Surging oil production is one of two great fears, the other being weaker demand growth, permeating through the oil markets. It's the mix of these two fears that has been responsible for WTI crude plummeting over the past several weeks and taking energy companies' shares with it. To see what precisely the facts appear to be, I decided to dig into the recent numbers from the EIA's Drilling Productivity Report and explain what, to be sure, investors, bulls and bears alike should be anticipating for the next year or so. At first glance, the data will look scary, but when you place everything into context, the picture for bulls still has excellent potential moving forward, and investors would be wise to act accordingly.
I'm not here to tell you that US output won't be rising. If I did, I'd be lying to you. In fact, if anything, US oil production will grow by a great deal next year. How much is the interesting question though. In its latest Short-Term Energy Outlook, the EIA (Energy Information Administration) claimed that US oil output next year would average 12.06 million barrels per day, up 1.16 million barrels per day from the 10.90 million barrels per day generated this year. OPEC, on the other hand, has a different target in mind. Its forecast in its latest monthly report was for US production to climb a whopping 1.69 million barrels per day in 2019 versus 2018.
While there are other variables that differ in their respective analyses of the global oil markets, the change in US production is certainly one of the biggest areas of divergence between the organizations. Generally speaking, I like to think that on the global stage, OPEC's data is more accurate than anybody's, while when it comes to domestic figures, the EIA should be the go-to source. That said, to blindly choose because of areas of focus is a mistake, and a review of the data suggests that the EIA's production estimates might be off.
So far this year, the oil production picture in the US has been extreme, with output roaring back in response to higher crude prices. In the Permian alone, production ended last year at 2.85 million barrels per day, and if current estimates are correct, it will end the year at 3.69 million barrels per day. That's a year-over-year increase of 0.84 million barrels per day from just one shale region. Based on current figures, it's looking like all of the major regions covered by the EIA's Drilling Productivity Report (or DPR for short) will post increases.
For investors on the bullish side of the equation, this looks painful, and it is, but the fact of the matter is that output won't stop here. Using some of my own assumptions regarding rig counts (applying increases to some regions and a flatline for other regions), decline rates, and rig productivity improvement rates, I was able to create the following table below, which illustrates projected output for this year and next for all 7 major regions covered by the EIA in its DPR.
*Created by Author
What the data shows is that if all goes according to plan, next year we should see oil production in the Permian Basin rise by an impressive 760,120 barrels per day. It should be noted that this figure and all the others will represent the average monthly output, aggregated throughout the year, not the year-end to year-end growth rates. The Bakken and Eagle Ford should see significant increases as well, with the Niobrara and Anadarko coming in behind, but not far behind. Only the Appalachia and Haynesville regions should post growth that in the grand scheme of things is marginal.
Put together, this means that my model is forecasting shale growth to expand by 1.38 million barrels per day in 2019 compared to 2018. Excluded from this is Alaska, which should add another 0.01 million barrels per day to US output, and the Gulf of Mexico, which the EIA thinks will add 0.26 million barrels per day for the year. Combined, this all translates to an extra 1.65 million barrels per day, only slightly lower than what OPEC is forecasting. It's worth mentioning that with the exception of output from Alaska, these numbers exclude conventional onshore oil production, so that could make up the disparity between what my numbers show and what OPEC's show, but given years of underinvestment in conventional drilling, I wouldn't be surprised to see it actually drop some to offset some of this higher output from shale.
With output likely to grow far more than the EIA anticipates, bears might be rejoicing, but that would be a mistake. All along during the energy downturn and as the market began improving again, I made a very consistent case: that the markets will come to see US shale as the plug for future oil demand growth. Each year, until logistical constraints (we have already seen temporary ones) or a lack of attractive drilling opportunities make it impossible for shale to grow meaningfully, shale can and will absorb a significant chunk of global demand growth, and OPEC and key non-OPEC nations will adjust for this by finding the right balance and keeping their output level approximately there. Only once shale's best days are behind it will non-US players be able to increase output materially.
Some bears might be pointing out that my idea has failed. After all, crude prices have recently plummeted amidst fears of oversupply again, but that wasn't because of a failed strategy, it was due to an overreaction on OPEC's and Russia's part in response to continued declines from Venezuela and sanctions that have been placed on Iran. In particular, sanctions on Iran haven't been as severe as markets thought they would be. Had they been more severe and effective, then we would likely be talking right now not about a supply glut, but about whether shale can ramp up quickly enough to bring prices back down from $100 or more per barrel.
Moving forward, the likely outcome is that OPEC will cut again. As I stated in another article, the simple math works out in favor of a cut. It always will, because market share isn't important, profits are. Already, Saudi Arabia has said it will cut its own oil shipments by 0.50 million barrels per day in December, and rumors are circulating of an OPEC cut of between 1 million and 1.4 million barrels per day. Russia, for its part, to remain at or below the target forecasted by OPEC, will need to cut its own output from the 11.41 million barrels per day it generated in October to 11.24 million barrels per day, but if OPEC acts on this matter, then Russia might see its own figures dip below 11 million barrels per day.
Oil bears are right about one thing: US production is rising, and it will continue to do so. However, that doesn't mean the end for the bullish argument. If anything, OPEC and non-OPEC allies will want to repeat the success of their latest cut in order to boost crude prices higher, with a likely long-term target of between $70 and $80 per barrel for WTI.
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This article was written by
Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and he runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.
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.