US crude output and its impact on oil prices: How the shale boom turned world oil markets on its head

US crude output and its impact on oil prices: How the shale boom turned world oil markets on its head

SUMMARY:
  • Crude oil prices are primarily driven by supply and demand fundamentals. As prices rise, more capital is deployed, and more supply comes online, eventually outstripping demand. Prices then begin to drop, causing less productive wells to get shut-in. Output falls until markets return to balance, putting a floor under the oil price. The cycle then repeats.
  • US oil output peaked in 1973 and steadily declined through 2008, despite a sharp recovery in oil prices.
  • The shale boom, which began in 2010, changed the dynamics of global supply. Improved technology, coupled with the availability of cheap credit, allowed US output to rise by over 5 million bbl/day by the end of 2015, tipping markets into a dramatic oversupply, and sending oil prices plunging.
  • Curtailments and disruptions, primarily from OPEC members, would help oil prices recover to more than US$50 a barrel, which is above breakeven for most US shale producers.
  • Total US output has now soared to 12 million bbl/day, with another 3 million bbl/day expected to be added in the next three years, again outstripping demand growth. And that will likley keep oil prices lower for longer during this economic cycle.
  • So far, OPEC and its members have eaten a lot of those extra barrels. But the implications are enormous for countries like Canada, who still have billions of higher-cost barrels in the ground.

Supply and demand is an underlying driver of all commodity prices, including crude oil.

Low oil prices have traditionally benefitted the world's largest importers, namely Europe, China, India and Japan, along with the world's biggest consumer, primarily the US. As the economy expands, energy consumption expands along with it.

As oil prices rise, consumers feel the pinch and dial back. Countries with little or no domestic supply get hit especially hard. Spikes in oil prices can trigger recessions, as high energy prices divert funds from other parts of the economy.

There's a certain oil price below which the capital dries up and wells get shut-in. Go above a certain threshold and more capital gets deployed, bringing more oil online. Oil price forecasting is therefore the art of figuring out where that breakeven point lies, for any given point in time.

Although breakevens will obviously vary by region, and even by company, this is the story of US oil producers, how they disrupted the industry and may be responsible for keeping oil prices lower for longer in this economic cycle.

HOW IT WAS FOR A LONG TIME

US oil output peaked in the 1970s, then steadily declined over the next few decades. Despite a surge in oil prices to as much as US$140 in 2008, US producers were unable to grow production, and hit rock bottom at just under 4 million bbl/day. The US oil industry was left for dead, as the more prolific basins were depleted, and no new sources were visible on the horizon.

Just a few years later, all bets were off the table.

Enter the shale boom — a revolutionary step change that combined fracking, an existing technology, with horizontal drilling. Throw in improvements in seismic imaging, and producers would now beable to pin point the exact location of their reservoir, drilling further with fewer wells. This step change in technology shifted the dynamics of the entire global energy sector.

HOW SUPPLY IMPACTS OIL PRICES, AND OIL PRICES AFFECT SUPPLY

US crude oil production peaked in the late 1970s at just over 10 million bbl/day. The country had just emerged from a mild recession that lasted almost a year. Oil prices were low at the time, barely US$21 a barrel (in 2019 dollars), and wouldn't see a meaningful uptick until OPEC's embargo at the end of 1973.

INFLATION-ADJUSTED WTI SPOT PRICE (1970-2018)
2019 USD/bbl • monthly data from EIA
INFLATION-ADJUSTED US OIL PRICE (WEST TEXAS) 2019 DOLLARS PER BARREL

Despite a massive surge in oil prices that would last through the remainder of the 1970s, US output failed to recover. Supply hit a short-term high of 9.4 million bbl/day in the spring of 1985, then began an almost linear descent for more than two decades.

Then the financial crisis hit in 2008. Credit markets seized up, as several prominent US banks and investment firms went under. As funding dried up, producers cut all non-essential spending, taking all uneconomical barrels offline. Total US production would touch a low of 3.97 million bbl/day in the fall of 2008.

TOTAL U.S. CRUDE PRODUCTION (1960-2018)
million bbl/day • monthly data from EIA
HISTORICAL US CRUDE OIL PRODUCTION (1960 TO 2018)

As interest rates were cut to zero, the energy patch managed to stage a small, albeit impressive, recovery. Oil companies teetering on the edge of bankruptcy were suddenly able to stay afloat, thanks to cheap credit that flooded the markets. Several hundred oil rigs came online and output was restored to about 5.5 million bbl/day by the summer of 2009. Total US crude supply would remain stuck at that level through much of 2011. 

Oil prices had recovered nicely at this point, returning to US$100 a barrel (2019 dollars), a level at which all producers, including OPEC, were generally happy. 

