[Long post alert]
I sense that few people appreciate that when the US shale oil industry arrived on the global oil scene in around 2010 it would have been the biggest new single source of oil supply since the 1970s.
In the space of just 5 or 6 years, development of shale oil industry in the US added crude oil capacity of around 8 mmbl/day, turning the US from a significant oil importer, to even enjoying export capability.
For context, total global supply at the time was around 90 mmbbl/day, so an additional 8 mm bb/l is a highly material increase. For further context, Saudi Arabia produces around 10.5 mmbbl/d so the US shales coming online was akin to the global oil market bringing on board almost a new Saudi Arabia.
So, in today's world where supply has been constrained while demand growth exceeds expectations, what happens in the US shale industry over the next 12 to 24 months matters a great deal.
Before Covid, the US was producing
13 mbbl/day. Then Covid struck and the US shale industry went into total disarray. Drilling all but ceased, with the number of active rigs falling from 900 in 2019 to less than 200 by mid-2020, many oil service companies went to the wall and there were mass layoffs of workers in the industry.
So what's the state of play in the US shales today?
Well, if we look back over the roughly the past 18 months (so from the start of 2021), the number of oil rigs operating in the US has doubled, from 280 on 31 December 2020 to 560 today.
There are a few salient takeaways to be made from this:
1.) Despite the decade-high oil prices, the industry has only been able to mobilise less than two-thirds of the number of rigs that were operating pre-Covid, when the oil price was roughly half of its current level.
That's a very significant statement, and it reflects the severe input constraints on the industry - lack of availability of labour, consumables and, importantly, fresh capital. And then there's the not-insignificant matter of a government in the US which is overtly hostile to the oil and gas industry there: It is probably safe to assume that the incoming administration's pre-election threat to jail oil company execs hasn't exactly been conducive to the willingness, on the part of oil company executives, to invest in new oil production (!!).
2.) Despite this doubling in the number of rigs in the field over the past 18 months, US production has increased by only ~8%, to the current rate of 11.9 mn bbl/day, from 11.0 mn bbl/day at the end of December 2020.
And even then, the bulk of that modest increase was made during the course of 2021, with the exit production rate at the end of December 2021 being 11.8 mn bbl/day.
During YTD, CY2022, US crude production has increased by a mere 0.1 mn bbl/day, less than 1%. That's despite the number of operating rigs having gone up by almost ~20% since the start of the year.
The disconnect between rig number and output is already evident:
View attachment 4366627
[Source: EIA]
So, marginal rig productivity has been nothing short of woeful.
Which suggests very strongly that during, and just after, the Covid period - when the oil price was in the doldrums - operators in the shale took their most marginal wells offline and concentrated their limited drilling on the high-grade parts of their acreage. This shouldn't be too contentious conclusion to make, as it is a perfectly economically rational thing to do.
And because of this high-grading of the most productive acreage in prior years, it means that expectations of US shale ramping up output, pro-rated based on an increasing number of rigs in the field, are going to not be met.
Not by a long way.
Because the US shales are facing the double headwind of 1.) not enough rigs are able to be mobilised because of the shortage of critical inputs, and 2.) each additional rig that does become operational does so in a less-optimal part of it's operator's portfolio.
Against that sluggish operational backdrop, you have the fact that shale well output tends to drop off rather quickly due to natural decline - 3% to 5% pa - so you need to run harder merely to stand still, anyway.
The fundamentals for meaningful increases in production from the US shale industry therefore don't look art all positive. Quite the opposite, actually - future production looks like it is going to be heavily constrained, because of the current inadequate capacity mobilisation (i.e., rigs), combined with deteriorating rig productivity.
Of course, one argument that is tempted to be made is that the observable sharp decline in rig productivity is because not all of the additional rigs that have been put into use over the past 18 months are being applied to drilling wells for immediate completion, and that what the industry is doing is building up its "well inventory" by drilling wells that are only to be completed for production at a future point in time.
But the facts show that the exact opposite of this is true: the inventory of drilled, but uncompleted wells (aka DUC's) in the US is
declining. And declining at a rapid pace:
View attachment 4366810
[Source: EIA]
The US oil industry is depleting its inventory of future capacity.
And remember that the US is a very significant source of global oil supply (12% of the world's total).
So you've got one of the world's largest oil producing regions not investing sufficiently to sustain itself at current levels of output.
Based on the discussion above, it should come as no surprise then, if US production actually peaks before too long, and that we in 12 months' time actually see a
decline in US crude production; not an increase, which is what consensus expectation in the market would be today.
I don't believe for one minute that the possibility of that unfavourable US supply scenario is being even remotely factored into current the futures curve for crude.
And if US production disappoints at the same time that pent-up Chinese demand recovers after the current Covid restrictions in China are lifted, that confluence of events would be very positive for the oil price.
And its not as if today's starting position is one of adequate buffer of crude stockpiles; stocks are sitting at near two-decade lows:
View attachment 4366891
Needless to say, I remain very bullish on the oil price.
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(20min delay)