Oil prices soared on Monday and early Tuesday on news that a pipeline in the North Sea had suffered significant damage. 450,000 barrels per day of oil will be shuttered for several weeks while the damaged pipeline is repaired. Brent crude rose briefly to a high of $65 per barrel. WTI, which is not directly impacted, climbed just above $58 per barrel.
WTI experienced a similar jump in price last month when a portion of the Keystone pipeline was taken offline to repair a leak in the northern part of the United States. It is now back online, although functioning at only 20% of previous capacity. Though the pipeline disruption in the North Sea is much more serious than the 5,000 gallon leak in the United States, traders should expect to see a drop in Brent prices when the North Sea pipeline is repaired and transportation of oil resumes.
However, elevated oil prices from this disruption could impact the U.S. shale oil industry as drillers look to lock in future crude deliveries at today’s higher prices. Some fear that the high prices will send shale oil producers into overdrive and they foresee a major drop in prices ahead when more oil from shale producers hits the market at the same time as the North Sea resumes production. There is usually a fear with short-term disruptions that the resulting return to the status quo will cause prices to fall below the pre-disruption price.
However, shale may not actually be able to significantly increase production during this blip of higher prices. In 2015 and 2016, many shale producers had the ability to quickly increase production, but now there is reason to doubt that ability. The shale oil industry is no longer as nimble as was once assumed. The output from shale oil wells drops off much more quickly than from traditional wells, forcing operators to spend more money and drill more wells to keep production constant. Also, shale oil drilling companies are facing rising service costs which make it harder to increase production. At the same time, many investors are pressuring companies to show profits, not just growth, which means some shale producers will not be able to invest in increased production.
Moreover EIA forecasts for U.S. shale oil production, which many oil traders rely on, may be overstating U.S. production. An MIT study recently suggested that EIA forecasts incorrectly depend on continued productivity growth from shale oil wells while that productivity is actually slowing. As I suggested back in August, rising service costs would then make it extremely difficult for shale oil companies to profit, even at the higher prices we are now seeing.
Market watchers should keep an eye on shale growth, shale productivity and investor confidence in shale oil companies before assuming that today’s highs will quickly evaporate in the face of massive increases in shale oil production. If shale production does not grow, the higher prices have a better chance to last longer.