The Fuse

Shale Forecasts Run the Gamut

by Nick Cunningham | December 10, 2019

OPEC+ cut production by an additional 500,000 barrels per day (b/d) last week, hoping to eliminate the brewing surplus in the market.

However, the whole notion that there is going to be a big glut in supply in 2020 is predicated on ongoing production gains from U.S. shale. But there is disagreement from market analysts over how fast U.S. shale will continue to grow, which is to say, there is no consensus on how large the global surplus will be.

By a variety of metrics, the U.S. shale complex is slowing

Drilling slowdown
By a variety of metrics, the U.S. shale complex is slowing. Weighed down by huge levels of debt, and plagued by an ongoing inability to produce positive cash flow, investors have begun to spurn the industry. With capital markets closed to indebted drillers, the only response is to slash spending and pare back drilling plans.

The U.S. rig count fell to 799 for the week ending on December 6 (663 oil rigs and 133 for gas), down more than 20 percent from 1,082 at a recent peak a year ago. A survey of shale E&Ps by Cowen & Co. shows that they are on track to spend $4 billion less in 2019 than they did in 2018, and could cut spending by another 13 percent in 2020.

Investment bank Standard Chartered pointed out that the industry might need higher prices than it used to because investors are more tightfisted. “It is hard to escape the conclusion that the relationship between oil drilling and prices has moved higher over the past two years,” Standard Chartered wrote in a note. “In 2017 USD 50/bbl was enough to allow rig counts to track upwards, while in 2019 USD 57/bbl does not appear enough to put a brake on the year-long decline.”

The financial stress within the U.S. shale industry aids OPEC+’s effort in balancing the market. “We believe the sharp and visible drop in energy capex gives OPEC+ confidence that it can continue to manage oil surpluses in 2020 despite the large expected surge in non-OPEC production next year,” Goldman Sachs wrote in a note in November before the OPEC+ meeting.

Even industry insiders agreed. “I don’t think OPEC has to worry that much more about U.S. shale growth long-term,” Scott Sheffield, CEO of Pioneer Natural Resources, said during the company’s third quarter earnings call.

It’s not clear that drillers in North Dakota and Texas will see a dramatic change in their fortunes.

A wide range of forecasts
The logic may work the other way too – the OPEC+ cuts could boost prices by taking more oil off of the market, a welcome development for struggling shale drillers, should it occur. But prices only rose modestly after last week’s surprise deal, and it’s not clear that drillers in North Dakota and Texas will see a dramatic change in their fortunes.

The slight upgrade in the pricing forecast from Goldman Sachs following the OPEC+ deal “does not lead us to raise our 2020 U.S. shale production growth forecast which remains at 600 kb/d,” the bank said. “Poor financial performance, excess leverage and an increased focus on emissions have pushed the cost of capital of shale oil producers sharply higher, with this pressure no longer delivered by oil prices but by equity and debt markets.”

Against that backdrop, the investment bank said that it expects “shale restraint to persist even at moderately higher prices given it will take years to clean up the debt, capacity and emissions excesses.”

Wood Mackenzie largely agrees on the growth figure, estimating that U.S. shale adds 610,000 b/d in 2020, half of the 1.23 Mb/d added in 2019. WoodMac also singled out lack of access to capital as a pivotal factor in the slowdown. In addition, however, there are drilling problems affecting the industry. “The remarkable gains in productivity that have characterized the U.S. shale oil industry for most of its short history appear now to be coming to an end,” Ed Crooks, Vice-Chair for Americas at WoodMac, wrote in a commentary. “Output per foot of well has been stagnating for a while.”

Meanwhile, IHS Markit is even more downbeat, estimating shale growth of only 440,000 b/d in 2020.

However, other analysts see the industry ploughing forward with strong growth. The EIA sees production growth of 0.9 Mb/d, which is now at the optimistic end of the spectrum. Crucially, the EIA seems to wave away some of the operational problems that have cropped up in the past year. “Despite the decline in rigs, EIA forecasts production will continue to grow as rig efficiency and well-level productivity rises, offsetting the decline in the number of rigs,” the agency said in its latest Short-Term Energy Outlook.

Rystad Energy largely agrees with that assessment. The Oslo-based firm says that both U.S. oil production growth and gains from a handful of other non-OPEC countries will add huge volumes of new supply in 2020. Non-OPEC will grow by roughly 2.26 Mb/d next year, creating a “headache” for OPEC. Rystad sees the U.S. adding 1 Mb/d, with other substantial supply increases coming from Norway (+0.527 Mb/d), Brazil (+0.459 Mb/d) and Canada (+0.244 Mb/d).

“The record high production growth from non-OPEC tight oil and offshore puts significant pressure on OPEC’s ability to balance the oil market in 2020. Rystad Energy believes that OPEC will need to extend and deepen production cuts if they have any hope of supporting the oil price in the near-term,” Espen Erlingsen, head of upstream research at Rystad Energy, said in a December 4 statement on the eve of the OPEC+ meeting.

Rystad says that U.S. shale will continue to grow even with low prices. “In spite of the decline in spending and activity levels, the North American shale supply is not following the downward trend,” Sonia Mladá Passos, a product manager of Rystad Energy’s Shale Upstream Analysis team, said in a separate report. In fact, Rystad says U.S. shale will continue to grow well into the early 2020s, and it will take WTI averaging as low as $45 per barrel in order for the industry to flatten out.

Overall, then, the forecasts range from a meager few hundred thousand barrels per day of supply growth up to as much as 1 Mb/d. If shale optimists are closer to the mark, OPEC+ may struggle to balance the market. But if the shale industry slows down more dramatically, the market may turn out to be tighter than many expect.