CERAWeek, the annual industry conference held here in Houston which is discussed more in detail in another article, marked a new level of friendliness and openness between OPEC and U.S. producers after bitterness caused by OPEC’s abandoning its role as market stabilizer in favor of maintaining market share which caused a bitter price war between the two.
OPEC has apparently realized that U.S. producers are here to stay while simultaneously feeling the pain associated with lower oil prices on their budgets. U.S. producers, who cannot by law coordinate production, seem to realize the necessity of OPEC as a market stabilizing force that insures more long-term stability in pricing.
Nevertheless, as we have reported in other articles this week, the U.S. seems to already be going strong again. Rig counts have doubled since June, and inventories have been steadily building. OPEC, through Saudi oil minister al-Falih, is warning the world, and probably U.S. producers in particular, that there will be “no free rides” and output cut extensions are not guaranteed. Some of the Minister’s comments were probably directed at fellow OPEC members, warning them that Saudi Arabia would only continue its substantial cuts if other members did as well.
But OPEC faces a decision, and must do so on rather incomplete data. Minister al-Falih noted that world inventories have not fallen as quickly as he anticipated. While not stated, I think he also did not expect the rather large increase in U.S. production as quickly as it has come.
But now OPEC has a problem. As you are all aware from prior editions of the Five Star Standard¸ the production cuts agreed to by OPEC and the other 11 nations expire in June. OPEC is slated to decide whether or not to extend those production cuts at their meeting in May.
While OPEC continues to tell markets that it is too pre-mature to discuss whether or not continued output cuts are necessary, it has to make a decision in relatively short order. And while Saudi Arabia has every incentive fiscally to continue cuts, they may have some political pressure to increase output as the summer months approach and the Kingdom is forced to utilize substantially more of its own production to feed its increased summer energy demand.
Either way, OPEC members find themselves with a huge dilemma going into their meeting. U.S. drilling activity has surged, but so far the impact on production is limited. While the number of rigs has doubled since hitting the cyclical low at the end of May, output since May of crude and condensates has risen less than 5% and is below the level of the corresponding point from last year.
This makes some sense as there is generally a month or two delay from the decision to drill and when the rig actually arrives on site. Rigging up, drilling, and dismantling can take another month. And then the arrival of the frac crew and well completion can add 2-3 months of delay. In essence, you have a 4-6 month delay from decision to first barrel.
And even after that, there is a delay in production data. Production data is published based on calendar months, and output for the first month of a new well is generally significantly lower than subsequent months. Therefore, the production from the new well is not likely to actually be recorded until two months after drilling is complete. Even once the new barrels make it into those numbers, they are still tallied by regulators and then eventually released – resulting in further delay.
Therefore, historically, it can take 9 months for the increase in rig count to show in production figures. While we are seeing output growth in U.S. numbers, those are likely growth numbers for rigs brought online in 3Q 2016. Last quarter 2016, and the first quarter of this year, will not show up in production numbers for a while.
Now clearly, there are some caveats to this. DUC (drilled uncompleted) wells are likely to come to market sooner, and will presumptively be reflected in production numbers more quickly.
But either way, OPEC now faces a bit of a dilemma. They will have to make a decision in about 75 days whether or not to extend output cuts and to try and build a consensus with non-members to continue those cuts using incredibly incomplete data. I continue to believe that they have every incentive to continue production cuts, and indeed, may be starting to become concerned about output shortages in the coming years. But I believe everyone seems to be of the opinion that continued production restraints are necessary to allow the market to rebalance to the level necessary for a sustainable recovery. But we shall see.
By: Ty Chapman
Five Star Metals, Inc.
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