US crude oil production looks set to slow sharply over the coming months, and that should keep prices well supported in the second half of the year.
That’s the view of Daniel Hynes, senior commodity strategist at ANZ Bank, who points to a reduced number of active drilling rigs, along with the prospect of heightened financial stress in the energy sector, as two factors suggesting output will fall “significantly”.
“Active or new drill rigs in the US have fallen from 1,600 to 316 (in May), the lowest level since September 2009,” says Hynes.
He believes that “this is only just being translated into a fall in US oil production”, adding “we believe the rate of falls in weekly US oil production is about to accelerate as the impact of the falling rig count will be compounded by forced closures and low prices biting.”
The chart below, supplied by Hynes, does nothing to undermine this view, demonstrating the lag effect US output has on changes in new and active drilling rigs in production.
Although he admits efficiency levels have improved, the suggests the collapse in active drilling rigs is now more than offsetting an improvement in productivity, reducing output levels from those seen in mid-2016.
“To maintain production would require 439 rigs, compared to the 280 currently in operation,” says Hynes. “If that trend persists, production could fall below 8.5mb/d [million barrels per day] by July.”
Alongside the collapse in active drilling rigs, Hynes also suggests that financial stress in the sector could also exacerbate the decline in output levels.
“Increasing financial stress on North American producers will likely increase the downward pressure on oil production this year,” he says.
“The EIA’s latest energy outlook forecasts a decline in US crude oil production to 8.2bbl/d by October 2016 from 9.1 mb/d currently, then remaining at that level through 2017. This could prove conservative.
“”We expect the increasing indebtedness to magnify the losses, with US oil production forecast to fall to below 8mb/d in Q3 2016.”
Hynes estimates that non-investment grade firms accounting for around 1.3mb/d of US production have debt maturing over the next 12 months, adding to the risks of an even steeper decline in output levels.
Should this eventuate, it could lead to a sharp decline US crude inventories, says Hynes.
“All else being equal, a monthly decline in production of merely 0.1 bbl/d could see US stocks fall below 400 million barrels by the end of 2016. If the declines are as great as we suspect they will get, inventories could be as low as 380 million barrels,” he says.
This, in turn, will create upside risks for the West Texas Intermediate (WTI) price in the second half of the year.
“Given the sharp falls in production volumes over the past few months, we would expect to see downside risks to the EIA’s forecasts for US crude stocks, and therefore upside risk to WTI prices in 2016 when supply cuts start to be felt on stock levels.”
Over a three month time horizon, Hynes is forecasting a 3.6% gain in WTI prices, something that equates to a price of $50.70 per barrel based on current front-month futures pricing.
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