The latest forecasts published by the US Energy Information Administration show that US oil production is steadily increasing. In February Short-term Energy Outlook output from US wells is rising from 11.9 million barrels per day at the end of 2018 to 13.5 million barrels per day by the end of 2020. Most other assumptions agree.  It may therefore be a surprise to know that production by the end of 2020 may have decreased from December 11.9 million barrels per day to 11.3 to 11.5 million barrels per day. This lower figure represents the level of production that should be expected given the economic activity of the independent businesses behind the shale exit.
The upcoming downturn will mainly occur in the areas that have seen the greatest growth over the past five years: the Ground, Eagle Ford, Haynesville, Julesburg and Permian Pools. The fall in production will occur because the companies operating there have been forced by monetary constraints to reduce drilling. The latest reduction in debt and equity issuance from these companies ensures the decline in production.
Drawing an analogy between agriculture and drilling frackers will help explain the coming downturn. Every year, farmers spend heavily on buying seeds, fuel and fertilizer for the summer season. They hope to pay their loans when they sell their fall this fall. To ensure that they can make their loans, they will sell some or all of their production in the future. They will also buy insurance to protect against waste errors.
Data on bank loans and statistics issued by the futures authorities provide some advance notice of the farmers' planning decisions. The amount of bank loans issued to them gives an indication of the size of the crop. Increases in open interest in futures such as grain in the spring also signal future production.
Many non-breeders behave like peasants, except that "crops" appear to be longer, maybe two years. These companies will lend or sell equity one year and then drill for sixteen to twenty-four months. Production will increase two years later, and so, as many authorities have noted, fall off quickly. Related: Analysts: Permian Oil Output Set To Double By 2023
These companies will also enter into hedges as soon as the size of their new discoveries is limited. Future sales are likely to occur when wells are completed and before they are fracked to ensure that the company can cover costs and perhaps profits, even if prices fall.
Data on debt issuance and equity of slate companies and their positions in futures Markets thus provide an indicator of their future production. These data today point to a large decline in production.
On February 24 The Wall Street Journal article by Bradley Olson and Rebecca Elliott should warn everyone about the impending downturn. A key chart that shows that debt and equity issued by US shale manufacturers fell to $ 22 billion in 201
When comparing the sum of debt – and equity issue for lower-48 onshore production delayed two years, one finds a close relationship. Decrease of 48 onshore production increased from 3 million barrels per day to 8.5 million barrels per day in 2018. However, the decline in equity and loan issuance shows that this production may fall by one third to six million barrels per day at the end of 2020 if the relationship lasts.
The activity of futures markets is pointing in the same direction. Figure 1 compares the increase in US oil production in the five major fracking areas (Permian Basin, Bakken, Eagle Ford, Haynesville and Julesburg Basin) to open interest in WTI futures. Note that open interest began to fall in late 2013. Production decline began eighteen months later. Related: Blackout knocks down Venezuelan oil exports
(Click to enlarge)
The decline in open interest expected future decline in production. In our opinion, drilling companies that were forced to reduce activity also reduced sales of future production, understanding that they would produce less.
These falls were mirrored by a decline in the short position of swap dealers, the financial institutions that wrote tailor-made hedging instruments to manufacturers. The reduction in hedging in 2014 and 2015 led to the later decline in production.
The same phenomenon occurs today. Total open interest has fallen by 20 per cent, as can be seen from the figure. The merchant's short positions have also entered into a contract. The message is clear: the manufacturers ensure less, and they ensure less because they expect to produce less.
The statistics point to one to two million barrels decline in production from frackers. Some, but not all, of this loss can consist of the increased activity of companies such as Exxon.
PS: Further details will be posted here Monday afternoon.
By Philip Verleger for Oilprice.com
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