Should Oil Markets Brace for A U.S. Shale Comeback?

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By Tsvetana Paraskova

The 2020 crisis put an abrupt end to the growth in U.S. crude oil production, which had just hit 13 million barrels per day (bpd) before oil prices and demand collapsed with the spread of the pandemic.   Between March and May 2020, U.S. oil production plunged by over 2.5 million bpd as companies slashed spending on drilling and curtailed output in response to the low oil prices. In May, U.S. oil production hit 10 million bpd—its lowest monthly level since late 2017.

After the trough in May, oil output in the United States has been gradually growing as producers restore curtailed volumes and oil prices recover part of the losses from earlier in 2020, due to encouraging news about vaccines, which gave the market hopes that the long-awaited oil demand recovery was finally in sight.

EIA estimates point to U.S. oil production staying at around 11 million bpd for at least another year, as production rates from existing wells in the U.S. shale patch will fall faster than production gains from fewer newly drilled wells.

But some analysts say that the market has been too quick to write off U.S. shale again, and will be surprised by the rebound in American oil production in 2021.

Some even suggest that the U.S. shale patch and the EIA are deliberately painting a gloomier picture than reality in order to ‘fool’ the OPEC+ alliance to continue withholding large volumes from the market and sustain oil prices at levels around $50 a barrel that would help U.S. production to jump this year.

According to energy economist Philip K. Verleger, the EIA is under-reporting U.S. crude oil production in recent months, thus helping the narrative of some U.S. oil executives—such as Pioneer Resources’ chief executive Scott Sheffield—that American production will only see modest gains this year and next.

Verleger’s energy consultancy PKVerleger estimates that U.S. oil production was 12.4 million bpd at the end of November, while the EIA has estimated it at 11 million bpd.

“One might say EIA officials are deliberately underestimating the rise in US production to boost prices and facilitate hedging by US producers, thereby helping to strengthen and perpetuate the industry,” PKVerleger said in the ‘Fracking Comeback’ note in early December.

“Oil-exporting countries have been fooled. Their agreement to limit output increases to support oil prices has laid the foundation for a renewed boost in US production. Once again, OPEC and other oil-exporting nations have wasted the gains of a price war,” the note says.

In its latest Short-Term Energy Outlook (STEO), the EIA sees U.S. crude oil production declining on an average annual basis from 12.2 million bpd in 2019 to 11.3 million bpd in 2020 and 11.1 million bpd in 2021. Rising drilling activity in response to higher oil prices is set to push monthly output to 11.4 million in December 2021, according to EIA estimates.  The outlook of the U.S. oil industry itself has considerably improved in recent months, the Dallas Fed Energy Survey for Q4 showed. The business activity index moved into positive territory, rising from -6.6 in Q3 to 18.5 in Q4. This was the first positive reading for the business activity index since the first quarter of 2019, with the increase driven by both E&P and oilfield services firms, according to the survey. Moreover, most E&P executives—72 percent—expect their firm will have access to capital from nonbank sources over the next 12 months.

“E&P and supplier consolidation needs to increase to reduce substantial costs from the system,” one E&P executive said in the Dallas Fed survey.

Pressured by plunging oil prices and the need to adjust to the lower oil demand, U.S. oil producers have slashed costs and managed to bring down their average breakeven costs over the past year by nearly 20 percent to $45 a barrel on average, BloombergNEF (BNEF) said in a report last month.

Declining costs could additionally help the U.S. shale rebound this year, Dan Eberhart, chief executive at privately held U.S. oilfield services company Canary, writes in Forbes.

“Don’t write off the great shale story just yet. The final chapter — maybe its best — is still being written,” Eberhart says.

Not everyone is so optimistic about U.S. shale, with bankruptcy filings still rising and consolidation deferring smaller-scale developments.

“It’s going to be hard for the shale development in the U.S. to get U.S. production back to 13 MMbd. Now, especially as consolidation occurs and as people really focus on full-cycle returns and net present value of their developments, the economics is going to drive a lot of decisions to not do these smaller-scale developments,” Occidental CEO Vicki Hollub told IHS Markit Vice Chairman Daniel Yergin in mid-November.

The worst for U.S. oil production is over. Still, the fate of the shale patch in 2021 and 2022 will depend on access to capital, cost reductions, and spending discipline, as much as it will hinge on global oil demand and the OPEC+ policies to support oil prices.

Crude Oil

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