It’s not just OPEC production cuts, Venezuelan chaos, and sanctions that are pushing up oil prices this year--U.S. shale production is slowing, too.
And the result is a phenomenal 30-percent rally in WTI Crude prices in the first quarter, with the U.S. benchmark jumping from as low as $45 a barrel in early January to as high as $60 at the end of March.
These improving supply fundamentals, including waning concerns over global economic and oil demand growth, have led to oil’s best quarterly performance in a decade.
But the key driver has been slowing growth in the U.S. shale patch in response to the 40-percent slump in prices in the fourth quarter of 2018, according to a note from
John LaForge, Head of Real Asset Strategy at Wells Fargo Investment Institute.
While Saudi Arabia is the "swing" producer, managing the market by deliberately withholding or increasing production regardless of price, the U.S. is the world’s marginal oil producer—the country pumping what the industry refers to as the extra barrel of oil—so shale breakeven prices are key to determining global oil prices, LaForge says.
But U.S. oil production growth is now slowing, with average daily U.S. crude oil production slipping in January from the previous month for the first time in nearly six months, according to the EIA’s report from end-March.
And it’s in the margins that we should be looking.
"Commodity prices are often set on the margin, which means that they are set by the country that is producing that extra barrel of oil, ounce of gold, or pound of copper. In the case of oil, the U.S. is producing that extra barrel of oil for the world to consume," LaForge notes.
"The 2019 oil-price rally is a direct reaction to the potential for future U.S. production growth to slow," according to Wells Fargo Investment Institute, which has a $65 a barrel year-end 2019 price target for WTI.
Referring to the breakeven prices at the world’s marginal oil producer, LaForge said:
"The mid-$40s is the point at which the average U.S. shale producer starts seriously questioning (curtailing) its future drilling plans—and this is precisely what happened at the end of 2018."
Shale producers tend to agree with that view.
According to the Q1 Dallas Fed Energy Survey, with executives from 82 E&P firms chiming in, average breakeven prices to profitably drill a new well range from $48 to $54 per barrel, depending on the region. Drillers need $50 a barrel on average to profitably drill a new well, down from $52 per barrel when the same question was asked last year. Average breakeven prices in Midland in the Permian were $48, the lowest-cost in the U.S., and the lowest-cost region in the past three years.
"With the recent recovery in oil prices, the majority of firms in the survey can profitably drill a new well at current prices; 78 percent of responses were at or below the March 22 WTI spot price ($59 per barrel)," the survey showed.
However, the Q1 rally from $45 to $60 has been significant, so looking forward, the higher WTI prices will likely result in extra U.S. oil production in the coming months, setting the stage for more supply on the global market, Wells Fargo Investment Institute’s LaForge said.
"The next short-term oil move may be down, probably into the low-to-mid $50s. Later in the year, though, we suspect that WTI will make a run at $65 as geopolitical tensions heat up among oil-related countries," he noted.
Later this year, oil prices will be driven by a combination of many factors, including, but not limited to, the pace of U.S. production growth. The tightening U.S. sanctions on Venezuela, the upcoming U.S. waivers decision for Iranian oil buyers, OPEC’s next production policy move, and geopolitical flare-ups such as those in Algeria and Libya will influence the supply side of the oil market. Global economy and trade issues will determine how resilient (or not) oil demand growth will be this year.
By Tsvetana Paraskova for Oilprice.com
