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Is $57 WTI Crude Oil Sustainable?

The oil price roller coaster has definitely been on the up side over the past two months, up $10 a barrel from the mid-December through, much of the credit belonging to overseas producers who have reduced supply to stabilize the market, as well as continuing problems in Venezuela and Libya. At the same time, many have noted that the market balance appears to be weakening as the figure below shows, with non-OPEC supply growing faster than total demand.

The simplistic meaure of world demand minus non-OPEC supply is used, ignoring NGLs, processing gains, etc.

Prices can always surge quite easily given the right geopolitical developments, most especially new supply disruptions. At present, it might seem as if the recent losses from Iran, Libya, Nigeria and Venezuela are probably as bad as they can get, but the reality is that the bottom could be lower and broader, i.e., spreading to other producing countries. (I presume that the positive impact on demand of a China-U.S. trade deal will not be very significant.)

It would seem highly likely that weaker demand for oil from OPEC (plus stocks) predicted at a drop of 0.4 mb/d by the IEA, 0.77 mb/d by OPEC, and 1.08 mb/d by the EIA, will be offset by lower production in Iran and Venezuela, possibly requiring an increase by some producers to keep prices from growing. The precise offset is uncertain but should mean a relatively balanced market.

But clearly producers cannot count on continued declines from those countries forever, and longer term their production is likely to recover, maybe even surge. Which means that Russia, Saudi Arabia and others presumably want growing demand for OPEC oil or else they will face not just a decline in market share but the requirement to cut absolute production volumes (or at least exports).

Which brings us to consider why prices dropped in the past. In at least two instances, 1986 and 2014, it appears that the Saudis were concerned that prices had reached unsustainable levels, specifically, that competition from non-OPEC sources were pressuring their markets. The two cases were somewhat different, as the figure below shows, in that OPEC market share was down sharply in 1986 but only slightly in 2014.

But following the theory that the desired price for Saudi Arabia is what they believe the sustainable price to be, the fact that U.S. shale production was soaring in 2014 and that Iraqi production was also growing rapidly (figure below) suggested a growing market imbalance.

The addition of 5 mb/d of new supply from the beginning of 2010 to the end of 2014 just from those two sources was a clear and present danger to other oil producers, and especially the Saudis, who had long been pressured by other OPEC members to make room for additional Iraqi oil.

At present, the major forecasters project a slowdown in U.S. shale oil production, as the table below shows. Of course, in February 2018, they are too pessimistic about last year’s growth (the figures are for total U.S. production) and could prove so again.

Moreover, this pessimism reflects more the pipeline capacity constraints on shipping production out of the Permian than production slowing. Drilled, uncompleted wells in the Permian have been growing steadily, dwarfing those in other regions, as the figure shows.

Although Wall Street is said to be pressuring shale producers to scale back investment plans, and some are said to be responding positively, the number of rigs active both nationally and in the Permian does not show significant decline, as the figure below shows. And with the expansion of pipeline capacity towards the latter part of this year, the realized price for some producers will improve sharply, encouraging more investment.

Which raises the important issue of how producers, and especially the Saudis, will perceive the impact of soaring shale oil production on the sustainability of the current price. If, at $50+ per barrel, shale oil grows by more than 1.5 mb/d per year, it should be clear that either the major oil exporters will have to accept lower production, or prices will have to drop enough to slow upstream investment in the U.S. shale fields.

The United States Oil Fund LP (USO) was trading at $11.93 per share on Thursday afternoon, up $0.04 (+0.34%). Year-to-date, USO has declined -0.67%, versus a 5.00% rise in the benchmark S&P 500 index during the same period.