Market Insight

We've seen this movie before


Even as OPEC reported that its members had achieved their targets, the group saw trouble on the horizon in light of rising stock inventories not only in the US, but also in Europe. In its monthly report, the cartel revised its forecast for non-OPEC production growth upward by 160K b/d to 400K b/d in 2017. US production growth this year was revised up by 100K b/d. "Nevertheless," OPEC said, "Prices have undoubtedly been provided a floor by the production accords." That analysis, however, was presumably written before crude prices fell by about 10% in the week from March 7.

Meanwhile, some OPEC delegates have privately said that the group may be running out of strings to pull. "It was obvious that with a reversal in prices, the US shale production was going to pick up," said one. "But the magnitude of the improvement was really not known." A delegate from an African country added "As prices go up, you attract a lot of producers back. This has become the reality. With US shale producers and others, you certainly can't just get rid of them. That much is clear…the era of high oil prices is over for the time being. And maybe for good." Independent analysts agreed. "Cuts are not enough to re-absorb the world's excess supply," said Leonardo Maugeri, a senior fellow at the Harvard Kennedy School's Belfer Center for Science and International Affairs. "So, unless oil demand growth rebounds to record levels in 2017, oil prices could head for another substantial fall."

Russian state producer Rosneft warns that there is a risk that renewed production from US shale fields will cause OPEC's newfound unity to fall apart once more, setting off another round cut-throat competition among producers. "It became evident that US shale oil output has become and will remain a new global oil price regulator for the foreseeable future," Rosneft said. "There are significant risks the deal won't be extended partially because of the main participants, but also because of the output dynamics in the United States, which will not want to join any deals in the foreseeable future…we think that in the long-term global oil demand dynamics and reduced investment during the period of ultra-low prices will balance the market, but that the risk of a price war resuming remains."

This renewed price war looks like a rerun of a movie called "Blame US Shale Plays". If this is the case, we will see this rerun over and over again for the foreseeable future. OPEC and some non-OPEC (NOPEC) producers have limited tools—especially since driving oil prices down to below $30 a barrel in early 2016—to constrain shale oil production in the US.

Market disruptor refuses to go away

Similar to how Uber has acted as a disruptor in the transportation market, US shale plays are completely changing the industry. In the case of shale oil in the US—perhaps coming soon in other parts of the world—the impact will have a long-lasting effect. So far, OPEC and some NOPEC producers have realized that US shale producers are very adaptive and innovative by improving technologies and working with energy services companies by negotiating for lower fees. In the downturn, some small and marginal players did not survive, but stronger ones have become leaner, in terms of cost-cutting, and meaner while buying depressed assets and amassing acreage in prime locations.

Big Oil raises stake in shale business

International oil majors are now turning attention to shale business in a big way. It would definitely create a formidable competitor in the global market. In Jan., ExxonMobil paid $6.6B to acquire land in the Delaware Basin portion of the Permian from the Bass family that more than double the acreage the company holds in the play. The company is reportedly planning to increase production from the Delaware Basin this year and may bring up to 15 new drilling rigs online in the play going forward. Exxon added that its total production from the Permian as a whole could rise from 140K b/d last year to 350K b/d this year as a result of the increased drilling activity in the Delaware Basin. The company added that the expected uptick in production from the Permian combined with its production from the Bakken means tight oil could account for 20-25% of Exxon's total crude production in 2017.

Meanwhile, Shell is planning to boost its production across its shale assets from 280K boe/d currently to 500K boe/d within the next decade. The firm will particularly focus on accelerating the development of its US shale assets as a result of better-than-expected cost-cutting program at these assets that has lowered the breakeven cost at these wells to $40/bbl. By 2020 Shell is aiming to increase production from its Permian Basin assets in west Texas and Duvernay assets in Canada by a combined 140K boe/d. Shell is also considering investing $300MM with YPF to develop 250K acres in the Vaca Muerta shale play in Argentina.

Impacts of oil market volatility on global refiners

Once considered a solution to the oil market rout which began in mid-2014, the production cut agreement by OPEC and several NOPEC producers from Jan. to June 2017 is apparently falling apart. The primary reason is a fast recovery of resilient US shale plays. At the same time, fuel demand growth is lagging despite rising consumption in some parts of the world. With currently unpredictable political and economic conditions, the oil supply and demand imbalance remains and price volatility will prevail in the foreseeable future.

As a result, many refiners around the world are motivated to buy more price-advantaged heavy and lighter grades on the spot market and try to blend them together in order to create so called look-alike crudes similar to what they are processing. The rewards from shopping for relatively cheaper oil on the spot market are there, but changing crude types more frequently and increased blending of different crudes pose challenges for refineries. The problems go beyond crude-refinery mismatch as "improper" blending of light and heavy grades to make the look-alike crudes will create feedstocks with dumbbell qualities and generate undesirable product mix. Also, the changing and blending of crudes could lead to equipment failures, poor catalyst performance, unit shutdowns, and safety issues. At the same time, refiners are confronting fuel demand shift from diesel to gasoline (in certain parts of the world), International Maritime Organization's decision to lower the sulfur content in the bunker pool, and the Paris Climate Agreement to lower GHG emissions.

Finally, to find out more on how to survive and prosper in this volatile and uncertain market environment, read our just published multi-client report, Novel Strategies of Processing Price-Advantaged Crudes in a Volatile Oil Market. This study discusses flexible operations and technology innovations to meet changing crudes and shifting product demand. Details of this study can be found by clicking here.


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