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According to the latest forecast released by the US Energy Information Administration, oil production in the United States is increasing steadily. February Short-term energy outlook sees the production of American wells increase from 11.9 million barrels per day at the end of 2018 to 13.5 million barrels per day by the end of 2020. Most other forecasters are in agreement.
It may therefore be surprising to learn that production at the end of 2020 could actually have gone from 11.9 million barrels a day to 11.3 million barrels a day, from 11.3 to 11.5 million barrels a day. barrels a day. This lower figure represents the level of production that can be expected given the financial activity of independent firms at the origin of the surge in shale production.
The future decline will occur primarily in the areas that have experienced the strongest growth over the last five years: Bakken Basins, Eagle Ford, Haynesville, Julesburg and Permian. Production will decline because the companies working there have been constrained by monetary constraints to reduce their drilling activities. The recent reduction in debt and equity issuance by these companies ensures the decline in production.
An analogy between farming and fractional drilling will help explain the future decline. Every year, farmers borrow heavily to buy seeds, fuel and fertilizers for the summer growing season. They hope to repay their loans when they sell their harvest in the fall. To be sure of being able to repay their loans, they will eventually sell some or all of their production. They will also take out insurance to protect themselves against bad harvests.
Data on bank loans and statistics published by the futures authorities provide preliminary indications of farmers' planning decisions. The amount of bank loans granted to them gives an indication of the size of the crop. The increase in open interest for futures such as corn in the spring also provides a signal for future production.
Many frackers behave like farmers, except that the "crop cycle" seems to be longer, maybe two years. These companies will either borrow or sell shares for one year and then exercise for 16 to 24 months. Production will increase two years later and, as many authorities have noted, is decreasing rapidly. Related: Analysts: Permian oil production is expected to double by 2023
These companies will also enter into hedging as soon as the size of their new discoveries is defined. Forward sales are likely to occur when the wells are completed and before they are fractured so that the company can cover the costs and possibly the profits, even if the prices go down.
Data on the issuance of debt and equity securities by shale companies and their positions in the futures markets provide an indicator of their future output. These data indicate today a significant decline in production.
February 24 the Wall Street newspaper The article by Bradley Olson and Rebecca Elliott should warn everyone of the impending slowdown. A key graph presented here shows that borrowing and equity issued by American shale producers declined to $ 22 billion in 2018, less than half of the amount raised in 2016 and one-third of the total. amount obtained in 2012.
When comparing the total issuance of debt and equity issues to lower onshore production 48, with a lag of two years, there is a close relationship. Onshore production of less than 48 has risen from three million barrels per day to 8.5 million barrels per day in 2018. However, the decline in equity and debt issuance suggests that production could fall from one third to six million barrels a day by the end of the year. 2020 if the relationship is true.
The activity on the futures markets goes in the same direction. Figure 1 compares the increase in US oil production in the five major fracking zones (Permian Basin, Bakken, Eagle Ford, Haynesville and Julesburg) with the opening of an interest in futures contracts. of WTI. Note that open interest began to decline in late 2013. The decline in production began 18 months later. Related: Power outage slows Venezuelan oil exports
(Click to enlarge)
The decline in open interest anticipated the future decline in production. In our opinion, drilling companies that have been forced to reduce their operations have also reduced their sales of future production, knowing that they would produce less.
These declines resulted in a decline in the short position of swap dealers, with financial institutions writing tailored hedging instruments to producers. The reduction in coverage in 2014 and 2015 resulted in a more recent decline in production.
The same phenomenon is happening today. Total open interest fell by twenty percent, as can be seen in the figure. Short broker exchange positions were also contracted. The message is clear: producers cover less and they cover less because they expect to produce less.
Statistics show a drop of 1 to 2 million barrels of fracker production. Some, but not all, of this loss can be offset by the increased activity of companies such as Exxon. In short, the growth in US oil production is about to reverse.
PS: More details will be posted here Monday afternoon.
By Philip Verleger for Oilprice.com
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