Oil market players are locked and loaded but still waiting to pull the trigger. Prices struggled for direction yesterday and ended little changed in the wake of industry data pointing to an unexpected build in US crude stocks. Those of a bullish disposition were also unnerved by signs of waning fidelity to OPEC+ production curbs. Compliance with supply curbs in December reached 99%, two sources from the producer group told Reuters on Thursday. The figure is slightly below November’s 101%.
But the biggest source of concern for the energy complex right now is rising coronavirus cases in China. The commercial hub of Shanghai reported its first locally transmitted cases in two months on Thursday. Authorities have since urged people not to travel during the upcoming Lunar New Year holiday as they contend with the biggest outbreak since last July. Needless to say, this will dampen the near-term consumption outlook in the world’s epicentre for global oil demand growth.
Meanwhile, US stock markets continued to trade at record highs yesterday on anticipation of a major new US stimulus package that will help drive the global recovery. These gains came in spite of the now customary set of gloomy weekly jobless claims figures. The number of Americans filing claims for unemployment benefits dipped slightly last week but remained painfully high. The stubbornly high jobless claims total underscores the ongoing economic damage caused by the pandemic and challenges facing the incoming administration.
Speaking of which, in his first full day as US President, Joe Biden offered a dose of reality after the fantasy excuses of the Trump days. He told reporters that Covid cases will continue to mount and that the death toll will probably top 500,000 next month. This solemn prediction came as the US reported record daily increase in deaths. In other words, no quick fix is on the cards with tough times still to come.
Rising from the ashes
Look up resilience in the dictionary and you’ll find a picture of nodding donkeys in the Permian Basin. The US shale sector has been written off time and time only to return stronger than ever. And sure enough, after crumbling under the pressure of the pandemic, improvements to the supply side of the equation for US shale are already apparent.
US energy firms added oil rigs for an eighth week in a row in the week to January 15. The number of active rigs rose by 12 to 287, their highest since May versus their nadir of 172 in August. All the while, in their latest monthly reports, the EIA/IEA/OPEC triumvirate have taken a less dim view on US oil growth prospects for this year. According to the EIA, US crude output will decline by 190,000 bpd this year, less than a previous estimate of 240,000 bpd. The IEA also adopted a slightly more optimistic view for the US after upping its supply forecast by nearly 200,000 bpd since last month’s report. As for OPEC, it upgraded its latest projection for US oil production, so much so that it has pencilled in a return to annual growth for the shale patch. The organisation now expects US tight crude output to rise by 70,0000 bpd this year to 7.37 mbpd.
At the heart of the brightening outlook are rallying oil prices. Benchmark US crude prices have scrambled past the $50 sweet spot for the first time since the onset of the pandemic. The upshot is that a big chunk of US shale is now profitable. Underscoring the profitability of current prices levels is the fact that US shale oil companies have taken the opportunity to lock-in higher future revenues. Short positions on WTI contracts in the ICE & CME futures and options market opened by producers hit a six-month high of 706 million bbls in the week to January 12. This flurry of hedging activity will not only bolster cash flows but also limit the downside to production.
As things stand, a stronger-than-expected shale recovery is in the making for this year. Yet that is not to say that growth is assured in 2021. This is especially true given that US shale companies are unlikely to lift production in the near-term. The days of spending beyond their means in the pursuit of faster growth have given way to a disciplined approach to production control. As a consequence, they will most probably use the windfall from the Saudi gift to pay back debts and give more back to investors.
Small wonder, then, that current production remains subdued. Total US crude output has been steady at 11 mbpd over the past few weeks. What’s more, the EIA said this week that overall US shale output is expected to decline by 89,000 bpd in February to 7.52 mbpd. This is the legacy of sweeping bankruptcies and capital restraint by US shale producers in previous months.
Looking ahead, however, provides cautious optimism for a return to growth towards the end of the year. US shale producers are expected to be the top beneficiaries should oil demand come roaring back in the coming months. This, coupled with the allure of higher oil prices, should set the industry on the path for stronger growth at the tail end of this year and into 2022. That said, much depends on OPEC+, and specifically Saudi Arabia, providing continued price support. There is every risk that the producer alliance may taketh what it giveth, full in the knowledge that its actions will enable its competitors to ramp up supplies.