We’re witnessing the slow death of US shale oil production.
Shale oil producers have long been seen as the most vulnerable group in the oil crash, but have proven far more resilient than markets expected.
And in the last 18 months oil prices have crashed about 70% while US-based production in 2014 led the global oil market.
But with oil prices this low, the burden of balancing the oversupply problem lies with the weakest link, which Pantheon Macroeconomics’ Ian Shepherdson believes is US-based shale producers.
In a note to clients Tuesday, Shepherdson wrote (emphasis ours):
The required recalibration of global oil output, to bring down inventories and put a sustainable floor under prices, is going to fall on the least powerful, financially vulnerable private sector producers. The major multinationals won’t take the hit, given their strong balance sheets and huge economies of scale. Instead, a disproportionate share of the necessary global production cuts will fall on the over-leveraged producers of U.S. shale, where output is now beginning to drop, finally.
Throughout the oil crash that has been blamed on a glut of global supply, US shale oil has been seen as the “swing producer”: turn off the US shale taps and the market would be brought into balance with prices rebounding; keep pumping oil, prices stay low.
Now, every oil producer has felt some pain, whether it’s the Russian or Saudi economy or a public US company cutting dividends. But unlike many of the world’s largest oil producers such as OPEC’s members and non-OPEC nationalized giants, shale producers are private and operate without government backing.
And in Shepherdson’s view, this means they will be the first “blink” in what has long been seen as a stand-off between US shale production and nationalized incumbent production from the likes of OPEC.
Two weeks ago, US shale output fell year-on-year for the first time in four-and-a-half years, which to Shepherdson begins the slow march towards a major decline for the shale industry.
Shepherdson again (again, our emphasis):
In the week ended February 5, production slipped below its year-ago level for the first time in four-and- a-half years. When oil prices were at their peak, production was rising by about 15% per year, and double-digit growth was sustained until August last year. We don’t know how far U.S. shale production will now fall. But with U.S. crude oil inventories standing at about 60 days of consumption, nearly 20% above their long-term average, the outlook is bleak. The picture has been made worse by the ending of sanctions on Iran, which the government says will result in production rising by an incremental one millions barrels per day over the next two years. That’s new supply equivalent to more than a quarter of the rise in shale output in the past three years alone. We can’t avoid the conclusion that U.S. shale production is going to have to drop a long way.
News Tuesday of a Saudi-led production freeze is unlikely to have the desired effect of boosting prices, according to analysts.
Additionally, this announcement will also not sit well with Iran, which is just gearing up to boost its exports now that sanctions are lifted.
As a result, oil prices are likely to remain low, keeping the pressure on US shale producers and, in turn, US shale production.
As for the impact of shale oil production on the US economy, Shepherdson notes that oil capex has already fallen 51% from its peak in the fourth quarter of 2014, meaning it cannot fall much further unless the entire industry packs up, which is unlikely.
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