Will U.S. Oil Producers Spoil The Party?

OPEC and non-OPEC members worked hard to reach an agreement that will, hopefully, move crude not only into balance but into supply deficit sooner rather than later. When deficit will occur is a matter of some debate. Some believe, such as the IEA that it will happen in First Half 2017. More energy traders seem to believe, based on the current spreads in futures contracts, that the deficit will not occur until Second Half 2017.   (See this week’s Ty’s Take for a very brief explanation of a very complex topic).

One thing I mentioned in last edition’s Ty’s Take is that I am scared the U.S. would blow up the party if producers jump too soon and rush to lock in cheap rig contracts and otherwise benefit from lower service pricing (as we all know, as demand goes up, if supply is constant, so do prices). Because the reality is this accord that has been reached amongst OPEC and non-OPEC members is only for six months, is very fragile, and while it theoretically throws the market into deficit (assuming compliance by signatories to the agreement), it is not that substantial of a deficit in the grand scheme of things. And one must wonder, if OPEC feels like it got the short end of the stick, might it turn the pumps back on in six months? Nevertheless, I tempered that with my note that banks, and others who control the purse strings, would have to loosen up and they were not likely to do so until they are confident that the recovery is sustainable.

In the article this week on optimism, I laid out a basic case of how U.S. producers view pricing. And fortunately and unfortunately at the same time, producers are indicating they are ready to start pumping sooner rather than later.  To summarize a few of those factors:

In an interview with Squawk Box, Hess CEO John Hess stated that given the production cut agreement, the friendliness of the incoming U.S. Presidential administration to oil, he believes we are beginning a new chapter of rising oil prices that will attract investment. He further appears to believe that new investment is, at this point, necessary, to insure continuing supply to keep up with world demand. Mr. Hess predicted $60-$80 per barrel oil next year.

            Gulfport Energy Corp just struck a deal to purchase acreage in an oil and natural gas field in Oklahoma for $1.85 billion. The significance of the deal is it is a bit more risky as it is outside the traditional heart of the U.S. shale gas boom. To me, this indicates a greater willingness for risk taking which is characteristic of a belief in higher prices.

And as we stated previously in an article on earnings, every major player indicated they would resume at least some drilling at $60.00 a barrel.

But apparently it was less than sixty a barrel that spurred drilling. U.S. rig counts bottomed out in May at 316, but have steadfastly risen to 498 as of the last report.

Last week, we learned that U.S. drillers had increased production by about 100,000 bpd to nearly 8.8 million barrels. The EIA now forecasts U.S. crude production to average 8.8 million bpd in 2017 as opposed to its previous forecast of 8.7 million bpd for 2017. It also projects an average WTI price of $50.66 a barrel next year, up 1.5% from its prior forecast.

But even more interesting is that we see American Shale Companies’ rushing to hedge. Given the run-up in the price of oil over the last few weeks, oil companies have been able to lock in prices for their crude above $50.00 a barrel. Pioneer Natural Resources, Co., for example, increased its hedges from 50% of production to 75% of production. In effect, these oil companies have guaranteed a certain rate of return. While most of the hedging activity right now is anecdotal, a record 580,000 crude options contracts were traded on the NYME on December 02, 2016 – right after oil ran up on news of the OPEC agreement. This may give us a glimpse of how the oil companies are viewing the recovery and what they believe the future price point is.

In effect, these producers can now produce with almost reckless abandon in their hedged properties as they are guaranteed a certain level of profit that they are comfortable with. This might also allow them to gamble more on other properties.   If they now know they are guaranteed a certain rate of return, they will pump.

So will American producers ruin the party? Who knows. As I have said before, I’d rather have a sustained recovery than a short lived one, even if it means a bit more pain in the interim. American oil has indicated they are ready to strike (and have already started).   If they go hog wild, or if OPEC refuses to agree to extend production cuts in June, we might be in for the next downturn before we are even fully out of this one.

By: Ty Chapman

Five Star Metals, Inc.
Raising the Bar for Customer Service and Quality
Twitter: @FSM_TY

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