Energy Monitor March – Record high US crude production

by: Hans van Cleef

  • US will be the world’s biggest oil producer in the foreseeable future…
  • … but that doesn’t make them a ‘swing-producer’
  • Gas prices temporarily affected by extra winter demand
080318-Energy-Monitor-Mar.pdf (259 KB)

It seems only a matter of time before the US has become the biggest oil producer…

US oil production has increased significantly over the past few months. In February, the production level reached 10.4 million barrels per day (mb/d). This was the highest level since 1970 and was mainly the result of ongoing growth in US shale oil production. Market expectations are that US crude production will continue to increase in the coming years. At this moment, the US surpassed Saudi Arabia (10.0 mb/d) and currently ranks number two, after Russia (11.0 mb/d). It seems only a matter of time before the US becomes the biggest oil producer in the world. The main question which keeps investors busy is when exactly this will be reached. The US Energy Information Administration (EIA) predicts that the production will reach the 11 mb/d at the end of this year. The International Energy Agency (IEA) and the OPEC don’t expect this level to be reached before the summer of 2019. The main difference lies in the growth projections of the Bakken and Eagle Ford basins. After all, there is a risk that the most interesting production sites already went in production. This could mean that production in these regions may stabilize or even start to decline in the coming period. That raises the question whether an increase in production in the Permian basin would make up for the eventual decrease in production at Bakken and Eagle Ford.

… but what does that mean?

The fact that the US will become the world biggest oil producer seems to be a given. The question is what does that mean. It is important to distinguish the difference between the several hundreds of oil producers in the US, all focusing on their own commercial interests, and the oil producers in Saudi Arabia and Russia. These are state owned. The correlation between the US oil production and the oil prices will remain considerable. This in contrary to the oil production in Saudi Arabia, the one and only real ‘swing-producer’. With swing-producer we mean that the Saudi authorities are able and willing to adjust the production level – both upward and downward – in order to bring or keep stability to/in the market. Especially downward adjustment of production to keep prices elevated is something which a US crude producer won’t do because it will have a negative impact on its short-term profits.

Therefore, it is important to closely monitor OPEC’s market share, especially the share of Saudi Arabia, versus the other (non-OPEC) oil producers. There is more room for growth for US crude production to meet a fair share of the global demand growth for oil. Especially now several countries and oil majors outside OPEC and outside the US keep their investments in new exploration and upstream activities subdued. But, as the aggressive production policy by the Saudi’s in 2014 proved, they will not allow their market share (of around 40%) to become too small at the benefit of the Americans.

Room for growth; both for US and OPEC

We assume that the global demand will continue to grow by 1.5 mb/d in both 2018 and 2019. This would offer enough room for US oil producers to increase production and for OPEC and her allies to minimalize the production cuts towards the end of 2019. Saudi Energy Minister Al-Falih indicated that he does not see a necessity to extend the production cut agreement, at all cost, after its expiry at the end of 2018.

These comments could be seen as a warning signal towards market speculators and investors who anticipate further strong growth of US shale oil production, which will trigger more pressure on oil prices. However, at the same time, Al-Falih said that a period of ‘over stimulation’ could be a possibility as well. In other words, he suggested that OPEC may decide to keep the production cut agreement in place for a longer period of time, or longer than needed. This may result in a global shortage of oil, if the rise in global demand cannot be met by enough production growth. Although the impact of these words remains limited, it does seems to signal the start of a new round of verbal intervention in order to prepare the market for more oil supply entering the market. Preferably, in combination with higher oil prices.

Gas demand temporary higher due to increased seasonal demand

Dutch and UK gas prices jumped higher last week as a result of extra strong demand for natural gas. Although the Netherlands has enough reserves to meet this sudden rise in demand, the TTF spot price jumped by almost 150%. The main triggers were problems with gas deliveries. There was a disruption at a gas connection between UK and the Netherlands and problems at several production locations in the UK. For a short period of time, there was even a risk of shortages. Although, there was hardly any impact on future prices. With the Spring season coming, future prices already eased towards ‘normal’ levels.

As a result of higher TTF gas spot prices, the price of electricity jumped higher. As gas accounts for 40% of the Dutch energy mix, the impact was significant for power prices as well.

Coal price fluctuations triggered by Chinese policy

The direction of coal prices is mainly determined by the Chinese policy on coal production and consumption. The 2017 rally in coal prices was triggered by the first annual rise in Chinese coal demand after a series of declines in the years before. The start of 2018 was characterized by the implementation of a price cap by the Chinese authorities, leading to a 16% drop in coal prices. This decline was followed by an almost 10% recovery in price based on increased demand ahead of the Chinese New Year festivities.

Coal demand for the coming two years is expected to remain stable around current levels. Although headlines in the newspapers may suggest that coal demand will peak soon, in reality demand will remain solid in the coming years. The lack of affordable alternatives, the risk of increased geopolitical exposure as well as abundant supply keep demand in many – mainly Asian – emerging markets stable. Especially in India, coal demand is expected to double towards 2040. However, imports will drop sharply as local output is projected to increase by 4% per year. In the longer run, global coal demand will start to decline, especially in Europe and the US. More renewable energy and natural gas are seen as the main alternative sources of energy.

The main coal supply comes from Australia, South Africa and Colombia. As there is a global oversupply, investments in new capacity are limited. Main investments aim to sustain production in existing operations. Thermal or steam coal accounts for roughly 80% of the total coal production. All in all, the coal market is changing. However, this is happening at a moderate pace.

We do see shifts in global trade of coal. In recent years, US exports dropped by 25%, while producers in Australia (+19%), Russia (+13%) and South Africa (+20%) were able to benefit from higher exports (source IEA WEO 2017). Note that only approximately 20% of the production is traded. Although the US President Trump tries to stimulate the US coal sector, it seems unlikely that this will lead to major shifts. Locally, US natural gas proves to be a cheap alternative for coal used for power generation. As a result, gas consumption topped coal consumption for power generation for the first time ever in 2016. Asian customers seem to prefer imported coal from countries close by which come with lower cost of transportation.