The remarkable growth of U.S. oil production has been the most prominent force in global oil markets for the past decade. Driven by the shale boom, U.S. oil production surged to 13 million barrels a day in January, surpassing Russia and Saudi Arabia to become the world’s top producer.
Shale projects, where new wells can be brought online in months, if not weeks, have held many advantages for operators. Firms could ramp up drilling and fracking activity when oil prices were high to take advantage of strong market conditions or pull back investments when prices were low.
The “short-cycle” nature of shale theoretically meant that it could serve as a swing producer in global oil markets, satisfying demand growth when needed and pulling back when new barrels were unnecessary.
But it didn’t always work out that way, and many market “experts” said shale would always be a poor swing producer. Only Saudi Arabia, with its vast spare capacity of ready-to-produce conventional barrels, could perform this function. And the shale sector did itself no favors during the last price crash when it took nearly a year for U.S. production to begin responding to lower prices.
But times have changed. Back then, the sector was undisciplined, under tremendous investor pressure to grow, and massively overcapitalized.
Today, investor demands are focused on returns, not growth, and capital markets are primarily closed — and were even before the Covid-19 crisis — to all but the strongest shale players. That means the industry largely must live within its means now and not outspend internal cash flow.
The difference is night and day for the United States’ ability to serve as a swing producer, as the current downturn demonstrates.
Major pipeline companies have estimated that U.S. oil producers have shut in some 3 million barrels a day in recent weeks, taking total output down to around 10 million barrels a day, in response to low prices caused by massive Covid-19 demand destruction.
These market-driven curtailments stabilized oil prices after benchmark West Texas Intermediate (WTI) crude plunged into negative territory — trading at nearly -$40 a barrel for a day in late April. WTI is now above $33 a barrel and trading at a minuscule discount of about $1.50 to international benchmark Brent crude. The spread between WTI and Brent prices is usually much wider — between $5 and $10 — but the massive production shut-ins in the U.S. have narrowed it dramatically recently as the U.S. physical oil market has tightened.
That swift, dramatic supply response should make oil market analysts rethink the United States’ capabilities as a swing supplier. American producers took signals from the markets, from both low prices and rapidly filling storage tanks, and quickly responded with less output.
And it didn’t require regulators stepping in to impose production restrictions on private companies. As I testified before the Texas Railroad Commission back in April, the market spurred companies to curb production to protect their bottom lines.
The response was so overwhelming that the industry should never again need to consider regulations on output from any government body.
It’s true that the recent oil price rally also reflects the historic 9.7 million barrels a day OPEC-plus supply cut deal, which was championed by President Trump and took effect on May 1. But those cuts alone were not enough to overcome the combination of oversupply and demand destruction. Additional cuts were needed to rebalance the market. According to the International Energy Agency, global demand is expected to take a hit of more than 20 million barrels a day in the second quarter.
North America has done the lion’s share of this work, with Canada chipping in with about 1 million barrels a day in market-driven curtailments.
There are concerns that U.S. shale producers could bring shut-in wells back in the coming weeks and months under higher prices, but they would need WTI prices in the $40-$45 range to materially restart activity. Prices closer to $50 are required to return to growth mode, and that probably won’t happen until 2021, according to Goldman Sachs.
The same concerns apply to OPEC-plus, with members like Russia and Iraq known for cheating on quotas in the past. There are already reports that Russia plans to start easing oil production cuts in July.
As for Saudi Arabia, the only “true” swing producer, its immediate response to the Covid-19 crisis was to start a devastating price war, flooding markets with its cheap oil, thus compounding the price collapse and putting the entire oil industry on the brink of implosion.
While perhaps not ideally suited to the role of swing producer, the U.S. oil industry faced a critical test with this market crisis and has passed with flying colors.
