U.S. shale drillers are bringing back shut in production three months after the onset of the current downturn. But steep decline rates will increasingly take hold, dragging down overall U.S. output later this year. With oil prices approaching $40 per barrel, many drillers are covering immediate operational costs. Rystad Energy estimates that “a bit more than 300,000 bpd” of shut in U.S. oil production has come back online.
A total of 1.15 million barrels per day (mb/d) was shut in in April and May, and that output will “return swiftly over July and August,” JBC Energy wrote in a note.
But that doesn’t mean U.S. oil production will rebound in a V-shaped fashion. “$40 is a blessing in disguise. Nobody’s going to add rigs, nobody’s going to add fleets at $40 oil,” Scott Sheffield of Pioneer Natural Resources told Bloomberg. “I’m trying to convince OPEC members that our industry has changed. It’s all about less growth, it’s all about returning cash back to the shareholders.”
The return of shut in production is different from returning to drilling new wells. “I see no change at $40. We need to get up to $45 to $50 before you see people start adding rigs and add frack fleets,” Sheffield added. “Most companies have too much leverage,” and they are going to “use cash flow to repair balance sheets because the equity markets are closed. So, there’s not going to be a rush back to adding activity at all in my opinion,” he said.
Because shale wells decline precipitously, overall U.S. production will continue to decline, despite a temporary jolt from the return of shuttered wells. Sheffield puts shale decline rates at an average of between 35 and 40 percent per year without investment. A lot of drillers will try to keep output flat this year, or minimize decline. He estimates that U.S. oil production will be down below 11 mb/d by the end of 2021 because of declines.
Other analysts have similar outlooks. “[B]y September, the natural declines from shale wells will have accumulated to almost 2 million b/d, keeping US supply suppressed until mid-2021,” JBC said. Goldman Sachs says the oil market’s outlook in 2021 is “broadly bullish,” due to “a more conservative outlook for Permian rampup.” After analysts with the investment bank met with six large Permian producers, the bank said that one of its key takeaways was that oil executives were serious about prioritizing cash flow and reducing leverage over the return to double-digit production growth. “Producers broadly characterized teens production growth as more an upside case than a base case,” Goldman analysts wrote in a note. The executives, Goldman says, are not expecting oil prices to rise into the $50s in 2021, instead predicting oil to remain in the $40s.
Oil remaining stuck in the $40s comports with the objectives of OPEC+, which hopes to keep a lid on a shale rebound. “The plan is to stick to prices of $40-$50 per barrel because as soon as they rise any further to say $70 per barrel it encourages too much oil production, including U.S. shale,” a Russian source familiar with OPEC+ talks told Reuters.
The OPEC+ agreement and the short-term extension has rescued oil markets, and it may even lead to a supply/demand deficit in the second half of 2020. “As long as the demand recover stays intact, we believe the crude market will be in deficit also in August and onwards, despite cuts being tapered by 2 million bpd to the scheduled 7.7 million bpd level,” Rystad Energy’s Head of Oil Markets, Bjornar Tonhaugen, said in a statement. Rystad sees a stronger shale response from the deficit, with higher prices “spurring a quicker reactivation of curtailed US oil production, and eventually frac crews ending their holidays early.”
But the market will not go back to pre-pandemic conditions for years. In addition to the mountain of inventories that need to be worked off, U.S. shale has a wall of debt coming due. On top of that, while demand is on the upswing, it could flatten out well short of pre-pandemic levels.
Pioneer’s Scott Sheffield said that the quick rebound of demand to around 94-95 mb/d following the “reopening” of so many economies will give way to stagnation for a few years until a coronavirus vaccine can be widely distributed. He predicts that oil demand won’t rebound to pre-pandemic levels of around 100 mb/d until 2022 or 2023.