Written on: February 21, 2018

Oil Prices Fail to Show Direction

On Tuesday, oil prices failed to show directional conviction, likely due to opposing fundamentals. On the bearish side, the U.S. dollar was stronger, U.S. equity indexes other than the Nasdaq were weaker and U.S. crude production continues to rise. On the bullish side, tensions between Israel and Iran are elevating, excess developed nation crude inventories are declining and OPEC is vigorously jawboning the market. Saudi Arabia said a tighter oil market is preferable to ending output cuts too early and OPEC claims to be favoring a long-term alliance with Russia and others for many more years beyond 2018.

Higher Crude Prices Incentivizing Shale Production

John Kemp of Reuters points out that, as expected, higher crude prices are incentivizing a surge in U.S. shale oil production and this is presenting OPEC with a quandary: Do they settle for lower prices or do they lose market share? Initially they went with lower prices, then changed strategy and gave up market share. The result of the latter can be seen in the most recent EIA Short-Term Energy Outlook. EIA projects that “U.S. crude output will average almost 10.6 million bpd this year compared with 9.3 million bpd in 2017. If this forecast proves correct, U.S. shale producers will capture all or most of the predicted growth in global oil consumption this year.”

Kemp further suggests that if OPEC’s current “production restraint succeeds in drawing down global inventories even further, and pushes Brent significantly above $70 per barrel, [it will result in a shale mega-surge and a further slowdown in global consumption growth, which would ultimately return the marketplace to oversupply. Therefore, OPEC and their allies would be wise to not] risk tightening the market too much [by] maintaining production restraint until the end of the year.”

For good reason, U.S. shale oil is expected to produce the lion’s share of non-OPEC output growth in 2018. However, shale oil will have some help. “Output growth from U.S. shale basins, Canadian oil sands and Brazilian deepwater platforms should more than match projected global demand growth for the remainder of this year.”

Oil Sands Two—Thirds of Canada’s Energy Output

According to Reuters, in Canada “oil sands currently account for two-thirds of the nation’s 4.2 million barrels per day of crude. They will contribute heavily to Canada’s energy output, because oil sands projects, once built, produce for decades. But the era of oil sands mega-projects is coming to an end, due to poor economics. Because shale oil can yield quicker returns on smaller investments than extracting bitumen from oil sands … Canadian energy officials are now counting on shale to lure new investment. Capital spending outside the oil sands [this year is expected to hit] nearly three times the amount predicted for oil sands investment.”

“Canada is the first country outside the United States to see large-scale development of shale resources, which already account for 8 percent of total Canadian oil output. China, Russia and Argentina also have ample shale reserves but have yet to overcome the obstacles to full commercial development. The Canadian resources are said to be prolific. One formation is thought to have about half the recoverable resources of the whole oil sands region. Canada’s shale output [currently] stands at about 335,000 bpd.” This is 13 percent of present Permian output, so they have a long way to go yet.