The Only Story That Matters for Oil

It’s been a tough few weeks for crude oil punters.

After months of trading above US$50 per barrel, oil prices have nose-dived. The record amount of long speculative positions have reversed. West Texas Intermediate (WTI) crude is now trading at US$48.48 per barrel.

There are two main catalysts behind the price fall…

Last November the Organization of the Petroleum Exporting Countries (OPEC) claimed it would ‘freeze’ crude supplies at 1.2 million barrels of oil per day (MMBOPD) into June. The ‘cut’ was a manipulative tactic, aimed at artificially driving up crude prices. It meant OPEC would still produce more crude than in 2015 — a year when crude prices were in freefall.

Of course, that’s old news. A newer development is rising US crude production. It’s moving towards all-time highs, thanks to OPEC’s manipulation.

US crude output has jumped 8.3% to 9.11 million barrels per day (bpd) since August. That’s close to the 9.7 million bpd record hit in April 2015 — the highest since May 1971.

As Reuters reported yesterday: ‘We now forecast U.S. crude oil production to reach a multi-decade high by December, within sights of the all-time high reached in 1970,’ Barclays told clients.

The forecast shouldn’t be a surprise to Markets & Money readers. As I wrote to you on 15 March, ‘all signs point to crude prices sliding.

The only story that matters for crude

Investing.com reported last Friday (my emphasis added):

U.S. shale producers are drilling at the highest rate in 18 months but have left a record number of wells unfinished in the largest oilfield in the country — a sign that output may not rise as swiftly as drilling activity would indicate.

Rising U.S. shale output has rattled OPEC’s most influential exporter Saudi Arabia and pushed oil prices to a near four-month low on Wednesday. U.S. production gains are frustrating Saudi-led attempts by the world’s top oil exporters to cut supply, drain record-high inventories and lift prices.

Investors watch data on the number of rigs deployed in North American oil and gas fields as a leading indicator for output. But the rising rig count and frenetic drilling activity in the Permian Basin in West Texas is not all about pumping oil.

During the 2014-2016 downturn in global oil prices, the number of wells left incomplete grew as companies shut down rigs, laid off workers and retreated from the fields. When prices picked up, operators were expected to pump the oil from those incomplete wells before spending money on drilling new ones.

Indeed, the US oil rig count indicates that more production is on the way. It has increased 34 times in the past 37 weeks. Baker Hughes said the rig count jumped by 21 to reach 652 last week.

That’s the highest level since September 2015.

The US crude oil rig count peaked at 1,609 in October 2014. Take a look at the rig count on the chart below:


Source: Reuters Graphics
[Click to open in a new window]

Interestingly, while there are more oil rigs coming online, the production surge has been less than expected. That may sound contradictory. But the number of incomplete wells has also risen. In other words, oil companies are drilling more shale wells but not producing them…yet.

To complete a well, shale producers need to ‘frack’ it. That involves pumping the hole with sand, water and chemicals at high pressure until the rock fractures and releases the oil.

There is typically a lag of a few months between drilling and completion. That means some wells could be ‘fracked’ in the coming months.

The truth behind crude oil

Digging deeper into the matter I spoke with a number of industry oil executives. They all told me they aren’t surprised about the lack of completions. When oil prices slumped in 2014/15, companies ‘laid-off’ a lot of specialist workers who have now moved onto other jobs. My contacts tell me that there’s a shortage of skilled labour in the US oil and gas sector…and people are reluctant to come back due to the cyclicality.

A record 1,764 wells were left unfinished in the Permian Basin last month — the largest US oil patch.

This is shown on the chart below:


Source: Reuters Graphics
[Click to open in a new window]

In February, 395 wells were drilled and only 300 completed. That was the highest drilling rate in the Permian in two years. If that completion rate continues, I believe that crude oil production will rise regardless of any lack in hiring.

Remember, there’s more to this story than hiring. Technology is also a factor that must be considered. According to Norway-based industry consultant Rystad Energy, the well-head break-even costs for US shale plays declined 46% between 2014 and 2016.

Although some of the drop is due to lower costs, such as hiring for drilling rigs, steel pipes and other kit, most is due to efficiency and re-engineering. As technology and engineering processes improve, the breakeven price will continue to fall for US shale players. That means companies are likely to drill and complete more wells.

The bottom line: expect more US oil production in the months ahead. That should eventually drive down the price of oil as low as US$42 per barrel — a major technical support level.

Regards,

Jason Stevenson,
Editor, Markets & Money

PS: Although the oil and gas sector doesn’t look good, another energy sector does — lithium. I’ve tipped two lithium stocks that are drilling for ‘white gold’ in the weeks ahead. These plays are dirt cheap and located in strategic locations. If they tap the mother lode, their share prices could skyrocket. For details, go here.


Jason Stevenson is Markets & Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options. He originally studied accounting and finance at Curtin University, where he was awarded a first-class honours degree. His professional background stems across high-net-worth, top tier accounting (corporate finance, tax and auditing), and sell-side equities research. Before joining the team at Markets and Money, Jason worked at boutique firms which advised fund managers and high-net-worth clients on where to invest. Whether it’s gold, crude oil, copper or an obscure metal like vanadium, you can rely on an in-depth analysis in Markets and Money. Jason also brings you extensive macro, political and geopolitical analysis from around the world. He leaves no stone unturned when it comes to telling the truth. Jason is also the lead analyst of Gold Stock Trader, a premium service for investors serious about precious metal stocks. Websites and financial e-letters Jason writes for:


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