It’s safe to say that the oil market is still feeling the effects of Hurricane Ida. The volume of oil shut in the Gulf of Mexico rose on Thursday to 1.7 mbpd despite the return of more crews to platforms. All the while, nearly 2 mbpd of US Gulf Coast refining capacity is estimated to be currently offline. The key question is which will make a quicker return – offshore oil production or refining capacity. As things stand, the loss of US refinery demand will likely be more prolonged than the loss of crude supply given the extent of power outages and flooding in the region. Reports are doing the rounds that refinery outages could take weeks to resolve whereas US Gulf output recovery is poised to begin within a few days.
Yet the prospect of smaller crude demand in the USGC as refiners struggle to bring back full capacity anytime soon was lost on crude prices yesterday. Brent and WTI rallied by around a buck and a half. Oil bulls took heart from the latest pullback in US crude stocks and improving demand side fundamentals. Buying pressures were also supported by upbeat US macro updates. The number of Americans filing new unemployment claims dropped to a pandemic low last week. Moreover, in another encouraging sign, US factory orders continued to rise in July despite supply constraints. All eyes will now be on today’s non-farm payroll report. A solid number should ensure that risk assets including oil finish the week on a high.
Emerging from the sidelines
The US shale industry has been notably restrained so far this year even as oil surged past $70/bbl. Shale operators ditched the oil growth playbook and instead chose to reward shareholders with more dividends and healthier balance sheets. Consequently, US oil production has stagnated at around 11 mbpd since March. More recently, however, the US oil patch has been undergoing a mini-revival. Output is trending higher and hit 11.5 mpbd in the week to August 27, the highest reading since May 2020.
US oil production has ticked up in recent weeks as shale producers go through a massive backlog of drilled but uncompleted wells (DUC). EIA data showed that the number of DUC wells in the seven shale regions fell by 258 from June to stand at 5,957 in July, the fewest in any month since November 2017. The monthly completions of DUCs between March and July averaged 283 DUCs per month. This combination of more wells being completed but fewer wells being drilled is contributing to the return of oil production.
Now though, as DUC inventory levels normalise, shale producers are ramping up drilling activity to offset legacy declines. Baker Hughes data showed a fourth straight weekly rise in US oil rig count last week. Drillers added five rigs in the week to August 27, taking the total to 410, the highest since April 2020. For August as a whole, drillers added 25 oil rigs, the most in a month since January. All the while, well completions are still ticking higher. The Frac Spread Count provided by Primary Vision, which is the number of completion crews finishing off previously drilled wells, shows that the number of fracking crews rose to 240 in the week to August 27, up from 236 in the previous week.
Robust activity among US drillers and frac crews suggests that domestic oil production will pick-up further in the final third of this year. According to the latest EIA drilling productivity report, US shale oil output is expected to rise to 8.1 mbpd this month, the highest since April 2020. Moreover, in its latest report, the EIA said it expects US crude oil production to average more this year than previously forecast. This is based on the assumption that oil prices stay near current levels.
The fledgling uptick in US crude production will be quietly cheered by Washington. Despite its climate change agenda, the Biden administration is keen on more supply as it frets over high oil prices. After having been recently shunned by OPEC and its allies, it will be encouraged to see home-grown producers doing its dirty work. Meanwhile, US crude exporters will also be taking heart from accelerating growth in US oil production. As more domestic supply reaches the market, the discount between WTI and its global peers should widen, which in turn will boost arbitrage economics.
For all the talk of the improving outlook for the US oil patch, it must be said that production is not on the brink of soaring. It will be more of a trickle than a flood. After all, US shale players are still committed to capital discipline. What’s more, they will not produce barrels that cannot be absorbed by world markets. Yet that doesn’t take away from the fact that the US crude complex is no longer stuck in neutral. US oil output is emerging out of its pandemic-induced slumber and will continue to do so once the latest weather-related disruptions are resolved.