Ritterbusch Warns OPEC Agreement May "Collapse Within Months": Here's Why

As OPEC, which currently is pumping crude at a record rate yet has managed to fool algos and "experts" into bidding up crude to multi-month highs on "promises" it will cut a little over 1 million bpd in output starting in 2017, an "agreement" which Russia and other Non-OPEC nations may or may not join depending on whether OPEC states comply with the cuts (Russia has made it very clear it won't start cutting for a a while in the new year), a problem OPEC has long hoped to avoid mentioning, let alone addressing, has emerged. We are talking, of course, about US shale, the biggest marginal swing producer in the world.

The problem, in a nutshell, is one of clean balance sheets (those companies which had to file bankruptcy, have done so by now, and as a result most now have a far lower All-In Production Cost, not to mention far less debt, and re-energized management teams) as well as one of rising efficiency due to drilling technological advances. Nowhere is this more evident than in this excerpt from Bloomberg:

[A]t 8.8 million barrels a day, the U.S. is already pumping almost as much crude as two years ago, with just a third of the rigs it operated at the peak, data from Baker Hughes Inc. and the Energy Information Administration show.


And while drillers have added about 200 rigs since May according to Baker Hughes, taking advantage of rising prices as talk of an OPEC supply cut circulated, one wonders what will happens to US oil production once the number of rigs returns to its recent historical levels between 1,800 and 2,000?

One thing we do know is that after two years of quietly avoiding the spotlight, the shale industry is ready to return with a bang, and according to Reuters, "US shale drillers are set to ramp up spending on exploration and production next year as recovering oil prices prompt banks to extend credit lines for the first time in two years."

The credit increase is small, but with major oil producers worldwide aiming to hold down production in 2017, U.S.-based shale drillers are looking to boost market share to take advantage of higher prices, and greater availability of capital will make that easier. 

 

North America-focused oil and gas producers are expected to increase capital investments by 30 percent in 2017, according to analysts at Raymond James. A number of shale producers including Pioneer Natural Resources, Diamondback Energy and RSP Permian have forecast bigger budgets and increased output for next year.

 

Every six months, oil and gas producers negotiate credit with banks based on the value of reserves in the ground. Through the latest round of talks in the fall, 34 companies had their available credit lines raised an average of about 5 percent, or more than $1.3 billion, according to data compiled by Reuters.  The combined bank credit for the companies stood at $30.3 billion, compared with $28.9 billion at the end of spring 2016.

 

The industry's available credit had been cut by 40 percent over the past three reviews as it contended with a two-year price rout. "The 'animal spirits,' seem to be coming back to the exploration and production market, albeit slowly," said Reorg Research analyst Kyle Owusu, referring to the human emotion that drives confidence.

 

Of the 34 companies, 12 saw increases of 5 to 90 percent, while 10 companies had their borrowing bases cut in the latest round, and 12 companies' credit limits were left unchanged.

Curiously, despite the recent renaissance within shale, overall U.S. crude oil production is forecast to fall to 8.8 million barrels per day in 2017 from 8.9 million bpd this year, according to the DOE. But, according to many analysts, shale output could increase from 200,000 to 500,000 bpd in 2018.  Furthermore, according to a Citi report, if oil prices jump by another $10 from the current level of ~$50, shale output could quickly rise by a further 500,000 barrels.

Still, some such as SocGen head of commodities research Mike Wittner,, believe that shale companies could struggle to revive output quickly enough to disrupt the re-balancing of the oil market. “It’s going to take them a while to gear up,” Wittner said. “The investment’s got to gather pace, the drillers and the fracking contractors also need time. It’s a gradual process.”

And then there are those like commodity expert Ritterbusch & Associates who believe that US shale will be able to return to recent output levels far faster than consensus, and certainly OPEC believes.

According to a recent report by Ritterbusch, US drillers are returning to work at a pace that will threaten the tenuous agreement among OPEC and other major producers to cut output.  

"It appears OPEC is already furthering a US shale recovery despite the fact that OPEC cuts have not even begun," Ritterbusch & Associates writes, pointing to the rapidly rising rig count and increased output from US fields.

As a result, and taking a contrarian stance to the consensus, Ritterbusch now expects US oil production to rise to 9 million bpd as soon as the end of Q1 in 2017, from 8.8M currently.

Such an accelerated return to production  would not only allow US producers to grab "a significant portion of OPEC's market share," but more importantly would cause the OPEC production cut agreement to break apart as early as next spring, Ritterbusch says, as Saudi Arabia once again panics and scrambles to recapture market share lost not to Iran and/or Iraq this time, but to a newly resurgent US shale industry, which as a reminder, is what caused the historic OPEC cartel breakdown on Thanksgiving 2014 which sent the oil price crashing and from which it has yet to recover.

As a reminder, all this excludes the all too high likelihood of a surge in production from previously mothballed regions like Nigeria and Libya, both of which are aggressively ramping up output to recapture long lost market share, and are willing to aggressively underbid the competition in the process.

If Ritterbusch is right, buy lots of 6 month Brent/WTI puts, because today's high price will be a fond memory once the latest OPEC agreement collapses as it becomes every oil producer - and shale - for himself.