US oil rigs increased by six this week according to Baker Hughes oil rig data released today. It was the fifth straight week that US energy companies added rigs since OPEC agreed to cut production in December pushing oil prices higher.
Total rigs in the US now stand at 597, the most since October 2015 and up from 413 rigs one year ago.
Activity and spending in the Permian basin has heated up so much that one contractor told Reuters recently that “we could easily see an extra 100 rigs in the Permian by June.”
US shale production is also responding to higher prices over the last several weeks. Official EIA data has US production just shy of 9 mbd and soon to be climbing higher. US production had peaked at 9.5 mbd in April 2015 due to OPEC’s decision in 2014 not to cut production that sent prices spiraling downward.
In addition to rig gains, we are also seeing dramatic productivity gains in US shale production. Firms are drilling faster: in 2011 it took 22 days to drill a well while today it takes only 5-7 days. There is also a lot more production per rig with first-year well decline rates of 74% several years ago now reduced to 30-40% today.
The cause of the “US rig-covery” appears to be OPEC’s practice of talking up oil prices last year, and of course, the group’s production cut deal last December which boosted prices even higher.
At the start of this week, OPEC producers began boasting about its 90 percent compliance in January - the first month of its six-month agreement to cut production.
This high compliance number was achieved thanks to Saudi cuts of 598 million b/d from its October 2016 production level of 10.56 mbd – much more than the 486 million it had agreed to under OPEC deal. It was not particularly difficult for Saudi Arabia to make these cuts since its January production is typically lower. Indeed EIA data reported January 2016 Saudi production was already down about 10.2 mbd.
But if you add in the OPEC members exempt from the cuts – Libya, Nigeria and Iran – compliance is more like 75%. Still pretty good but not great, and this will probably be the high mark of compliance during the six-month period.
Non-OPEC compliance, on the other hand, is not so good. OPEC’s monitoring committee is to receive its report on non-OPEC compliance on the 17th day of each month. So far today (Feb 17), no data has been released publicly. But we do know that Russia only cut production in January by about 100,000 b/d out of its 300,000 b/d commitment.
As a result, OPEC sources say non-OPEC compliance will be less than 50 percent in January. And it seems unlikely Russia will ever catch up on its commitment. Russia’s production level is also noteworthy because its participation in the cut agreement was the key factor that got Saudi Arabia to make the deal at last December’s OPEC meeting.
Meanwhile, EIA weekly data released on Wednesday showed US crude stocks rose by 9.5 million barrels to 518 million barrels – an 87-year high. Ironically, most of this increase in stocks is due to imports of record OPEC production at the end of last year.
For OPEC to achieve its stated goal of drawing down global crude stocks in the 2H 2017, the group needs better continued compliance from OPEC and non-OPEC producers who signed the agreement.
The big question going forward is whether OPEC will extend its production cut agreement when it expires in June. If global stocks are to begin its downward trend, OPEC must renew the production cuts for another six months. But renewing the agreement means US production will continue to rise – undermining the entire objective.
Saudi officials know US shale will respond to higher prices but they believe it will take about a year for such a recovery - allowing time for higher demand later this year to smooth out prices when more US production comes online. Certainly economic growth in the US in particular could strengthen global oil demand. But for now, it appears that US shale is once again confounding the market with its resiliency.
About two weeks ago Saudi Arabia raised the spectre that the deal might not be extended because they contend the cuts are working to balance the market. This is aimed at two audiences: 1) OPEC members to incentivize compliance, and 2) US shale to make companies wary about higher prices and cranking up production.
When the agreement was reached, the market had priced in an automatic extension of the cuts because it was needed to generate draw downs in global stocks. But now it appears the extension is very much up in the air.
As expected, Gulf producers are largely complying with the agreement while non-OPEC producers’ compliance is thin. Regardless, the current OPEC cut deal appears not to be working as intended. OPEC production is actually up in the first quarter compared to last year, and even more ominous, is the “US rig-covery” with rising US rig counts and production in response to higher prices.
