Phibro’s (currently Astenback Capital Management) Andy Hall knows a thing or two about the oil market – and even if he doesn’t (and it was all luck), his views are sufficiently respected to influence the industrial groupthink. Which is why for anyone interested in where one of the foremost oil market movers sees oil supply over the next decade, here are his full thoughts from his latest letter to Astenback investors. Of particular note: Hall’s warning to all the shale oil optimists: “According to the DOE data, for Bakken and Eagle Ford the legacy well decline rate has been running at either side of 6.5 per cent per month… Production from new wells has been running at about 90,000 bpd per month per field meaning net growth in production is 25,000 bpd per month. It will become smaller as output grows and that’s why ceteris paribus growth in output for both fields will continue to slow over the coming years. When all the easily drillable sites are exhausted – at the latest sometime shortly after 2020 – production from these two fields will decline.”
From Astenback Capital Management
The speed with which an interim agreement was reached with Iran was unexpected. Equally unexpected was the immediate relaxation of sanctions relating to access to banking and insurance coverage. This will potentially result in an increase in Iranian exports of perhaps 400,000 bpd. Beyond that it is hard to predict what might happen. The next set of negotiations will certainly be much more difficult. The fundamental differences of view that were papered over in the recent talks need to be fully resolved and that will be extremely difficult to do. Also, Iran’s physical capacity to export much more additional oil is in doubt because its aging oil fields have been starved of investment.
As to Libya, it seems unlikely that things will get better there anytime soon. The unrest and political discontent seems to be worsening. Whilst some oil exports are likely to resume – particularly from the western part of the country (Tripolitania), overall levels of oil exports from Libya in 2014 will be well below those of 2013.
Iraqi exports should rise by about 300,000 bpd in 2014 as new export facilities come into operation. But there is a meaningful risk of interruptions due to the sectarian strife in Iraq that increasingly borders on civil war. Saudi Arabia’s displeasure at the West’s quasi rapprochement with Iran is likely to add fuel to the fire in the Sunni-Shia fight for supremacy throughout the region.
If gains in 2014 of exports from Iran are assumed to offset losses from Libya, potential net additional exports from OPEC would amount to whatever increment materializes from Iraq. Saudi Arabia has been pumping oil at close to its practical (if not hypothetical) maximum capacity of 10.5 million bpd for much of 2013. It could therefore easily accommodate any additional output from Iraq in order to maintain a Brent price of $100 – assuming it wants to do so and that it becomes necessary to do so. Still, $100 is meaningfully lower than $110+ which is where the benchmark grade has on average been trading for the past three years.
So much for OPEC, what about non-OPEC supply? Most forecasters predict this to grow by about 1.4 million bpd with the largest contribution – about 1.1 million bpd – coming from the U.S. and Canada and the balance primarily from Brazil and Kazakhstan. Brazil’s oil production has been forecast to grow every year for the past four or five years and each time it has disappointed. Indeed Petrobras has struggled to prevent output declining. Perhaps 2014 is the year they finally turn things around but also, perhaps not. The Kashagan field in Kazakhstan briefly came on stream last September – almost a decade behind schedule. It was shut down again almost immediately because of technical problems. The assumption is that the consortium of companies operating the field will finally achieve full production in 2014.
Canada’s contribution to supply growth is perhaps the most predictable as it comes from additions to tar sands capacity whose technology is tried and tested. Provided planned production additions come on stream according to schedule in 2014, these should amount to about 200,000 bpd.
Most forecasters expect the U.S. to add 900,000 bpd to oil supplies in 2014, largely driven by the continuing boom in shale oil. That would be lower than the increment seen this year or in 2012 but market sentiment seems to be discounting a surprise to the upside. As mentioned above, many companies have been creating a stir with talk of exciting new prospects beyond Bakken and Eagle Ford which so far have accounted for nearly all the growth in shale oil production. Indeed at first blush there seem to be so many potential prospects it is hard to keep track of them all. Even within the Bakken and Eagle Ford, talk of down-spacing, faster well completions through pad drilling and “super wells” with very high initial rates of production resulting from the use of new completion techniques have created an impression of a cornucopia of unending growth and that impression weighs on forward WTI prices.
But part of what is going on here is the industry’s desire to maintain a level of buzz consistent with rising equity valuations and capital inflows to the sector.
The hot play now is one of the oldest in America; the Permian basin. A handful of companies with large acreage in the region are making very optimistic assessments of their prospects there. These are based on making long term projections based on a few months’ production data from a handful of wells. We wonder whether data gets cherry picked for investor presentations. We hear about the great wells but not about the disappointing ones. Furthermore, many companies are pointing to higher initial rates of production without taking into account the higher depletion rates which go hand in hand with these higher start-up rates. EOG, the biggest and the best of the shale oil players recently asserted that the Permian – a play in which it is actively investing – will be much more difficult to develop than were either the Bakken or Eagle Ford. EOG figures horizontal oil wells in the Permian have productivity little more than a third of those in Eagle Ford. EOG has further stated on various occasions that the rapid growth in shale oil production is already behind us.
In part this is simple math. The DOE recently started publishing short term production forecasts for each of the major shale plays. They project monthly production increments based on rig counts and observed rig productivity (new wells per rig per month multiplied by production per rig) and subtracting from it the decline in production from legacy wells. According to the DOE data, for Bakken and Eagle Ford the legacy well decline rate has been running at either side of 6.5 per cent per month. When these fields were each producing 500,000 bpd that legacy decline therefore amounted to 33,000 bpd per month per field. With both fields now producing 1 million bpd the legacy decline is 65,000 bpd per month. Production from new wells has been running at about 90,000 bpd per month per field meaning net growth in production is 25,000 bpd per month. It will become smaller as output grows and that’s why ceteris paribus growth in output for both fields will continue to slow over the coming years. When all the easily drillable sites are exhausted – at the latest sometime shortly after 2020 – production from these two fields will decline.
Others have made the same analysis. A couple of weeks ago the IEA expressed concern that shale oil euphoria was discouraging investment in longer term projects elsewhere in the world that will be needed to sustain supply when U.S. shale oil production starts to decline.
Decelerating shale oil production growth is also reflected in the forecasts of independent analysts ITG. They have undertaken the most thorough analysis of U.S. shale plays and use a rigorous and granular approach in forecasting future shale and non-shale oil production in the U.S. Of course their forecast like any other is dependent on the underlying assumptions. But ITG can hardly be branded shale oil skeptics – to the contrary. Yet their forecast for U.S. production growth also calls for a dramatic slowing in the rate of growth. Their most recent forecast is for U.S. production excluding Alaska to grow by about 700,000 bpd in 2014. With Alaskan production continuing to decline, that implies growth of under 700,000 bpd in overall U.S. oil production, or 200,000 bpd less than consensus.
The final element of supply is represented by the change in inventory levels. The major OECD countries will end 2013 with oil inventories some 100 million barrels lower than they were at the beginning of the year. That stock drawdown is equivalent to nearly 300,000 bpd of supply that will not be available in 2014. Data outside the OECD countries is notoriously sparse but the evidence strongly suggests there was also massive destocking in China during 2013.