U.S. Shale Oil to Grow?
US Shale Production To Soar By 3.5 Million Barrels/Day Over Next Five Years: BofA Explains Why
Two years ago, when Saudi Arabia launched on an unprecedented campaign to crush high-cost oil producers, in the process effectively putting an end to the OPEC cartel (at least until last year’s attempt to cut production), it made a bold bet that US shale producers would be swept under when the price of oil tumbled, leading to a tsunami of bankruptcies, as well as investment and production halts. To an extent it succeeded, but where it may have made a glaring error is the core assumption about shale breakeven costs, which as we reported throughout 2016, were substantially lower than consensus estimated.
In his latest note, BofA’s Francisco Blanch explains not only why a drop in shale breakevens costs is what is currently the biggest wildcard in the global race to reach production “equilibrium”, but also why US shale oil production could surge in the coming years, prompting OPEC to boost production in hopes of recapturing market share. Specifically, Blanch predicts that US shale oil production could grow by a whopping 3.5 million barrels per day over the next five years.
Here’s why: as he explains “many oil companies around the world have survived the price meltdown by bringing down breakeven costs in the last two years.
But what parts of the world can grow output in the years ahead? In BofA’s view, US shale oil producers will come out ahead and deliver outsized market share gains by 2022. Shale oil output in the US may grow sequentially by 600 thousand b/d from 4Q16 to 4Q17 on increased activity in oil rigs and fast productivity gains. Importantly, breakeven costs for key major US plays now stand around the $55/bbl mark.
As crude oil prices recover further, cost reflation may partly offset reduced costs linked to less regulation. So assuming a gradual recovery in oil prices into a long-term average of $60 to $70/bbl, BofA projects average annual US shale oil growth of 700 thousand b/d in 2017-22, or roughly 3.5 million bpd over the next 5 years.
Shale production could rise even more if prevailing oil prices are higher than $55/barrel. Here is BofA’s sensitivity analysis:
We estimate that US shale production will decline annually by 270 thousand b/d, on average, until 2022 in a $40/bbl WTI environment. At $50/bbl, growth returns, though only at a small average of 240 thousand b/d. Should WTI trade at $60 for the next five years, growth reaches 700 thousand b/d, and at $70/bbl it reaches 950 thousand b/d (Chart 15). It goes without saying that the level of US shale output in 2022 will highly depend on the average price of WTI in the next five years (Chart 16).
It’s not just the US however: in addition to US shale, BofA sees incremental growth in Brazil, Russia, Kazakhstan and Canada over the next five years, driven by giant projects in the Lula, Kashagan or Johan Sverdrup fields. However, many of the gains in supply from non-OPEC non-shale producers will come on the back of investments dating to before the collapse in global oil prices. Meanwhile, countries such as Mexico and the UK will keep facing output declines. All in, BofA projects non-OPEC output to reach 61.7 million b/d by 2022. This equates to 830 thousand b/d of annual average growth in the next five years, or around the 20-year average of 790 thousand b/d (Chart 3).
Put differently, Blanch sees 84% of the incremental non-OPEC supply gains coming from US shale, as production in many parts of the world either stagnates or declines outright (Chart 4).
Which brings us back to square one, and specifically the migraine-causing dilemma faced by OPEC, which Saudi Arabia had hoped to eliminate in 2014: volume or price?
With non-OPEC poised to grow again, OPEC will need to increase oil output by just 2.2 million b/d to meet global incremental oil demand of about 5.5 million b/d over the 2017-22 period, according to BofA calculations. So about 1/3 of global oil supply growth will come from OPEC in 2017-22 (Chart 5). In this context, Blanch believes that Saudi, Iraq and the UAE are the only countries able to increase their output in the medium term, while Algeria, Nigeria or Venezuela would need massive investments to reverse current trends and boost output.
This may be true, unless of course just like US shale, production breakeven costs are sliding across the world. Furthermore the actions of such giant “vendor-financing” providers as China (seen best in the case of Venezuela, where China continues to provide Caracas with much needed funds in exchange for far below market oil deliveries) remain unpredictable, and may afford these non-core OPEC nations just the funds they need to also steal market share from Saudi, Iraq and UAE.
According to BofA, while OPEC countries have the resources to grow production, its previous work shows that OPEC revenue would likely be higher if no additional investments are made compared to scenarios where increased OPEC production leads to lower prices (Chart 6).
For this reason, Francisco Blanch says he expects limited OPEC oil output growth over the next 5 years.
We, however, disagree, especially following today’s news that Russia overtook Saudi Arabia as the world’s largest crude producer in December, when both countries started restricting supplies ahead of agreed cuts with other global producers to curb the worst glut in decades.
As Bloomberg reported earlier, Russia pumped 10.49 million barrels a day in December, down 29,000 barrels a day from November, while Saudi Arabia’s output declined to 10.46 million barrels a day from 10.72 million barrels a day in November, according to data published Monday on the website of the Joint Organisations Data Initiative in Riyadh. That was the first time Russia beat Saudi Arabia since March. Iraq came in fourth at 4.5 million barrels a day, followed by China at 3.98 million barrels a day, the data show. The US, which has emerged as the oil swing producer, was the third-largest producer, at 8.8 million barrels a day in December compared with 8.9 million barrels a day in November, according to JODI.
It is unlikely that if BofA is right and US shale manages to boost oil output by 3.5 million bpd – or more, if oil prices rise further – over the next five years, potentially surpassing Saudi Arabia should the kingdom’s production remain stagnant, that Riyadh will sit and watch as not only Russia but the US threatens its standing as the world’s biggest producer of crude.
Whether this is accurate will be revealed over the coming months based on what happens to the record level of crude inventories currently in the US. Should the much anticipated “rebalancing” fail as excess demand fails to materialize, the oil-rich kingdom may have no choice but to once again try to put marginal producers out of business but breaking up the OPEC cartel and replaying the post-2014 episode once again, sending crude prices in freefall.