By Nick Cunningham
Oil is back at $50 per barrel, restoring some semblance of confidence in the market. But that is just about as much as we can expect in terms of a rally, according to most analysts, with momentum likely to dissipate from here.
But not everyone agrees. Many are worried that oil prices will crash again next year as OPEC scrambles for an exit strategy, but there is actually a bullish case for oil that is not outlandish.
First, crude oil inventories continue to fall. The EIA just released another week’s worth of data, showing another drawdown in inventories. It was a bit more modest last week – 1.5 million barrels – compared to previous four weeks, but the drawdowns continue. U.S. crude oil inventories are now down more than 50 million barrels from the peak hit in March, with stocks back within the five-year range.
But a larger reason why oil prices could deviate from expectations and actually rise quite a bit is because the market is poetically assuming a lot more oil is set to come online than might actually be the case. As Andy Lipow, president of Lipow Oil Associates, notes in a CNBC column, the market has already factored in further production gains from Libya and Nigeria, a major reason why market pessimism really spread in the month of June. But because that assumption is baked into today’s price, if those two countries – beset with violence and instability – fail to come through, then a lot less oil will reach the market than is generally assumed.
Moreover, the U.S. could also disappoint. As discussed in previous articles, the shale drilling boom is starting to slow. A bottleneck of services is held back the completion of some wells, while many shale companies have actually started to throttle back on their spending and drilling activity. In the past few weeks, a list of companies have announced cuts to spending plans for this year, including Anadarko Petroleum, ConocoPhillips, Whiting Petroleum, Hess Corp., and Pioneer Natural Resources. Those five companies alone have slashed a combined $850 million in spending.
The cuts, coming in response to the recent dip of oil prices into the mid-$40s, will likely translate into much lower production next year. As a result, the projection from the EIA that shale will hit 10 million barrels per day (mb/d) in 2018, or even the more recent downward revision to just 9.9 mb/d, could be hard to reach.
However, there is one other important uncertainty that could point to higher oil prices in the near-term. Not only will future production come in lower than expected, but what if current production is actually lower than we think? What if we are overestimating the shale boom?
The market bases its expectations for U.S. oil on the EIA weekly production surveys, which have shown a steady climb in output right up through July. The most recent data for the week ending on July 28 pegs current U.S. oil production at 9.43 mb/d.
But the thing is, these weekly estimates are not always accurate, and are often subject to revisions – sometimes large revisions – later on. On the other hand, the EIA publishes more accurate monthly figures, but only on a several month lag. The most recent data is for May, which has U.S. oil production at 9.169 mb/d.
The problem is that there is quite a gap between these two sources, with the more recent but less accurate weekly figures reflecting much higher oil production.
For example, while the EIA is now pretty certain the U.S. averaged 9.169 mb/d in May, that wasn’t what they thought at the time. Back in May, the EIA published these weekly estimates:
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• May 5: 9.314 mb/d
• May 12: 9.305 mb/d
• May 19: 9.320 mb/d
• May 26: 9.342 mb/d
To take a rough average, that would put May’s monthly production at 9.32 mb/d. In other words, back in May, the EIA was telling everyone that the U.S. was producing 151,000 bpd more than it actually was. This is not to put the blame on the EIA – estimating production in essentially real-time is difficult – but only to say that we only get an accurate picture of what is going on by looking in the rear-view mirror.
Which brings us back to the present. The EIA is now estimating that the U.S. is producing 9.43 mb/d, a figure that has steadily climbed in the past few months. But that would mean that production accelerated very rapidly since May. In the chart below, notice the jump that would need to take place between the monthly figures through May, and the weekly figures up until now.
This is a long-winded way of saying that U.S. oil production could quite conceivably be much lower than 9.43 mb/d right now. In that context, the slowdown in the rig count and the cuts to spending look even more important. Not only will the U.S. fall short of the projections for the rest of this year and next, but it could miss by quite a lot. If that is the case, then oil prices suddenly do not look like they are necessarily trapped at $50 per barrel.
By Nick Cunningham of Oilprice.com