The rebalancing of the oil market has been possible, in part, due to the sharp cutbacks in U.S. shale production. But what happens next for the industry?
The latest data from the EIA estimates that production plunged by a colossal 600,000 bpd in the week ending on June 12, a massive decline that puts output down more than 2.6 million barrels per day (mb/d) from the weekly peak hit in mid-March (to be sure, monthly EIA data shows the U.S. hit a slightly lower peak in November 2019).
At the same time, the industry is bringing shuttered production back online. Reuters says that 500,000 bpd of shut-in production could be restored by the end of June. For instance, Devon Energy (NYSE:DVN) shut in about 10,000 bpd in recent weeks, but is “in the process of bringing all of that back on,” Devon Energy CEO David Hager said at a JPMorgan conference on Tuesday, according to Reuters.
Analysts have varying perspectives on what happens next for shale drilling. According to Morgan Stanley, the industry will proceed in three phases. First, shut-in wells come back online. Then production stabilizes, but an average of $40 per barrel will be needed for that to occur. Finally, production growth resumes, assuming prices move back up to $50 per barrel.
However, there is “little room for US production to grow this year or next,” Morgan Stanley cautioned, noting that if output began to rise, it would merely derail the oil price rally. The capex cuts announced to date should translate into production declines of 1.8-1.9 million barrels per day by the end of 2020, compared to the end of 2019.
The bank said that the shale industry will need two years or so of WTI averaging at least $50 per barrel in order for shale output to rebound to pre-COVID-19 levels. “Some level of growth would likely come back quickly in the first year, and moderate thereafter without higher investment due to the reversal of temporary cost reductions, depletion of drilled-but-uncompleted (DUC) well inventory, and rising base declines,” the bank concluded.
JBC Energy forecasts WTI averaging $40 per barrel for the rest of the year. “Under this assumption we see completed wells having reached their nadir of below 200 in May with a gradual recovery to 700 by the end of the year and 1,000 by end-2021,” the firm wrote in a note.
If prices actually averaged between $45 and $50 per barrel, which would require better compliance from OPEC+ to their cuts, then it would be a “turning point” for U.S. shale, the firm argued. Shale output would reach an “inflection point” in November 2020, and see a “swift recovery thereafter,” JBC said. A year later, U.S. shale output would be back to pre-pandemic levels.
That is a more optimistic scenario. JBC’s base case calls for U.S. shale to take until September 2023 to return to peak production levels last seen earlier this year. But “[c]onsidering current sentiment…we would tend to see the risk to our shale supply base case skewed to the upside,” JBC wrote.
Others are more pessimistic, noting that both oil and broader financial markets are getting a little frothy. “[T]he rally across commodities has gotten ahead of fundamentals with the exception of metals,” Goldman Sachs wrote in a June 9 report.
They are not alone. “We think the oil market is not currently pricing in a significant probability of either second waves of coronavirus cases in key consumers and the associated lock-downs, or anything less than a rapid return to economic business-as-usual,” Standard Chartered wrote in a June 16 report. “We think this absence of shades of grey represents a downside risk to prices medium-term, but short-term, unnuanced hope is proving to be a powerful force supporting prices.”
The bank went on to criticize media representations of the oil market as “tight,” adding that “[w]e do not think a market with more than a billion barrels of excess inventories and more than 10 million barrels per day (mb/d) of spare capacity in OPEC+ can be described as tight.” While global supply may fall below demand in the coming months, it would take roughly two years to bring inventories back to the five-year average, the bank noted.
Meanwhile, many U.S. shale companies are drowning in debt. Just a few days ago, Extraction Oil & Gas (NASDAQ:XOG), a large shale driller in Colorado, declared bankruptcy. Chesapeake Energy (NYSE:CHK), which arguably best represents the debt-driven shale bonanza, is expected to file for bankruptcy any day now. The Chapter 11s, and even the “Chapter 22s” – a nickname for those that are set to declare bankruptcy for the second time – are expected to continue to rise.
All the while, steep decline rates will likely more than overwhelm any new drilling that takes place. Oil prices have bounced off of April lows, but U.S. shale is far from a comeback.