Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Oil is clinging to its forties like someone heading into their fifties. If only: It’s really staring its thirties in the face.

Crude oil has been sliding again, recently changing hands at about $42 a barrel. You can see in the chart below that it has made three game attempts at getting back above the $50 mark since the summer sell-off, all to no avail. It glimpsed the abyss in August when it dipped below $40. Another move down of roughly 5 percent would take it back to the $30s. 

Back to the Thirties
Nymex crude oil price per barrel
Source: Bloomberg

OPEC on Thursday provided a pretty big clue as to what might inspire such a move. Its latest monthly report noted that oil inventories in the developed world were at their highest in at least a decade. This is not a welcome development for a cartel which, nominally anyway, tries to keep stocks of oil pretty tight.

One problem area for OPEC is the U.S., where the latest weekly report from the Energy Information Administration included this now-familiar refrain: 

U.S. crude oil inventories remain near levels not seen for this time of year in at least the last 80 years.

Saudi Arabia was barely even a country back in 1935. Today, the OPEC kingpin’s strategy of taking market share back from higher-cost producers such as exploration and production companies in America’s shale basins is working, but exceedingly slowly.

The earnings season now winding down showed some signs of the sector buckling in the face of low prices -- chiefly promises to live within (reduced) cash flow next year as price hedges roll off.

Here and now, though, the theme remains one of surprising resilience. Reviewing 31 U.S. producers collectively pumping about 2.65 million barrels a day, analysts at Evercore ISI estimate their output fell by roughly 30,000 barrels a day in the third quarter -- a rounding error.

With spending coming down, the pace of production declines should accelerate. Indeed, that is what the EIA’s short-term forecasts suggest. In the latest set, released this week, U.S. production is forecast to be 9.02 million barrels a day in December, down from a peak of 9.6 million in April.

U.S. Crude Oil Production
Source: EIA

Thing is, those numbers move around a lot. A month ago, the EIA was projecting that U.S. output had already hit that 9.02 million level in October (time-lags mean projections actually encompass one or two months already gone). And in its latest monthly supply report released at the end of October, the EIA bumped up its production number for August by 180,000 barrels a day.

Expect more unexpected barrels to appear as we head towards year end, says Per Magnus Nysveen, who heads analysis at Rystad Energy, a consultancy. Based on data from individual wells, Rystad expects production to remain reasonably steady from here to year end.

An oil-price crash is the mother of invention in Houston, so E&P companies spent much of their third-quarter earnings calls touting efforts to squeeze suppliers on costs and focus every precious dollar of investment on the best prospects, including working off a backlog of wells drilled already but not yet completed. This explains why, despite the number of rigs in operation having dropped precipitously this year, output hasn’t fallen off a cliff.

In the Permian basin, for example, the average horizontal rig -- the type used to exploit shale -- drilled 1.18 new wells in May, each producing about 410 barrels a day, according to Rystad data. Meanwhile, output from existing wells dropped by 128,000 barrels a day. Do the math, and you needed 265 rigs operating there to keep output flat. There were only 171 operating that month, and so production has been falling.

Come September, though, each rig was drilling 1.3 new wells. The amount of production per well had come down to about 337 barrels, but faster drilling offset much of that drop. Moreover, the decline rate on existing wells had slowed dramatically, to about 81,000 barrels a day. The result: a 30 percent fall in the number of rigs needed to keep output flat, to 184. There were 186 running that month.

It is worth noting that the EIA’s revision of its August output numbers effectively brought them up to a level much closer to Rystad’s own tally. And Rystad projects production in December to be around 300,000 barrels a day higher than what the EIA forecasts.

Winter's Bone of Contention
U.S. crude oil output in million barrels per day
Sources: Rystad Energy, Bloomberg, Energy Information Administration

That all adds up. Consider the period September through December, for which the EIA is yet to issue final monthly numbers. Even against the higher projections the EIA just released, Rystad’s numbers equate to an additional 25 million barrels of U.S. production in that time.

That might not sound like a lot when global demand is around 95 million barrels a day. But when inventories are already at multi-decade highs, every extra barrel weighs on the market.

Since 2000, excluding the outliers of 2008 and 2014, U.S. commercial crude oil stocks have dropped by an average of about 9.2 million barrels in the final four months of each year. Last year’s anomalous jump of almost 31 million barrels foreshadowed the oil market’s pain of 2015. So an extra 25 million barrels materializing seemingly out of nowhere looks like more trouble.

Looking ahead to 2016, there are some hopeful signs for oil bulls. E&P budgets have been slashed, and some firms will likely go under or consolidate.

Meanwhile, the message from oil services firms is that shale drillers will not simply be able to turn the tap back on again once prices rise. Halliburton said on its earnings call last month that pressure pumping equipment currently sitting idle was being cannibalized for parts while the stuff still being used was being worked to its limits. And the falling backlog of uncompleted wells will also begin to make an impact.

So austerity should bring its own reward -- eventually. In these final months of a dreadful year for the oil market, though, the nights are still drawing in.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net