Saturday, March 26, 2016

US Shale: No Cure for Market Imbalance

The fall in US light, tight oil production has accelerated in recent months, as oil prices have reached new lows and pressures have mounted for producers. Output of these shale and similar unconventional oils is expected to continue declining rapidly this year if WTI crude prices remain below $40 per barrel. These trends are feeding the perception that a "natural rebalancing" of the oil market, led by the reduction in US supply, is gradually occurring - albeit more slowly than many initially expected. Yet the drop in US output does not necessarily vindicate the dominant oil market narrative that Opec is driving high-cost production out of the market. As productivity gains continue, the economics of US shale are now competitive with many other production sources, with output now likely to stabilize at around $50. Given both its evolving cost structure and short project cycle, the US shale is not the solution to the current oil market imbalance. Unless Opec decides to intervene, a sustained rebalancing will probably not materialize until deferrals and cancellations of other projects also start to bite.

US light, tight oil (LTO) production has decreased consistently over the past year, and the rate of decline has accelerated since November, as financial pressures have grown for producers and oil prices have reached new lows this cycle. Output from US shale plays dropped by 211,000 barrels per day in the past 4 months alone -- nearly half of the overall fall since its March 2015 peak of 5.49 million b/d.

With WTI prices below $40, major shale players, including ConocoPhillips, Continental Resources, EOG Resources, Hess, Occidental and Whiting Petroleum are significantly cutting capital expenditure again this year, further reducing rig counts. Many smaller debt-laden E&P firms are coming under intense financial strain and have barely enough cash to cover interest payments. Next month's bank redeterminations will hit struggling E&Ps harder than last October's resets, with borrowing capacities likely to be cut by around 25% on average -- and much more for some reserve-based lending agreements.


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