’ newfound capital discipline and focus on shareholder returns and debt repayment.
The reason for this assumption is quite simple. Most of the production gains last year came despite a consistently lower rig count and no meaningful increase in spending on new production. They came from efficiency gains such as longer laterals in horizontal wells and improved drilling technology. The question some are asking is whether these could be maintained at last year’s rate. The more important question is, however, will drillers want to do that?
Reuters’ John Kemp posed the first question in a column this week, in which the market analyst noted that the strong increase in U.S. oil output last year had interfered with OPEC’s expectations from its own output cuts.
“The critical question,” he wrote, “is how much longer efficiency gains can keep driving significant output growth without an increase in prices and drilling.”
If the Dallas Fed Survey is any indication, we may well see a slowdown in the rate of output growth this year. In the latest edition of the survey, the Dallas Fed noted waning optimism among producers and a significant slowdown in the growth rate of production over the final quarter of the year.
Indeed, figures from the Energy Information Administration support this. While for much of 2023, production grew by leaps and bounds—with the occasional slight monthly drop—in the three months between September and November, growth slowed to around 100,000 bpd, with October even seeing a slight dip in output growth.
On the other hand, the EIA recently estimated the change in production over the last two weeks at a hefty positive 700,000 bpd, which would signal that U.S. production growth is still going strong. It bears noting, however, that estimates are not the most accurate of figures, and final data, such as the production numbers for September, October, and November are much more reliable as indicators of future production.
The question of whether producers would want to continue expanding their output as strongly as they did last year is an interesting one. The short answer is yes, in the context of surging exports amid the Red Sea crisis. That crisis has been a boon for U.S. oil as it has hampered the movement of crude from the Middle East to Europe, forcing Europe to look west for supply.
The longer the crisis lasts, the longer Europe will remain an extra-big market for U.S. crude, motivating production gains. But countering the strategy of constant output growth are suspicions about future demand and the merit of investment in new production capacity—because sooner or later, efficiency gains will not be enough.
There is also the issue of finite resources. There is an argument against the finite nature of hydrocarbons, but that argument rests on the recognition that not all oil is economical to extract at any price. In other words, there is still plenty of crude untapped in the U.S., but tapping it requires a certain price level that hasn’t yet been reached. In short: dripping sweet spots are running out. At some point, drillers will need either higher prices or lower output.
So, while the assumption that U.S. oil production will continue growing at a breakneck speed seems to be quite popular, it might not be the safest assumption out there. For now, it is being fed by last year’s surprising output gains and a perception that these will continue because they don’t require additional investments.
On the other hand, however, we have traders fretting about demand amid Chinese manufacturing activity updates and IEA forecasts about peak oil demand, even though these are based on massive assumptions themselves. These factors are keeping prices subdued. And U.S. producers can’t keep pumping more with ever-longer laterals alone. At some point, they would need to start spending more to produce more—but only if it’s worth it.
By Irina Slav for Oilprice.com
