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Oil Supply To Remain Muted

ValueAnalyst profile picture


  • Oil prices have increased, but this is just the beginning.
  • U.S. oil production is expected to drive the global oil supply this year.
  • Where is the rig count surge that bears expected?

Investment Thesis

Oil prices have increased substantially in the last six months, but this is just the beginning. After a seasonal swoon in the winter, I expect oil prices to continue upward in 2Q18 into the summer driving season.

Recent Performance

Brent crude oil prices have fluctuated in recent weeks following a substantial rise in the second half of last year:

$65 Was Not Enough To Boost Supply

Despite substantially higher oil prices in recent months, the global oil supply has remained below global oil demand, causing a strong imbalance, which has led to continued inventory draws across the world. The International Energy Agency included the following paragraph in its latest Oil Market Report:

OECD commercial stocks fell in December by 55.6 mb, the steepest drop since February 2011, to reach 2 851 mb. Stocks drew by 154 mb (420 kb/d) during 2017 and ended the year 52 mb above the five-year average. In 4Q17, stocks fell sharply by 1.3 mb/d across the OECD.

Global oil inventories have declined at a fast pace, dragging prices higher, but the global oil production still has not reacted. Today, we received yet another indication of near future constraints in global oil supply:

The above table from Baker Hughes shows that, although the U.S. rig count had surged from the year-ago period, which has led to rising U.S. oil production in 4Q17, the rig count has recently been muted. This trend is also confirmed by the DI Drilling Index, which has been flat throughout the last several weeks:

Furthermore, the Baker Hughes table above shows that the international rig count still remains below 1,000, near all-time lows.

Bottom Line

I keep a close eye on U.S. oil production, because it is expected to be the growth engine of the global oil supply this year.

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This article was written by

ValueAnalyst profile picture
You'll never see me write a long bio listing all of my credentials and degrees or refer to myself in the third person. I love discussing ideas and I appreciate it when people can play devil's advocate without resorting to personal attacks. In short, I employ a long-only, long-horizon, focused value style, guided by thorough bottom-up research and backed by years of accounting and finance experience. When people ask me "what do you do?" I assume they mean for fun.

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Comments (24)

04 Mar. 2018
Great article.

As far as very recent rig increases; producers are flat out right now in Canada and the US. They are putting up as many new rigs as possible. It is difficult, its taking a long time as it always does.

(Despite bears suggesting it is simply a matter of cracking a valve open)

Lots of wells are mature, a lot of rigs are due to retire or need refurbishing. If the steel tariff goes through that will put a large hamper on rig count and transportation ability.

Opec and Russia want higher oil prices, and quickly.

I have high targets for crude 2018-2019
Taymere profile picture
errata "Furthermore, the Baker Hughes table above shows that the international rig count still remains below 1,000, near all-time lows."
You meant US rig count = 937, 937<1000. International = 2175, 2175 >1000
ValueAnalyst profile picture
No, I meant international. You may be thinking Global, which is different than International.
Rational Techne profile picture
So hilarious when those presuming to correct someone else are in fact themselves the ones in error, lol. Thanks for the article, VA.
In 2018, we have gone up 53 US oil rigs in 9 weeks. That is just just under 6 rigs/week and a total of over 50. It won't continue forever, but right now you are increasing 25/month. That is not tiny.

800 rigs for maintenance?? We grew over 1 MM bpd during last year. And that was with rigs in the 700s.

Oil prices didn't cross $50 until late SEP17 (after dropping to 40s for several months in spring/summer). So a JAN-FEB increase is completely consistent with a 4 month lag!
ValueAnalyst profile picture
Don't forget about the extreme decline rates of horizontal shale wells. We go through this cycle of Bulls claiming victory followed by Bears claiming victory every three months, while global inventories continue to decline at rapid pace. I expect oil prices to rise in 2Q18, as declines catch up with the drilling surge in recent months, just as we enter the next summer driving season. Thanks for the discussion.
I am well aware of the decline rate of shale wells.

See 1:01:25 at this link: http://reut.rs/2FI6aPM
Cyclical Trade profile picture
I agree the latest price increase hasn't been reflected in rigs yet. What remains to be seen is if $60's WTI induces a greater response than $50's. A lot of activity could be said to be desperate pay the bills no matter what activity. So $60's could see increase but not necessarily hog wild.
1. Very short article which does not really do analysis to prove its points.

2. Rig count rise can lag price by months.

3. Rig count increase and production increase are not proportional. Consider some number of rigs that is required to maintain production versus decline (say 600). If rigs are above that level, production will increase regardless of if rig count itself goes up or down.
ValueAnalyst profile picture
1. Despite popular belief, length does not matter.

2. Yes, but not this many months. The usual lag between price and rig count is about three to four months, and it's been eight months since prices started surging. I published an article in early Jan indicating bears were expecting rig count to surge in January, which has not come to fruition. Capacity to grow is clearly limited, either by labor or takeaway capacity, or both.

3. Agreed, and I estimate 800 oil rigs (now almost all horizontal w/ pad drilling so no more "rig productivity" gains) to support 8.5 to 9.0 mb/d of L48 onshore production, and that's it. Thoughts?
Robert P. Balan profile picture

#Where is the rig count surge that bears expected?#

This author has forgotten the leads and lags between oil price, rig counts and production. Can't blame the author though -- the lead function of oil price and the lagged function of production are long. Not easily seen, unless you work the data.

The oil price leads rig count trends by 4 months; rig count leads production trends by 3 - 4 months


The current anemic rig count? Wait another months, then let's see.
ValueAnalyst profile picture
"This author has forgotten the leads and lags between oil price, rig counts and production."

No. As indicated above, oil prices started surging in July, which was nearly nine months ago, and rig count has remained stable. The current lag is double of normal lead time. The capacity to grow production is limited by skilled labor and takeaway capacity. This will not bode well for 2Q18.
PalmDesertRat profile picture
does the steel import tariff affect your view? after all, drill pipe, pumps, compressors, etc. all use substantial amounts of steel.
ValueAnalyst profile picture
Not really... it's uncertain if these tariffs will stay and uncertain how quickly they can affect the economies. Longer term, I am concerned about trade wars, but I do not expect a major impact in 2018. If anything, higher steel cost would further limit supply growth, but I don't quite see a major impact yet. What do you think?
Krypto profile picture
I think President Trump is creating this for negotiation leverage, and to keep a promise to some of the people who voted for him.

He will try to use it to get some concessions on other areas of trade.

Hopefully, the miners of cobalt and lithium will retaliate if anyone does....
PalmDesertRat profile picture
I agree. Higher costs would cause certain wells/fields to be non-economic on the margin. I don't know if it would hinder production much, but it certainly wouldn't increase it.
long esv nov ypf
ValueAnalyst profile picture
ESV... I need to write another article on that one.
But us oil supply is only steady due to the spread, I believe . I think the spr policy in China and India counts on oil price
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