Kemp: North Dakota’s Steady Production Shows Why Market Rebalancing Is Hard

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North Dakota’s oil production has been flat for more than a year, but it hasn’t fallen despite the sharp drop in prices, illustrating the challenges of rebalancing the oil market.

Output was just under 1.18 million barrels per day (bpd) in November 2015, according to state records published on Friday (http://tmsnrt.rs/1S1OoYD).

Output first hit this level September 2014 and has been essentially unchanged for the last 15 months, the longest and deepest pause in growth since the shale boom began (http://tmsnrt.rs/1S1OoYz).

The drop in oil prices, which have fallen by more than 70 percent since June 2014, has curbed the former growth in output.

If production had continued growing at the pre-June 2014 rate of around 2.3 percent per month it would now be at around 1.63 million bpd (http://tmsnrt.rs/1S1Osro).

The reduction in actual output of around 450,000 bpd compared with the previous trend is a measure of how far lower oil prices have already gone towards rebalancing the market.

But most analysts and forecasters expected the state’s crude output to have fallen sharply by now rather than just to have levelled off.

Shale production was supposed to respond much faster to declining prices because it required the drilling of a large number of new wells to offset rapid decline rates from old ones.

Instead, shale output has proved unexpectedly resilient, as producers have found ways to maintain output while slashing drilling and costs.

Drilling expenditure has been switched from risky and expensive activities such as exploring for new fields and delineating the edges of existing ones to the development of well-understood core areas of existing reservoirs.

By standardising drilling operations as much as possible, minimising rig movements, and using only the newest and most powerful rigs, drilling firms have cut the time and cost involved each new well.

Horizontal sections are getting longer and the number of stages being fracked is increasing to squeeze more oil from each new well.

The number of active rigs in the state has fallen to around 50-60, down from around 180-190 before prices began to slide.

At least in the short term, the more oil prices have fallen, the more efficient shale producers have been forced to become.

In the long term, some of these efficiency gains may not be sustainable, as the development of the core areas of existing reservoirs is completed and new areas are required to maintain output.

And there are anecdotal reports shale producers are running out of options to continue cutting costs and boosting efficiency.

Shale producers are already outspending their revenues, with most of them reporting negative net cash flow in recent quarters.

It is becoming harder for most shale firms to raise fresh capital from investors to maintain drilling programmes and see them through the slump.

Positive Feedback

The oil market will eventually rebalance, probably with modestly lower output from shale, and sharply lower output from high-cost sources of oil outside OPEC.

Deepwater production, frontier exploration, Canada’s oil sands and even output from some of the weaker OPEC members in Latin America and Africa all look set to decline sharply relative to trend in the next 3-5 years.

Even in the non-OPEC non-shale production sector, oil producers are boosting efficiency, learning to extract more oil for less money.

The rebalancing is taking far longer than members of the Organisation of the Petroleum Exporting Countries and most analysts anticipated when prices started to slump in 2014.

The industry’s response to falling oil prices has been to produce more oil to offset the revenue impact of declining prices, or at least the same amount for a lower cost.

The reaction, which is making the slump deeper and longer, is an example of a destabilising “positive feedback” loop.

In systems characterised by positive feedback, an initial shock, such as the plunge in prices, produces a reaction, such as efficiency gains, which tend to make the shock worse, at least in the short term.

Markets and other systems characterised by positive feedback tend to be extremely unstable, prone to large and long-lasting cyclical swings in prices and production.

The market will eventually rebalance, as oil producers’ short-term coping strategies are exhausted, capital dries up and low prices stimulate more consumption.

But the adjustment is taking much longer and proving far more painful than almost anyone thought likely when prices began to slide 18 months ago.

 

 

 

 

 

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