Expect Global Oil Production Growth To Slow Down

Includes: BNO, OIL, USO
by: ValueAnalyst

Oil prices have declined in the last three months as US oil production continued to surprise following persistent US oil rig count increases.

US oil rig count seems to have slowed down as indicated by last week's small drop. Where does it go from here?

More importantly, however, I discuss in this article how global oil rig count has evolved recently and what the recent trend may mean for global oil supply in 2H17.

Overview of recent events

There has been much excitement around the booming shale oil production, which has boosted oil production in the United States from 5.5 million barrels per day ("mbd") in mid-2011 to more than 9.6 mbd in mid-2015. Threatened by the unprecedented growth from American producers, Organization of Petroleum Exporting Countries ("OPEC") decided in November 2014 to abandon its "swing-producer" role and instead quickly ramped up its own production in order to lower prices, drive higher cost shale oil producers out of the market, and protect its market share. As the following graph shows (source: Peak Oil Barrel), OPEC drastically boosted its collective production by more than 3.0 mbd from November 2014 to November 2016.

OPEC's production growth created a large glut of oil that sank oil prices from more than $100 per barrel to less than $30 per barrel in a little more than a year.

Notice in the graph above the large drop of nearly 1.4 mbd from November 2015 to January 2016, or 1.2 mbd from October 2015. This is because on November 30, 2016, OPEC reversed its previous decision to pump as much oil as they can, and reclaimed the role of a swing producer by capping its collective production at a level they believe will reduce global inventories and rebalance the oil market. Oil prices quickly responded by a jump of nearly $10 per barrel. A week later, OPEC was able to get a number of non-OPEC countries ("NOPEC") including Russia to join its efforts to limit oil supply for the first time since 2001.

Since the initial jump of $10 per barrel in December 2016, oil prices remained in a tight trading range for three months, before declining by $10 per barrel throughout the last three months as US rig count persisted its upward trend even as oil prices declined.

US production will continue to increase in 2H17

A key argument for oil bears is that US production will continue to grow as higher oil prices allowed shale producers to hedge 2017 production earlier this year. Bears point to the growing US rig count as a sign that the US production will continue to increase and neutralize OPEC/NOPEC cuts.

Indeed, US oil rig count has more than doubled to 756 as of last Friday from its low of 318 in May 2016, led by increases in the Permian Basin. This is a very large increase, heralding further increases in US oil production in the months ahead as rig count generally precedes oil production by three to four months. The key question is if the increase in US production will be enough to offset declines elsewhere across the world.

Global rig count is important

As oil is a global commodity, it is important to note that current US shale production of ~5.5 mbd comprises slightly more than 5% of the global oil supply of ~98 mbd. In order to understand where global supply of oil is headed, we also need to look at the global rig count, which is what the following table presents:

As the table above shows, although the substantial increase in oil prices in the last year has prompted North American producers to bring rigs back online, ex-North America rig count firmly remains at their lows. This is troubling for the world's oil supply as international conventional oil production comprises the vast majority of global oil production.

Readers should note that although the US rig count comprises nearly one-third of global rig count, this is because unconventional shale oil production requires continuous and increasing drilling for new wells as existing unconventional wells have very high decline rates of +50% in the first year and +80% in the first three years vs. ~5% per year for conventional wells.

To put things in perspective, the last time international (ex-North America) rig count declined to current levels was in 2009 at the depths of the Great Recession, following which, oil prices more than tripled from $32 per barrel in January 2009 to nearly $115 per barrel in April 2011.

Readers should note that even with the recent increase in US rig count, the total global rig count of 1,935 as of May 2017 is still lower than the lowest level of 1,953 that global rig count reached in May 2009. More importantly as conventional oil production comprises the majority of global oil supply, it is troubling that the international rig count of 957 has not yet shown any signs of meaningful recovery throughout the last 12 months and is close to the Great Recession low of 947. This is an important sign that higher oil prices will be needed to incentivize further investment in stabilizing and growing the global oil supply.

Bottom Line: Although oil bears argue that productivity of each US rig has increased with technological improvements, it has not increased enough to make up for the continuing declines in the global oil supply. US shale oil production requires continuous drilling, which is different than "conventional" oil production that is the predominant type of oil production in the world.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.