What’s interesting now?

What’s interesting now?

Alexander Sobko

On Thursday, at a regular meeting, representatives of the OPEC + member countries decided to keep the plan to increase oil production for June in the amount of 432,000 barrels per day. These are plan-ned volumes as part of a gradual return to normal after coronavirus restrict-ions. But taking into acc-ount the fact that Russian production is now somewhat reduced due to known circumstances, and not all other participants can boast of a quick exit to the planned volumes, the decision actually fixes the continuing deficit in the oil market.
In these circumstances, there is increased attention to the US shale mining sector, where, in theory, it is possible to increase volumes relatively quickly by the same one or two million barrels per day falling due to Russian export problems.
But with slate, everything is not easy.
Brief background. In mid-March 2020, the United States was producing a record 13 million barrels per day, and the number of oil drilling rigs was 683 units. Recall that since the productivity of shale wells is rapidly declining, new drilling is needed all the time. Therefore, the number of operating drilling rigs is, although crude, an indicator that correlates with the volume of oil production. Why rude, we will discuss below.
Shortly after the lockdowns and the fall in demand for oil, the number of drilling rigs was reduced by four times, but American production fell by only two to two and a half million barrels per day, that is, less than 20 percent. There is an effect of inertia, after all, even if you just stop drilling, production will begin to decline very gradually. But the main thing is that the remaining working drilling rigs were redirected to the best, highly productive areas. After all, oil was then cheap, up to negative prices, so it became justified to work only in areas with a minimum production cost.
Further developments are known – OPEC + deal, a gradual recovery in demand, and with it the increase in production, which is still going on. Behind the scenes, American shale players have also joined OPEC+. And because the volume of actual production cuts happened to be the same as that of OPEC+. But the main thing is that they did not take advantage of the price recovery, but limited themselves in new drilling. And at the same time, against the background of good incomes and high oil prices, they began to pay off debts and return money to shareholders. Gradually, the volume of production increased in the United States, as well as the number of drilling rigs. Now, 80 percent of drilling rigs are operating in the country compared to the dock level. And production recovered to 11.9 million barrels per day, but this is one million less than before the coronavirus pandemic. Along with the increase in volumes, not only the best areas are already being drilled, but also areas with worse productivity.
What’s interesting now?
Despite extremely high oil prices, shale production cannot or does not even want to reach pre-crisis levels. On the one hand, the above-described logic of the American shale companies to maximize their own income remains. But on the other hand, there is a political demand for additional volumes of supplies, and oil prices are now still very comfortable for producers. Of course, this request is short-term, as in the long term, the Democratic admi-nistration traditionally wa-nts to replace oil and gas w-ith renewable sources. But shale production is also fle-xible enough to quickly ea-rn extra money here and now. However, there are also objective difficulties in increasing volumes. Shale miners complain about the lack of everything – from labor to materials and equipment. To a large ex-tent, the shortfall was a re-flection of the pandemic a-nd the previous curtailment of work earlier. Recall that the number of operating drilling rigs initially “has formed” four times. All this, firstly, increases the cost of drilling new wells. Secondly, it increases the time of work. In addition, the materials needed for drilling have become very expensive in and of themselves, which is associated with a general increase in prices for many basic products. For example, in recent years, steel has increased in price by 40 percent, and hence pipes for wells. The cost of renting a drilling rig has also almost doubled. According to the estimatesFor some companies, new wells are already 35 percent more expensive than they were even as recently as last December.
As a result, a slight increase in production is still expected by the end of the year – up to 12.6 million barrels per day, but this is still 0.4 million less even compared to pre-Covid values. The head of one of the shale companies, Pioneer Natural Resources, is also skeptical : the forecasts of the US Department of Energy for production growth are too optimistic, the increase in production will be less than expected.
Finally, one more factor. These are the so-called DUCs (drilled but uncompleted), unfinished wells. What it is? The well is being drilled, but its completion, that is, hydraulic fracturing, after which production is possible, is postponed until later. Almost from the very beginning of active shale production, the number of such uncompleted wells has been growing, for various reasons, companies have preferred to make such a reserve. And they accumulated several thousand. But since the summer of 2020, everything has changed: unfinished wells, which had been accumulating for five years, began to be actively spent, that is, hydraulic fracturing is carried out – and production begins from them.
This means that if earlier, when we looked at the number of operating drilling rigs, we understood that some of them were working “in reserve”, now the opposite is true. Accordingly, the current work of drilling rigs does not take into account this increase, that is, without this reserve, and it may end somewhere in a year, with the same drilling volumes, production would be lower.
All this abundance of aspects once again emphasizes that shale is the most difficult sector of oil production in forecasting. However, for now, as can be seen from the above, direct market participants have a consensus: production will grow, but due to difficulties, at a very low pace, which in theory could be much higher, given the current geopolitical and price situation.
For the sake of objectivity, one cannot but say that this whole alignment does not guarantee high oil pr-ices, although such a scenario remains the base one. The risks are known – and they are on the demand side. While the destruction of demand due to the price of oil is believed to start cl-oser to $200 a barrel, there is also the risk of a general recession in the economy, which in itself could reduce global demand and prices. Another risk factor is the new coronavirus restrictions in China, which are already reducing that country’s oil consumption.
One way or another, the cost of shale oil production has increased markedly, and it seems to be about tens of percent. Of course, the increase in drilling costs can be compensated by the transfer of production to more productive areas, but they are not endless. The question is whether the current cost spike will be reversible at all—and if so, to what extent. And the question is important, because in the long run, it is the cost of shale oil as one of the last suppliers in the oil market that determines the global price for this energy carrier.

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