The list of superhero trios is long and illustrious. Think of Batman, Superman and Wonder Woman. Iron Man, Captain America and Thor. Well now you can add the ECB, BoE and Federal Reserve to that distinguished list. The leading guardians of global monetary policy brought out the big guns yesterday as they stepped up their fight against the villain that is the coronavirus pandemic. The offensive got underway with the ECB unleashing a $750 billion programme of new bond purchases. The Bank of England then jumped on the stimulus bandwagon after cutting rates to the lowest on record and further increasing its QE programme. Bringing up the rear was the Fed which boosted access to dollar swap lines in a bid to ease pressure on global dollar funding markets.
This flurry of supportive measures was cheered by market players. Global equity markets enjoyed a rare reprieve from the selling frenzy. Oil, meanwhile, surged into the stratosphere. A three-day wave of selling took a breather as both crude markers bounced back from near two-decade lows. Leading from the front was WTI which leapt 25% in what was its biggest one-day gain on record. Brent ended the session “only” 12% higher. Underpinning these gains was a pledge from President Trump that he would intervene in the Saudi-Russia oil price tussle. This stoked hopes that production cuts may soon be forthcoming from these two oil behemoths under pressure from Washington.
Yet for all of yesterday’s bullish heroics, the latest bout of price strength is unlikely to have the legs to carry on. The world is awash with oil. Saudi Aramco yesterday signalled it will pare back domestic crude throughputs in April and May to make more available for export. Alongside this flood of oil, there is underlying scepticism that the barrage of monetary stimulus will be enough to counter the adverse economic effects of the COVID-19 outbreak. Simply put, oil is facing a prolonged period of demand destruction. Accordingly, the current feel-good factor will not last and prices will soon resume their southerly trajectory.
Cast your mind back to November 2014. Saudi Arabia unleashed a price war on US shale in a bid to drive the industry into the ground. While it did inflict considerable damage to some shale players, ultimately the OPEC kingpin failed in its quest. US tight oil companies slashed spending in response to the price collapse. The industry made quick technological advances which led to a significant increase in production. When all was said and done, the industry emerged stronger and leaner from the period.
Fast forward to the here and now, Saudi Arabia has triggered anther price war, though this time it is different. Unlike un 2014, the oil price crash was unexpected, fast and brutal. Prices were close to the to the $50/bbl shale breakeven before prices crashed into the abyss. Furthermore, US shale producers are lacking support from investors. As for efficiency gains, they have all but fizzled out. Put in layman terms, there is no more fat left to cut.
This spells bad news for the growth outlook of the US shale patch. This is especially true given that the industry is already in the midst of a slowdown as producers curb spending plans for a second consecutive year. Underscoring the cooling narrative is the latest EIA drilling report. US shale output is forecast to increase by 18,000 bpd next month to 9.07 mbpd. This compares unfavourably to an increase of 127,000 bpd during the same month in 2019.
All seven major US shale plays bar the prolific Permian are expected to register a drop in production next month. Output in the Permian is set to increase by 38,000 bpd in April to 4.79 mbpd. Yet even here there are pockets of weakness. Production per rig in the basin has stagnated since year-end 2019 as producers shift to less productive wells. All the while, EIA forecasts Permian oil output will average 4.75 mbpd in March, down 101,000 bpd from last month’s forecast for the month.
Needless to say, the ongoing price slump will inevitably trigger another brutal round of cost cutting. The rumour mill is in full swing that US shale players will trim spending plans by as much as 30% this year. This could be even higher as they face increased pressure to respond to investor demands to maintain strict capital expenditure discipline given the backdrop of low oil prices. In short, US shale producers face their biggest ever credit crunch.
The upshot of these financial constraints is that drilling activity will not rebound in the near-term. Last year, the Baker Hughes oil rig count, an early indicator of future output, shrank by 23%. This was the first annual decline since 2016. The number of wells drilled in February was the least since June 2017, according got the EIA, and rig counts could easily decline by more than 25% this year. This deepening slowdown is reflected in production forecasts. The EIA most recently said that U.S. oil production will likely peak next month at 13.2 mbpd before it begins to decline, dropping by around 660,000 bpd by next summer. Others are more pessimistic. Analytical firm ESAI Energy warns that US shale output could drop by 1 mbpd in 2020.
Amid the decline in drilling capex and pullback in rig counts, there is another sign of the fading fortunes for US shale. Drilled but uncompleted wells, better known as DUCs, have ballooned since 2016 but are now being put into action by shale producers. The number of DUCs has fallen by more than 10% from last May’s peak to the lowest since November 2018. This decline is symptomatic of the slowdown in US shale. Specifically, it suggests that the industry is not drilling enough new wells to sustain upward momentum. Worse it yet to come as companies face a prolonged period of $30 oil. Ever since 2014, US shale has been a game of survival of the fittest, but never more so now.