Welcome to recovery

Feb. 19, 2018
Welcome to your oil-market recovery. Enjoy it while it lasts.

Welcome to your oil-market recovery. Enjoy it while it lasts.

Production is surging in countries that haven't agreed to restrain supply, especially the US. If global supply grows faster than demand, the crude price will weaken again. But other forces are in play. What's certain is that anyone hoping for a long and steady recovery, like those of the good old days, will be disappointed.

Firm against threat

Officials of the Organization of Petroleum Exporting Countries knew they faced new competition when they persuaded 12 member-countries and 10 nonmembers to restrain production, beginning a year ago January. So far, they have stood firm against the threat. Durability and compliance with the agreement have been remarkable. And the pact has endured extra pressure from dangerously high tension between OPEC members, especially Saudi Arabia and Iran. In response, industrial-world oil inventories, price-crushingly high in 2016, have returned to normal levels.

Until recently, though, new competition was mainly a threat, something for OPEC and its collaborators to account for in planning. Now it's fast becoming incremental oil supply. Slammed by the crude-price slump, non-OPEC supply spent 2016 below year-earlier levels and most of last year reclaiming the lost ground. This year, the International Energy Agency, US Energy Information Administration, and OPEC all project large increases in average non-OPEC supply: IEA, 1.77 million b/d; EIA, 2.35 million b/d; and OPEC, 1.4 million b/d. The increases by IEA and EIA exceed those agencies' projections of demand growth.

Pacing supply gains, which accelerated last quarter, is the US, where output from shale and tight-oil plays is zooming. A year barely under way is demonstrating the quick supply response of continuous reservoirs.

The EIA expects average US crude production to break the 1970 record this year at 10.6 million b/d. It expects output in 2019 to average 11.2 million b/d. Most of this is from tight-oil plays, where supply can change fast with crude prices. The front-month futures price in New York started its recovery from a low point of $28.15/bbl the week of February 12, 2016. The US oil-rig count began recovering after May 2016, when it averaged 320. The oil-production recovery began after bottoming at an average 8.553 million b/d the following September.

So how far can tight-oil production rise? The answer won't come until production falls before, instead of after, a downturn in the crude price. Geologic constraints apply even to unconventional reservoirs. Sweet spots have limits. Depletion happens. Oil-field costs rise.

But tight-oil supply is a function of what producers know about reservoirs and what contractors know about drilling and completing wells in them. That knowledge has grown impressively. Well designs and fracture strategies have changed greatly in just 10 years. Well performance and economics have improved greatly as a result. And producers and contractors increasingly leverage what they know and how they work with sophisticated analytics. As knowledge, amplified this way, grows, supply rises. Because much remains for operators to learn about unconventional reservoirs and completion methods, the potential is astounding.

Joining rapid-response supply from tight-oil plays, moreover, is a reviving offshore industry. New offshore projects were scarce in 2015-16. That's starting to change. Announcements of final investment decisions on offshore projects are appearing with growing frequency. The industry remains cautious. Projects lack the grand scales they attained before the crude price crash of 2014. But offshore economics have improved. Rystad Energy recently reported that unit capital development costs for offshore projects have fallen below those for North American shale drilling and completion, which are rising.

Intensifying competition

For countries limiting supply, this all means new, unmoderated supply and intensifying competition. Pressure will ease if demand exceeds expectations or supply falls because of disruption from something like economic distress in Venezuela or renewed militancy in Nigeria. Otherwise, the market will respond with lower crude prices. It already seems to be doing so.

But no one should panic. The market swings quickly nowadays. Ask OPEC.