Russia’s invasion of Ukraine triggered a sharp but brief rally in oil prices. The terror attack on Israel, the retaliation in Gaza and the resultant atrocities on commercial ships in the Red Sea also failed to cause considerable anxiety amongst market players. From oil’s perspective in these geopolitical hotspots there has been no disruption of supply, merely the realignment of oil flows. It is this status quo that has been upended lately, reflected in significantly declining Russian refinery utilization rates.

The pain Ukrainian drone attacks have been inflicting inexorably on Russian oil infrastructures for the better part of the last two months is growing. The latest casualty was a Rosneft-run refinery in the city of Samara, which was forced to halt one of its primary refining units on Saturday. It adds to the nearly 10% of the country’s offline refining capacity. Domestic supply has become a priority adversely affecting product exports. It should logically mean that unrefined crude should find its way to Europe and Asia. Yet, most plausibly because of lack of available domestic storage and lax additional demand from friendly nations, Moscow ordered producers to cut production by 500,000 bpd citing the compliance with its allocated OPEC+ quota as the main reason. Russian statistics are anything but transparent, consequently it is impossible to reliably assess production and exports, but it is a fair estimate that in total close to 1 mbpd of output and exports might have been impacted. Adding to this tally the loss of roughly 150,000 bpd of crude oil exports from South Sudan via Sudan due infighting it is more than comprehensible that macroeconomic developments, possible interest rate cuts and even the UN resolution that demands immediate ceasefire in Gaza have been put on the back burner and oil prices rallied as a result of diminishing supply.

Slowing US Shale Growth

Output from the seven major US shale oil producing regions have been defying expectations. After the Covid crisis, which saw LTO production plunge from 9.25 mbpd in December 2019 to 6.79 mbpd only 5 months later, the prevalent view was that output reached its peak and focus will shift from the ‘growth at any cost’ business model to the ‘leaner and meaner’ approach. Dividends and share buybacks were to come into focus at the expense of growth. True enough, the share prices of different shale producers were set on an upwards trajectory 3 years ago and have not deviated from it ever since. EOG Resources, for example, bottomed out below $30 in October 2020 and is now worth around $115, an increase of nearly 300%, outpacing the increase in the S&P 500 Energy (Sector) Index. Yet, what we have seen in the interim is that shale production has been rising unabated and matched the post-Covid high last March on its way towards 10 mbpd. It hit 9.93 mbpd in December before retreating, mainly due to weather-related shut-ins in January, which pushed output to 9.35 mbpd, a monthly loss of 580,000 bpd.

The recovery is under way. After forecasting a shale output of 9.76 mbpd in March, the EIA, in its Monthly Drilling Productivity Report, foresees a monthly increase of 10,000 bpd next month. There are no prizes for guessing which region is the juggernaut in the US shale sector. It is the Permian, which will pump as much as 6.11 mbpd next month. The basin is and has constantly been responsible for around 61-63% of the total US shale production.

Despite this recovery, what is noticeable is the declining monthly growth rate. The average expansion in 2023 is seen around 90,000 bpd per month, which has declined to 4,000 bpd in March and around 10,000 bpd in April this year as we ignore the anomalies mentioned above recorded in January and February. The question, therefore, is whether shale output, which makes up around three-quarters of the total US crude oil production, will plateau soon or the growth will continue relentlessly.

There are several indications suggesting that the peak is not exactly in sight yet, nonetheless the increase will slow down considerably – notwithstanding the EIA forecast of US production growth of 460,000 bpd in 2025, up from 260,000 bpd this year. Firstly, US rig counts, as reported weekly by service firm Baker Hughes are reluctant to recover. The latest reading was 509, and whilst it is somewhat above the recent low of 494 recorded last October, it is nowhere near the pre-pandemic high of 860. Secondly, DUCs are falling. These are wells that are successfully drilled but no gas or oil is extracted because hydrocracking has not started yet. Their numbers have declined from 7,765 in December 2021 to 4,483 last month. By utilizing these wells supply can be brought to the market faster and cheaper than drilling new ones and their diminishing numbers indicate that more wells are completed, and fewer new wells are drilled, which could have an adverse impact on shale growth.

Last but not least, the industry is undergoing a wave of consolidation, whereas publicly traded producers acquire private shale actors. Last year around $250 billion was spent on acquisitions and oil executives expect another $50 billion worth of deals in the next two years. The most significant of these were Exxon buying Pioneer Natural Resources for $59.5 billion, Chevron’s $53 billion offer for Hess (although Exxon has filed for arbitration) and Occidental’s $12 billion acquisition of CrownRock pending regulatory approval. This consolidation, on one hand, implies that large producers see long-term potential in the shale sector, possibly due to stable oil price estimates and resilient demand but at the same time the plethora of acquisitions will ensure that capex discipline will act as a brake on production growth as shareholders’ return must also be taken into consideration. The shale industry has done admirably well to recover from the 2020 devastation. The sector is firmly in the crosshair of investors again, yet unrelenting growth might be a thing of the past and may not stretch beyond 2025.
 

Overnight Pricing

tamas.varga@pvm.co.uk

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