World oil markets would then be turned upside down, once again. Another thousand oil rigs would come online over the next 5 years. Capital investment in the energy patch hit an all-time high in 2014, due in part to historically low borrowing costs. US producers put a record 1,600 oil rigs into service by the end of 2014.

REAL WTI SPOT PRICE VS RIG COUNTS (1987-2018)
monthly data from EIA and Baker Hughes
INFLATION-ADJUSTED WTI PRICE VERSUS RIG COUNTS

The shale boom brought a step-change in technology that allowed producers to tap into less productive wells, at a lower cost. Output surged from 5.5 million to 9.5 million bbl/day by 2015, an increase that no one had anticipated. All that extra crude would tip world oil markets into a dramatic oversupply, sending oil prices plunging back to earth.

U.S. CRUDE OUTPUT VS REAL WTI SPOT PRICE (1987-2018)
monthly data from EIA
INFLATION ADJUSTED WTI PRICE VERSUS OIL RIG COUNTS

HOW OIL PRICES IMPACT PRODUCTIVITY

There is a point at which only the strongest producers survive, and that point is about US$45 a barrel (2019 dollars). Oil prices were stuck in that universe through the latter half of the 1980s and into the 1990s. Productivity was insensitive to oil price, as more rigs didn't necessarily equate to more production.

But as prices slowly got above US$50 a barrel, more capital became available, bringing more rigs online. Productivity then declines, as companies tap into the less productive wells. 

WELL PRODUCTIVITY VS REAL WTI SPOT PRICE (1987-2018)
monthly data from EIA
OIL WELL PRODUCTIVITY VERSUS WTI SPOT PRICE (1987 TO 2018)

Prior to the 2010 fracking boom, US$50 oil demanded about 35,000 bbl/day of crude from each well, in order to remain economically competitive. Output would flatline at 15,000 bbl/day per oil rig, once oil prices got above US$100 a barrel.

But after 2010, the productivity curve shifted lower, as drilling and exploration costs declined. At lofty oil prices, output now drops to as little as 5,000 bbl/day per rig, almost one-third the level before 2010.

As WTI currently lingers in the US$50 a barrel range, there is still money to be made in the tight oil space, with as little as 15,000 bbl/day required per well, less than half the breakeven before the shale revolution. Despite languishing oil prices, US oil output has now surged to 12 million bbl/day, with less than 900 rigs in service. 

U.S. CRUDE OUTPUT VS RIG COUNTS (1987-2018)
monthly data from EIA and Baker Hughes
HISTORICAL US OIL OUTPUT VERSUS RIG COUNTS (1987 TO 2018)

IMPLICATIONS FOR THE REST OF THE WORLD, INCLUDING CANADA

Supply out of the US shows no signs of relenting any time soon. The country has added 1 million bbl/day of supply annually since 2012. By the end of 2019, world oil markets will have had to digest an extra 7 million bbl/day in just 7 years, outstripping world oil demand growth by a wide margin.

So far, Saudi Arabia has been forced to curtail a lot of those extra barrels, along with Russia. Political gridlock in Libya, Nigeria, Venezuela — and even Canada — has also helped ease the glut and keep oil prices afloat, although not by choice.

Despite persistently low interest rates, capital investment is only a fraction of the highs of 2014. And that has helped keep a lid on global production outside of the US, preventing oil prices from plunging even further.

According to the EIA, production is expected to top 15 million bbl/day by the early 2020s at current oil prices. Higher oil prices, technological advancements, and development of untapped resources could bring that number closer to 20 million bbl/day by 2040, a time when world oil demand is expected to be on the decline.

The implications are enormous for global oil producers, particularly for countries like Canada, Venezuela and Brazil, that have billions of barrels still sitting in the ground, or under the sea.

And that's especially bad news for OPEC, who have designated themselves the world's swing producer.

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US Oil Output and Impact on WTI • Excel data and charts
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Monthly supply and WTI data (Jan 1960 to Jan 2019):
• Total US output (million bbl/day)
• WTI Spot Price (USD/bbl)
• CPI Inflator
• Inflation adjusted WTI price (2019 USD)

Monthly oil rigs data (Aug 1987 to Jan 2019):
• No. of oil rigs in service
• Well productivity (output/rig)

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UPDATED:  MAR 1, 2019
SOURCES:  WIKIPEDIA • HYDRAULIC FRACTURING
WIKIPEDIA • 1973 OIL CRISIS
FORBES • HORIZONTAL DRILLING: A TECHNOLOGICAL MARVEL IGNORED
ENERGY INFORMATION ADMINISTRATION • ANNUAL ENERGY OUTLOOK 2019
BP • WORLD ENERGY OUTLOOK 2019
WSJ • BARREL BREAKDOWN
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