OPEC vs. Shale Oil

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IEA Sees OPEC Supply Jumping Most in Four Years on Saudi Surge

OPEC production climbed by the most in almost four years as Saudi Arabia, Iraq and Libya boosted output amid a stronger outlook for global oil demand, according to the International Energy Agency.

The Organization of Petroleum Exporting Countries raised output by 890,000 barrels a day to 31.02 million a day in March, the biggest monthly gain since June 2011, the IEA estimated. Preliminary data suggest output may rise further this month, it said. The agency cut its prediction for U.S. and Canadian oil supply growth in the second half of the year.

Oil prices are 45 percent lower than a year ago, trading at $59 a barrel in London today, as OPEC maintains a policy of defending market share in response to booming U.S. shale output. While members including Iran and Libya are urging the organization to support prices by curbing output, Saudi Arabia is insisting OPEC should only pare supply if producers outside the group share the burden.

“OPEC’s core Gulf producers -- led by Saudi Arabia -- appear to be sticking with their defense of market share,” the Paris-based adviser to 29 nations said in its monthly market report.

Surprising Strength

While “unexpected pockets of demand strength” have emerged, it’s too early to say whether they will last, the IEA said. Global oil demand will increase by 1.1 million barrels a day this year to an average 93.6 million a day. That’s 90,000 barrels a day more than projected in last month’s report, reflecting both global economic recovery and especially cold winter temperatures in the first quarter.

“Stronger-than-expected demand in the first quarter might signal a faster recovery” or “might just as likely point to a slower one if pockets of demand strength prove short-lived and lead to weaker deliveries later on,” the IEA said.

The agency trimmed estimates for North American production in the second half of the year by 160,000 barrels a day because of a weaker outlook for the U.S. and Canada. Drillers in the U.S. have cut the number of rigs in service to the lowest since 2010, according to Baker Hughes Inc. The IEA left projections for total non-OPEC supply in 2015 unchanged at 57.4 million barrels a day.

Global supply increased by 3.5 million barrels a day in March from a year ago as gains in the U.S., and some in Russia, added to the output surge from OPEC, according to the agency.

While the IEA increased global oil demand forecasts slightly for 2015, it said the market’s response to lower prices “may still be in its early stage.”

OPEC Boost

The jump in OPEC’s output in March leaves the organization’s production about 2.5 million barrels a day higher than the average of 28.5 million a day needed in the second quarter, according the report. The group will next meet to review output targets on June 5 in Vienna.

Saudi Arabia, OPEC’s biggest member, led the increases with growth of 390,000 barrels a day to 10.1 million a day in March, the highest since September 2013 and close to record levels, the IEA said. The country’s exports rose by 600,000 barrels a day to 7.4 million a day, with most of the increase headed to customers in Asia, according to the IEA.

Iraq restored output by 350,000 barrels a day to 3.67 million a day in March as improved weather in the Persian Gulf enabled the country to export a record 3 million barrels a day.

Libya revived production by 190,000 barrels a day to 480,000 a day even as conflict intensified between the country’s internationally recognized government in the east and a rival Islamist administration in Tripoli, the capital.

Iran’s crude exports rose to 1.27 million barrels a day in March, the highest in a year, amid rising purchases by China, according to the report. One of the biggest uncertainties for the market is whether the country will secure a deal with world powers that lifts sanctions on its oil exports, following a preliminary accord on April 2, the agency said.

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Shale Output is falling faster than expected

Shale drillers will see production drop sooner than expected under a U.S. government forecast, a momentum change that hints at an eventual price rally.

Just five months after Saudi Arabia put the market into a tailspin by refusing to cut supply despite a global glut, the shale oil industry will record its first monthly dip since U.S. officials began weighing output in 2013.

The projected production drop is small, just 1 percent. Yet investors took note, pushing oilfield stocks to the top five spots in the Standard & Poor’s 500 Index on Tuesday, led by rig operators Ensco Plc and Diamond Offshore Drilling Inc. The decline lags the idling of rigs because of a backlog of already-drilled wells that have gradually been coming online.

“OPEC’s plan is playing out and price is correcting the oversupply,” said Michael Scialla, an analyst at Stifel Nicolaus & Co. in Denver, in a telephone interview.

West Texas Intermediate crude, the U.S. benchmark, climbed 3 percent to $53.47 a barrel at 2:03 p.m. in New York, extending the rising streak to a fourth trading session.

