Oil markets bullish as US shale boom grinds to temporary halt

Focus article by Cuckoo James

LONDON (ICIS)–The latest news from oil markets seems to indicate that the US shale boom as we know it might be grinding to a temporary halt and transitioning to a new phase, leading to surges in the prices of Brent and WTI crude futures to their highest level in 2015. 

The US Energy Information Administration (EIA) released its April Drilling Productivity Report last week, forecasting a significant drop in total shale oil volumes in May, the first such forecast after the number of active US rigs began to fall sharply in the fourth quarter of 2014.

“We are starting to see the effect of the declining rig count coming into play,” said Carl Larry, director of oil and gas business development at Frost & Sullivan.

Output from seven key shale oil formations could drop by 57,000 barrels per day in May, the EIA said. This is the data oil markets have been looking out for, but the crucial point for traders is that it has come earlier than expected.

“Although a drop is not unexpected, a decline in May would still be a couple of months earlier than anticipated and could signal less drilled inventory than expected,” said John Corrigan, energy specialist and vice president at Strategy&, a PwC consultancy.

Crude oil prices rallied last week as traders mulled the possibility of a sooner-than-expected output cut, despite data from the International Energy Agency (IEA) announcing that in March rival OPEC recorded its highest monthly output increase in four years, and forecasting similar increases for April.

“Since we started seeing a decline [in active rig count], the shale areas have been surviving on EOR [enhanced oil recovery]. The innovation and technology in those EOR techniques have been saving a lot of oil producers money allowing them to continue to produce with lower oil prices,” Larry said.

The EIA report is the first sign the enhanced oil recovery could finally be coming to an end.

“The issue that has always been lurking in the background is that nobody really knew exactly when we would see the EOR hit a wall and stop producing at such a high rate. The first sign of this starting to make a difference is this EIA report,” Larry said.

Larry maintains this is not so much the end of the shale boom as an end of the EOR boom.

“We’re coming to what I think will be a “cliff”. We have been able to continue to extract oil at a high level from existing wells, but as fracking goes, all good things come to an end,” he said.

Production could come back up only under certain conditions: “If oil prices do return to above $70, we will see oil producers go back to less profitable wells that have been shut already and begin to return those to service.  If prices get above $85 at any time, that will give us enough of a cushion to bring new shale projects back on the board and we’re right back to the shale boom,” Larry said.

Corrigan prefers to see it as a transition to a second phase in the US shale oil phenomenon: “Phase one was abundant growth under the umbrella of high prices, an expected global shortage and a “peak oil” mentality that prevailed for the last 30 or so years.”

“Ultimately, shale is not dead,” Corrigan said although producers will be forced to respond to supply and demand balance for many years to come as surplus global crude struggles to find a home.

“While we do have line of sight to sufficient oil supplies until 2035 under most scenarios, shale is currently the marginal barrel. As a result, this sector will be forced to swing up or down based on near-term supply, demand imbalances.  There is ample resource to exploit and the next phase for shale will be a balancing act with activity having to adjust based on price signals and cost,” Corrigan said.

It is pivotal that the forecasted decline in US crude oil production in May will begin just when US consumption rises during the major oil refining season from June to September.

“So we’ll see WTI supported, but this too might not rise as fast as we might have seen in the past.  We still have record amounts of crude in storage so we’ll be able to lean on that for the coming months.  I think that we’ll see prices rise to above $60 during this time with a high around $68 if demand stays on pace of last year or higher,” Larry said on the NYMEX contract.

Brent will also remain well-supported if US summer demand eats into US crude oil inventories and the country starts to look for foreign oil, Larry said.
Meanwhile, other factors have contributed to the recent rally in crude oil prices. A slump in the US dollar as it posted its worst week in four against a basket of major currencies helped boost sentiment last week.

Moreover, demand for oil is higher than previously projected, the IEA said in its new forecasts. The Paris-based agency said in its April Oil Market Report that “unexpected pockets of demand strength have emerged” especially in Europe, India and the US.
OPEC has also said that demand for its crude in 2015 is higher than it previously estimated.

Adding to the plethora of data from last week is the heightened conflict in Yemen. The IEA said: “Intensifying fighting in Yemen… have revived concerns about the security of Middle East oil supplies.”

The deepening conflict has the potential to jeopardise crucial oil shipping routes as, in order to transport oil to its European customers via the Suez Canal, Middle East oil producers have to often route their oil past Yemen’s coastlines.

Alternative routes are longer and more expensive, and Egypt has said it would not stand by and watch as a $5bn revenue per year from Suez Canal deteriorates, leading to potentially more tensions in the region.

On Thursday 16 April, front-month Brent crude oil futures stood at its highest level in 2015 after the May contract expired on Wednesday 15 April.

Meanwhile, China – the world’s second largest oil consumer – announced the biggest cut to reserves held by cash lenders on Sunday 19 April, leading to oil markets opening in positive territory on Monday.

Brent rose to a high of $64.34/bbl during early trading on Monday and WTI stood at a high of $56.65/bbl, with no signs of the bull run abating.

Markets were also focused on data reported by Baker Hughes late on Friday revealing the US has once again reduced its number of active rigs – oil drilling machinery – to the fewest since November 2010.

But despite all the bullish data, especially the possibility of a sharp reduction in US May shale output, OPEC major Saudi Arabia’s push to increase its market share could put a damper on prices as it pumps out more product amid the supply glut.

In March, OPEC increased its share in global production by 0.6% to 32.6% as output rose by 810,000 barrels per day (bpd) to average 30.79m bpd because of higher Saudi Arabian, Libyan and Iraqi supplies.

The trend is expected to continue in April, the IEA said, “if not rise further.”

Even on the demand front, “Not all of the apparent pockets of demand strength may be sustainable. At least some product buying has been meeting storage demand. In China, in particular, product stocks have surged in early 2015, while implied crude builds have also remained strong,” the IEA said.

Traders have fixed their gaze on another major potential damper on prices – the potential for an Iranian nuclear deal as negotiators prepare to resume talks this week in Vienna, with the aim of reaching a comprehensive deal by the end of June.

“The outlook is only getting murkier. One of the many questions hanging over the market today is, how quickly could Iran be expected to ramp up output and exports if the agreement were to be made permanent?” the IEA said.