Oil just posted its worst week in more than two years — WTI lost 9.5 percent and Brent lost 8.5 percent. The last time the two oil benchmarks fell by that much in a single week was early 2016 when the oil market was in serious turmoil and prices dipped below $30 per barrel.
Of course, the latest sell-off is the result of both oil-specific problems as well as broader equity market volatility. The rebound in the dollar and the stock market meltdown have dragged down crude. But the surge in U.S. shale production to over 10.25 million barrels per day (MB/d) in the first week of February, plus expectations of output growth to 11 MB/d later this year, have sparked fears of a return to surplus. Those fears were seemingly confirmed with a massive increase in the rig count last week — Baker Hughes said the oil industry added 26 rigs, more evidence that the shale industry is ramping up.
“Oil is paying the price for rising too quickly to levels that attracted increased U.S. production,” Ric Spooner, an analyst at CMC Markets, said in an interview with Bloomberg. “Traders are also nervous about recent financial market volatility and the stronger dollar.” Spooner told Bloomberg that WTI could fall to “the low $50s range if volatility persists.”
But perhaps the sudden drop in prices is more of a correction than the beginning of a sustained downturn. Hedge funds and other money managers have likely sold off some of their bullish bets, pushing prices down but relieving some built-up pressure from short-term financial flows.
One of the most important variables in determining the outlook for oil prices for the rest of the year is the pace of growth for U.S. shale. The sentiment has turned decidedly bearish in the past two weeks, with several forecasts and data releases from the EIA pointing to an aggressive ramp-up in production. The agency sees the U.S. hitting 11 mb/d a year earlier than previously expected, a forecast that punctured the upward momentum in benchmark prices.
But not everyone is willing to give up on a more restrained outlook from U.S. shale. Goldman Sachs has assumed slower growth from the sector, predicting that more modest spending levels and drilling plans would result in sizable production gains, though not a tidal wave of fresh supply. In a February 12 report, the investment bank reiterated this belief, noting that a review of the CapEx guidance from 10 notable U.S. shale companies finds spending levels for the year 3 percent lower than analysts’ had predicted. Production guidance came in 4 percent less than the consensus.
In other words, the spending and drilling plans for this year are largely unchanged in response to the spike in prices in January. The takeaway is that the shale industry might not be drilling at the recklessly aggressive rate that many market watchers think. They are largely approaching 2018 the way they signalled before the run-up in prices, with minimal revisions to their spending and production plans.
Taken together, 2018 production from those companies would only rise 9 percent compared to last year’s levels. Moreover, Goldman Sachs says that the production gains could be frontloaded. “We continue to expect the most meaningful ramp-up in US oil production from our coverage to take place in 4Q17/1Q18,” the investment bank said. The sharp increase in output lately does not mean that production will climb at a constant rate over the course of this year.
Goldman acknowledged that not everyone is on the same page. “[I]nvestor fear around greater U.S. oil production/lack of producer discipline has risen,” particularly after the sharp increase in the rig count last week. Bank analysts also said that they received some pushback over their bullish forecast from investors and major energy consumers after meeting with them in Singapore and Hong Kong. “Meetings with investors in Hong Kong and Singapore last week yielded a lack of con?dence in the sustainability of the improvement in each of the 3 D’s — global oil Demand, voluntary/involuntary Disruptions, and US producer Discipline.” Goldman said that the investors they met with in Asia did not buy into the bank’s bullish demand forecast; they are wary that OPEC will ramp up gradually, and they “remain unconvinced U.S. producer discipline will hold.”
But the bank held firm to its forecast, citing not just the capex/production guidance from shale companies, but also noting that the recent rig data could be a one-off anomaly due to the way the data is reported. “We would not be surprised if the Baker Hughes-reported rig count starts to ?atten out around the current levels in the near-term,” Goldman analysts wrote in the note.
Overall, Goldman admits that if their production forecasts are wrong, the risk is skewed to the upside. But the investment bank did not abandon is mostly bullish forecast for oil prices this year.
By Nick Cunningham of Oilprice.com