Shale fields make up about half of total U.S. production, which will continue growing this year and next, rising to 10.3 million barrels a day in 2025, according to a new longterm forecast by the Energy Department Tuesday.

Crude lost almost 60 percent of its value since late June, making some shale fields unprofitable to develop and forcing companies to cut back exploration prospects. Oil explorers were forced to shut down more than half the rigs drilling for crude in the U.S. since the Saudi statement in November, and canceled expansion plans to conserve cash.

‘Hyperbolic Decline’

“The question on everyone’s mind was would we see it in the second or third quarter, and I’m not surprised it’s happening in the earlier part of that range,” said David Pitts, chief financial officer at Houston-based producer Carrizo Oil & Gas Inc.

Wells extracting oil from dense shale rock experience “hyperbolic decline rates,” Pitts said by telephone.

Comstock Resources Inc. halted all crude drilling at the start of the year and expects the oil production decline to begin in its third-and fourth-quarter results, said Gary Guyton, the Frisco, Texas-based company’s director of planning.

“Shale is a treadmill, so if you’re not drilling, you’re not producing,” Guyton said in a telephone interview. Overall, the production decline “might not be hugely significant but at least it won’t be growing.”

The flexibility to ramp operations up and down quickly makes shale fields especially attractive to oil companies coping with volatile fluctuations in world oil markets, said ConocoPhillips CEO Ryan Lance last week in an interview at Bloomberg headquarters in New York.

Resilience Matters

“We think we’re going into a world that’s going to be characterized by lower, gradually rising prices, but a lot of volatility,” Lance said. “When you have that volatility, what you want is the ability to be flexible and resilient and be able to flex your programs up and down.”

Shale producers such as EOG Resources Inc. have been predicting U.S. output would decline by the end of the year. In February, the Houston-based company said its own production would reach a nadir during the second and third quarters.

Lance said he expected U.S. output to fall in the second half of the year, helping prices to recover to as high as $80 a barrel in the next three years.

“There is a supply response happening. You don’t see it in the first half of the year because of the investments that we made over the last two years,” he said. “The reductions in capital that the industry has made are substantial. That’s going to start to materialize in the back half of this year.”

OPEC Role

Saudi Arabia, the dominant member of the Organization of Petroleum Exporting Countries, squelched efforts by some in the cartel to curb output in November, accelerating a fall in oil prices prompted by oversupplies. Saudi crude has been displaced from some U.S. markets as the flood of domestic shale oil offered refiners a cheaper alternative.

The five major U.S. shale oil regions will pump an average of 5.561 million barrels a day in May, down from this month’s estimated 5.618 million, the Energy Department said in a report released Monday.

The Niobrara formation northeast of Denver will lead the decline with a 3.3 percent drop, according to the Energy Department in Washington.

In the Niobrara formation, which lies beneath northeast Colorado and the edges of Kansas and Wyoming, the production fall-off will be sharper than in other regions because explorers were quicker to idle rigs, said Andrew Cosgrove, an analyst at Bloomberg Intelligence. Compared to other shale-oil areas, individual wells in the Niobrara don’t produce as much crude, reducing profitability, he said.

Hedge Help

The two biggest operators in the Niobrara -- Anadarko Petroleum Corp. and Noble Energy Inc. -- have been slowing activity and deferring work, according to Scialla, the Stifel Nicolaus analyst.

Only one of the primary producers in the formation -- Denver-based PDC Energy Inc. -- hasn’t slowed down, and that’s because they locked in cash flow prior to the oil market’s crash with financial instruments called hedges, Scialla said in a telephone interview.

“The Niobrara wells are cheaper and shallower than in the other shale plays but they’re not as prolific either,” he said. “They cost about half as much as a typical well in the Eagle Ford or the Bakken but they also only produce about half as much.”

Permian Rising

After the Niobrara, the Eagle Ford shale in Texas and the Bakken formation in North Dakota will register the next biggest month-over-month production declines in May, with 1.9 percent and 1.7 percent, respectively.

In the other two major U.S. shale oil regions -- the Permian in Texas and the Utica in Ohio -- output is expected to rise in May, the Energy Department said.

Explorers will be cautious about resuming their old pace of drilling out of fear that rising production would deflate prices again, Carrizo’s Pitts said.

“There would have to be a pretty significant bump up in prices for people to start picking up rigs again,” Pitts said.