Do Not Fear (Or Hope For) An Oil Price Spike

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Includes: DBO, OILU, UCO, USO, USOU, UWT
by: Anthony Lerner
Summary

Recent attacks on Saudi pipeline and tankers have caused volatility and fear in the oil market.

Fears of a price spike caused by a supply disruption are unfounded.

The USA is the new oil swing producer and has enormous spare capacity.

In recent days attacks on oil infrastructure in and around Saudi Arabia have created oil price volatility and fear of an oil price spike due to a possible supply disruption. These attacks are meant to cause fear, uncertainty and volatility. They have caused little damage and have little hope for serious damage. The fact that some of the attacks were from drones is meant to play upon the worst fears of the public. In truth there is very little to fear from these types of attacks and there is very little cause to fear any kind of supply disruption. There are 3 reasons: 1. Oil facilities in and around Saudi Arabia are some of the most secure installations on Earth 2. The US military. 3. The US is now the oil swing producer.

The US military owns the ocean and the skies. This is not just jingoistic nationalism from an American. The USS Abraham Lincoln Carrier Battle Group is heading for the region. This includes an aircraft carrier with a full carrier air wing, one cruiser, four destroyers, a group of heavy bombers, fighters, an expeditionary warship, and a surface-to-air missile battery. An unspecified number of B 52 Stratofortress bombers are already patrolling the skies above the region. President Trump has not been afraid to confront foreign policy problems head on and he has not been afraid to project power when necessary.

Iranian backed Houthi rebels from Yemen claimed responsibility for the attacks on Saudi oil pipeline pump stations. No one has claimed responsibility for the tanker attacks, but suspicion has centered around Iran. The reality is that this is Iranian saber rattling. They are scared. And they should be. For all intents and purposes President Trump has zeroed out Iranian oil exports. The oil market has barely reacted price wise to 3 million barrels per day of exports disappearing from the market. The world does not need Iranian oil. This scares the daylights out of them. The shortfall is easily being made up by the USA, Saudi Arabia and some others.

The USA is now the world’s oil swing producer. Saudi Arabia is still a swing producer as well. For decades there was only one. Now there are two. Let’s do a thought experiment. Let’s say one of these attacks succeeds in a spectacular fashion and takes out 2 million barrels per day of oil supply from Saudi Arabia. Oil prices spike $20 per barrel overnight. Now what?

The US Strategic Petroleum Reserve. The SPR has 647 million barrels of oil in storage. This oil, a vestige of the oil embargo era of the 1970’s, is completely unnecessary in modern shale boom America. In response to a supply crisis we could put 2 million barrels per day of oil on the market from our SPR for 323 days and we would not miss it.

US oil production has been rising by 1 million barrels per day every year effortlessly for 4 or more years. It is projected to do the same in 2019 and 2020. Some analysts predict the production in the Permian basin ALONE will be 8 million barrels per day by 2024. The point is all this has happened under “normal” circumstances. In a crisis production could rise much faster. The current oil rig count is about 805. In 2014 however it was twice as high, almost 1600. In response to a crisis it would not be unreasonable to see rig counts rise again to their historic high. Considering drilling efficiency, longer laterals and current average initial well production US oil production would rise twice as fast or 2 million barrels per day per year. Hypothetically it could be even higher. Here are the rough numbers. All data and numbers are from the EIA or as noted.

There are 805 rigs currently. It takes 60 days to drill and complete a well approximately. In a year 805 rigs will drill 4800 wells. Based on the last couple of years data about 1500 of those will be uncompleted thus 3300 new wells will produce oil. According to the latest EIA drilling activity report the average new well produces 700 barrels per day. 3300 new wells this year will produce 2.3 million barrels per day of new production. Subtract out approximately 1.2 million barrels per day of production declines from existing wells and you get 1.1 million barrels per day of new production in the USA in 2019. Run the same numbers with 1600 rigs. If your decline rate is only 1.2 million barrels per day the new production is well over 3 million barrels per day.

New-well oil production per rigbarrels/day

New-well gas production per rigthousand cubic feet/day

Region

May 2019

June 2019

change

May 2019

June 2019

change

Anadarko

404

412

8

2,840

2,856

16

Appalachia

143

143

-

15,930

15,930

-

Bakken

1,384

1,386

2

1,986

1,986

-

Eagle Ford

1,337

1,340

3

4,868

4,880

12

Haynesville

26

26

-

10,665

10,834

169

Niobrara

1,236

1,238

2

4,271

4,286

15

Permian

654

682

28

1,294

1,324

30

Rig-weighted average

689

703

14

3,989

4,020

31

Finally, there are DUC’s or drilled uncompleted wells. Right now, there are 8390 DUC’s in the USA with 3964 in the Permian alone. The EIA drill productivity report states the average new well production is 703 barrels per day. These DUC’s represent a whopping 5.9 million barrels per day of production if we were to assume every DUC was an oil producing well (not the case, some are gas wells). This is a heart stopping number.

The above has been a thought experiment designed to make a point. The new US shale oil factory is very efficient and has an enormous amount more spare capacity than people generally realize. If it were necessary, we could increase our production by a large number. As we come into the summer and USA refinery runs increase in response to summer gasoline demand, oil prices will likely grind slowly higher. Nevertheless, there is no reason to be afraid of a supply disruption in the Middle East.

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.