With WTI back under $50 once again (the mainstream media's new Maginot Line for oil complex stability - just like $80, $70, and $60 was), it appears more investors are waking up to the reality of an over-supplied, under-demanded global energy market. The 'squeeze bounce manipulation' that we saw over the last week - very reminiscent of the bounce seen mid-collapse in 2008/9, was predicated on falling rig counts (and capex). However, Goldman pours freezing cold fracking water all over that thesis as they explain that the decline in the US rig count remains well short of the level required to achieve a sufficient slowdown in US oil production growth to balance the global market. Simply put, they conclude, lower oil prices will be required over the coming quarters to see the US production growth slowdown materialize with risk to their already low price forecast to the downside.
WTI back under $50...
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Via Goldman Sachs,
Further rig count declines required to balance market
The US oil rig count has dropped sharply, with the recent acceleration helping trigger a large rally in oil prices. To help quantify the impact, we decompose oil production from the three big shale plays at the county level, separating the contribution of well and rig performance. Our bottom-up analysis suggests that the decline in the US rig count likely remains well short of the level required to slow US shale oil production to levels consistent with a balanced global market, especially if productivity gains and high-grading materialize as expected. Nonetheless, we also find that the rebalancing of the US oil market is closer than would be implied by the US shale gas template of 2012-13.
The past weeks have featured (1) an improvement in oil prices, locked in to some extent by production hedges, (2) an easing in the funding constraint of E&Ps, and (3) an acceleration in both cost deflation and deleveraging through significant rig cuts.
These three shifts and our expectation that the rig count decline is still short of achieving the required slowdown in US production growth suggests that the rebalancing of the oil market is far from achieved. We therefore reiterate our view that lower oil prices will be required over the coming quarters to see the required US production growth slowdown materialize.
The US oil rig count has dropped sharply over the past few months, with the recent acceleration helping trigger a large rally in oil prices. Looking at the county level data across the three major oil shale plays (Bakken, Permian and Eagle Ford), the rig cuts initially tracked expectations:
- the largest rig cuts came from vertical and directional rigs, although this decline is slowing given the low rig count level reached (Exhibit 1);
- the decline in horizontal rig counts was largest in the Bakken, where well head prices are the lowest given wide differentials to the Coasts (Exhibit 2).
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The breakdown of the most recent rig cuts was more surprising however:
- the Permian horizontal rig count posted a large decline last week, while the play’s overall rig count had held up remarkably well over the past weeks;
- the decline in the horizontal rig count has so far shown little relationship to either rig or well efficiency at the county level (Exhibits 3 & 4, see Appendix for rig count decline week-over-week and since peak, by play and by well or rig efficiency).
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Productivity growth will help offset the rig count decline
While this estimate assumes stable productivity, it has in fact steadily increased both at the well and rig level over the past couple years as we illustrate with the Mckenzie county of the Bakken play
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Our bottom up analysis suggests that the decline in the US rig count remains well short of the level required to achieve a sufficient slowdown in US oil production growth to balance the global market, especially if productivity gains and high-grading materialize, as expected.
The rebalancing of the oil market is far from achieved
The past week has featured (1) an improvement in oil prices, locked in to some extent by production hedges, (2) an easing in the funding constraint of E&Ps, and (3) an acceleration in both cost deflation and deleveraging through significant rig cuts. These three shifts in early February and our expectation that the rig count decline observed so far is still short of achieving the required slowdown in US shale production growth suggest that the rebalancing of the oil market is far from achieved.
Recent comments by E&Ps suggest that the drop is so far for non-contracted rigs with the goal of renegotiating rig rates sharply lower, leaving open the potential for a rebound in the US oil rig count.
The recent rally has offered an opportunity for producers to hedge their remaining 2015 oil price exposure. Specifically, CFTC NYMEX WTI Producer short oil positions have increased sharply year-to-date and especially over the past week (with the latest data point released February 6 reflecting the position as of the February 3 close, Exhibit 22).
Beyond the improvement in 2015 cash flow that the recent hedging/cost reduction has achieved, sentiment towards E&Ps has improved on the financing side as well, with five equity raises announced over the past week. And excluding the most dilutive one, these stock issues have been well received by the market, with stocks showing little underperformance relative to the rest of the sector. This reflects the interest in the sector and significant availability of capital sitting on the sidelines looking to invest in shale.
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We therefore reiterate our view that lower oil prices will be required over the coming quarters to see the US production growth slowdown materialize. See Lower for longer to keep capital sidelined (January 11, 2015) for details. Further, we reiterate our view that a slower slowdown in US shale oil production would leave risk to our price forecast skewed to the downside as it increases the risk of running out of crude oil storage capacity, requiring a decline to shutdown economics.
