How The Price War Is Hurting U.S. Tight Oil
How much will US Lower 48 liquids supply fall in response to low prices? The question keeps coming to us from all around the world. Cutting the legs from under tight oil became a goal of the price war after the March OPEC+ meeting fell apart. Linda Htein and Ryan Duman (US Lower 48 analysis) and John Coleman (crude supply and infrastructure) explained how it’s playing out.
First, the rig count is plummeting. Active rigs were stable early in 2020, operators diligently balancing spend with the positive cash flow generation expected by shareholders. All that changed the instant the oil price collapsed. Budgets were reset, with some E&Ps cutting spend by 50% or more for the rest of 2020.
Rigs were dropped almost immediately, and it’s snowballed ever since. In early March, 707 horizontal rigs were working across the Lower 48; by mid-May the count had fallen to 307, with 120 dropped in the last three weeks. Even with the oil price now recovering, there’s no sign of a bottoming out.
Second, supply has fallen quickly. US Lower 48 production is among the most price-elastic in the global supply stack, whether mature conventional with high short-run marginal cost or tight oil requiring continuous investment to maintain volumes.
Production reached a high of 10.4 million b/d in March 2020 on the back of a three-year tight oil boom. Tight oil volumes doubled over the period to 8.5 million b/d, driven by the development of the vast Permian Wolfcamp resource. The March Permian high of 4.7 million b/d might be a record that lasts for some time.
Our colleagues at Genscape reckon 1.2 million b/d of US Lower 48 volumes are shut-in today; and in a worst-case scenario shut-ins could max-out at 2 million b/d. Wood Mackenzie’s Oil Supply team estimates monthly production will fall by 1.4 million b/d by June, taking total volumes to a low point of 8.9 million b/d. The drop includes shut-ins, frac holidays and natural declines in equal proportion.
Third, whether June is the production low depends on price. Brent doubling to US$35/bbl points to a market in the early stages of rebalancing. Oil demand should recover progressively in the coming months as lockdowns ease, and we expect Brent to reach US$40/bbl through Q4 2020.
That’s enough to lift many shut-ins back above short-run marginal cost; and re-opening wells could push US Lower 48 production back up to 9.3 million b/d during Q3. But prices need a more lasting recovery to get oil rigs working again.
Fourth, it’s clear that the US Lower 48 will never meet the most bullish end of production forecasts of recent years. There is resource with low half-cycle breakevens, but few investors will support the addition of rigs below US$40/bbl. Brent stable at US$50/bbl (WTI US$47/bbl) – our Macro Oils team forecast for 2021 – is needed to generate even modest growth.
Only a handful of better financed companies, including the Majors, are in a position to grow production over the next year or two. Even this elite group will focus investment on the best of their inventory, drilling only the most economically robust wells.
We still expect growth, but from that lower base of 8.9 million b/d; and at a gentler pace. Our sense is that US Lower 48 production could be 15% to 20% below our previous forecasts of 12.8 million b/d in the mid-2020s (November 2019 Macro Oils Long Term Outlook). We will revise these numbers in detail in the next few weeks.
The Majors today account for around one-fifth of tight oil volumes. Chevron CVX and ExxonMobil XOM will deliver nearly all of the growth coming out of the trough, with Shell, BP and a handful of E&Ps also contributing. That means for the majority of US Lower 48 operators, future strategy will be about managing decline and harvesting cash flow.
Fifth, the drop in Permian volumes is more bad news for pipeline owners. A major build-out programme will lift takeaway capacity from the Permian to the US Gulf Coast to 7 million b/d by the end of this year. Production peaked at 4.7 million b/d in March, and pipeline utilisation looks set to fall to below 60% in 2021. There’s going to be a lot of spare pipe capacity for the foreseeable future.
Source: Wood Mackenzie