Shale Stumbles: Now OPEC Can Decide What Price They Want

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Includes: BNO, DBO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU
by: Andrew Butter
Summary

WTI hit $70 in May. Then, starting October it dropped to $42; probably mainly because OPEC started pumping.It bounced a bit because they said they would cut.

Shale oil initial production net of legacy loss, which measures how much new capacity is coming on line, plunged 44%.

In other words, at less than $50 WTI many shale operators don't make money.

If OPEC is happy with $50 WTI they won't need to cut, because new shale oil will drop from the 1.6 MBPD increase it achieved in 2018, to zero.

The wild card is that conventional E&P won't reboot until WTI is steady over $60. And if it does't reboot soon there could be a massive shortage in a few years.

E.I.A does not report total initial production of shale oil, but it's not hard to work that out from the numbers they do report. You take their number for "rigs" and multiply by "initial production per rig"; take away legacy-loss and you get the total change in capacity (new oil). That's down 44% since May 2018. That's a leading indicator.

IP-net-legacy is a better number to watch than changes in production (shipments) which lag IP-net-legacy by about three months. Year on year that's down 15% since August 2018. But the fundamental direction follows IP-net-legacy, which measures how hard the operators are going after growth and how good they are at bringing in the goods.

This chart shows the trend of IP-net-legacy per month, explained in more detail in previous posts

Schlumberger's (NYSE:SLB) CEO, Paul Kibsgaard, recently remarked: "We could be facing a more moderate growth in U.S. shale production in coming years." I agree, except if oil prices stay low, "moderate growth" is not the word I would use - more like "a massive drop in growth." Point is, 85% of what the drillers bring in, goes to top up legacy-loss.

He also said, "U.S. shale producers will ... focus on drilled but uncompleted wells (DUCs) instead of drilling new ones." I disagree, what's actually happening now is that the stock of DUCs is going up, not down; more likely the operators are finishing off plays where the rigs are in place. A big part of drilling cost is moving the rig from place to place, so it makes no sense to pull a rig that's in place just because the price went down and then making a decision to not pump the sand or install the top side, which accounts for 60%-70% of the total cost, waiting for more favorable prices. If that's what's happening, expect the fall in growth to accelerate.

Looks like soon we will soon start to find out how many of those DUC's, were in fact, dead-on-arrival (DOAs). I'm sure Paul Kibsgaard knows that number, but he's not telling. Personally, I wouldn't be surprised if half of those DUCs are DOAs and never get completed.

Production growth (shipments) went up by 1.6 million barrels per day in 2018 (Jan. 1 to Jan. 1), don't be surprised if that halves to 750,000 in 2019 and goes to zero in 2020. That's more than a moderate drop. Meanwhile, we know now that if WTI goes under $50 for long, many shale oil producers don't make money, so they stop completing wells.

The next decision for OPEC is what price they want. If it's $60 WTI, they may need to cut a bit. If it's $70 they will need to cut about 1.0 million bpd by my reckoning, and if they are happy with $50, they may not need to cut at all.

And why should they? The difference between shale and conventional is shale has to pump once they came online, OPEC can wait for better prices. Sounds like the new swing producer on the block is no longer shale oil, and the ball is back in OPEC's court.

Meanwhile, the low prices are still discouraging conventional exploration and production (E&P), with the risk that in 2020 oil will spike. That's something for the shale producers to look forward to if they can hold on that long.

Except, as soon as they start to spend, OPEC can open the taps.

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.