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Oil Prices Spike On Shale Slowdown

Nick Cunningham

The collapse of oil prices late last year, along with pressure from shareholders, has led to a slowdown in the U.S. shale industry.

The EIA released new monthly data on March 29, which revealed a decline in output of about 90,000 bpd between December and January, evidence that shale drillers slammed on the breaks after oil prices fell off a cliff in the fourth quarter. The 90,000-bpd decline came after a rather meager 35,000-bpd increase the month before, which was the weakest increase in months.

But the U.S. shale industry is facing more headwinds than just a temporary dip in oil prices. Shareholders have run out of patience with unprofitable drilling, and are demanding returns, which is tightening the screws on less competitive companies and forcing spending cutbacks across the board. More worrying for the industry is a growing recognition of the “parent-child” well problem – the unexpected poor performance of subsequent wells drilled in close proximity to the original “parent” well.

These obstacles are beginning to pile up. Schlumberger and Halliburton, the two top oilfield services companies, have predicted that shale drillers will be forced to collectively cut spending by more than 10 percent this year.

The slowdown could put some bullish pressure on the oil market, already suffering from outages in Venezuela, Iran and coordinated cuts from OPEC+. While U.S. inventories rose unexpectedly last week, much of the increase can be chalked up to turmoil in the Houston Ship Channel following a major fire at a petrochemical facility.

Indeed, some analysts see significant stock declines in the next few weeks. “The most visible inventory levels in the world…will fall victim to a potent mix of Venezuelan supply disruptions, a Houston Ship Channel chemical spill, and an uptick in refining runs,” Barclays wrote in a note on March 29. The investment bank sees WTI rising to an average of $65 per barrel this year.

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Adding to the bullish momentum is the rather sharp fall of 8 oil rigs last week, the sixth consecutive week of declines.

However, it is not guaranteed that the slowdown will last for long. Data firm Kayrros says that the production decline will be “short-lived,” and that there are already signs that industry activity picked back up in the last few months. “This drop, which tracks past seasonal behavior, follows a plunge in well completions measured by Kayrros in December via a combination of satellite imaging and advanced processing,” Kayrros wrote in a report. “But the same proprietary technologies show well completions bounced back in January and February, presaging a rebound in production.” In fact, Kayrros says that Permian production could once again exceed expectations this year.

Still, the pause in the shale patch is fueling higher prices. “We expect Brent to move into the $70-80 a barrel range,” said UBS’s Giovanni Staunovo, according to the Wall Street Journal.

Related: Reuters: OPEC’s Oil Production Drops To Lowest Since 2015

At the same time, other signs of tightening abound. A Reuters survey shows that OPEC’s production fell to four-year low in March, as Saudi Arabia cut below its requirement and Venezuela posted deeper supply losses. OPEC produced 30.40 mb/d last month, a decline of 280,000 bpd from the month before. Notably, Venezuela saw 150,000 bpd go offline, a volume that will not easily be recovered.

Crucially, fears of an economic slowdown have abated a bit recently. New data from China showed the largest monthly increase in the manufacturing purchasing managers’ index since 2012. The data diminished concerns about China’s impending slowdown. Moreover, there is hope that the U.S.-China trade talks lead to a breakthrough and the removal of tariffs, which would erase one of the largest downside risks to the oil market.

In early trading on Monday, WTI jumped over $61 per barrel and Brent moved up towards $69 per barrel. “Gaining approx. 27 percent, Brent oil enjoyed its strongest start to the year since 2005 in the first quarter,” Commerzbank wrote in a note. Although the bank cautioned that the upside for prices is somewhat limited, the Brent futures curve is taking on a bullish tinge. “OPEC’s production cuts are tightening supply on the world market. As a result, the Brent forward curve is in backwardation throughout.”

By Nick Cunningham of Oilprice.com

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