World Oil Price Depends on “Marginal” Barrel
AUSTIN, TEXAS – April 15, 2019
The production and supply of American oil is a more important factor for the global market than the situation in oil-producing countries, according to the Wells Fargo Investment Institute. The growth rate of production in the US will determine the movement of oil prices until the end of the year. However, the growth of production in the country is increasingly dependent on the development of shale deposits, which extract the "marginal" barrel - oil, the production of which may be unprofitable due to fluctuations in WTI quotations.
Falling is the key to future growth
Since the beginning of the year, the American WTI has risen in price by more than a third, exceeding $60/ bbl. John LaForge, the head of real asset strategy for Wells Fargo Investment Institute, is confident that the surge in oil prices in the first quarter of 2019 is a reaction to the fall in WTI prices at the end of last year.
Saudi Arabia, the largest exporter of oil in the world, can restrain, reduce or increase production regardless of the level of world prices since the cost of production in this country is very low. Despite the constant optimization of production and cost reduction, it is very expensive to extract oil in the United States compared to Saudi Arabia. The business of many American companies producing shale oil is balancing on the brink of profitability since the extracted barrel is “marginal” - it can cause losses even with a slight decrease in oil prices. Shale oil production is subject to great risks due to fluctuations in WTI quotes, even insignificant, LaForge said.
The latest official US Energy Information Administration data indicates that US production is slowing down - in January there was a decrease for the first time in six months. The data for February will be published at the end of April, and if production drops again, LaForge’s findings will be confirmed.
The cost of extracting
“Commodity prices often determine the cost of production in a country that produces a ‘marginal’ barrel, an ounce of gold or a pound of copper. In the case of oil, the ‘marginal’ barrel for the world market is produced in the United States," said LaForge.
"The oil really is a direct reaction to the possible slowdown in production growth in the United States," the Wells Fargo study said.
It also provides a forecast for the price of WTI at the end of the year — $65/bbl.
LaForge believes that in the middle of the range of $40-50/bbl. the average shale company is beginning to doubt the economic feasibility of drilling new wells. When at the end of 2018, the price of WTI went down sharply and approached $40/bbl, many US shale companies reduced their production drilling.
The Bank of Dallas, part of the US Federal Reserve, conducted a survey among managers of 82 companies that produce shale oil. According to the survey, the average price that ensures the break-even of production is in the range of $48-54 per barrel. The variation in prices depends on the conditions of shale oil occurrence in a particular region of the United States. American oilmen need a WTI price of $50/bbl to drill a new well and prevent losses.
The current break-even level of shale oil production decreased compared to last year when it was $52/bbl. The average break-even level at Midland deposits in the Permian structure dropped to $48/bbl. - the lowest in the region and the lowest in the United States over the past three years. Currently, Permian produces one-third of all oil in the US — over 4 million barrels per day.
The price level of profitability of shale oil production, determined by the Americans, differs little from Russian estimates. During the V International Arctic Forum in St. Petersburg, Russian President Vladimir Putin questioned the economic viability of oil production in the United States at a price below $40/bbl.
The direction of the movement of oil prices
In connection with the increase in oil prices in the first quarter of 2019, most of the top managers of the companies surveyed reported their readiness to increase drilling volumes. 64 reported profitability of shale oil production at an oil price of $59/bbl. according to a WTI quote on March 22, when the survey was conducted.
The growth of WTI quotes in early 2019 to $60/bbl. and higher will lead to an increase in production and an increase in oil supply on the world market in the coming months, which will put pressure on oil prices.
"The next trend in the oil market in the short term is a downward movement, closer to $50/bbl. However, in the second half of the year, we expect WTI to reach $65/bbl. as geopolitical tensions in oil-producing countries is growing," predicts LaForge.
In the middle and end of this year, oil prices in the world will depend primarily on the growth rate of production in the United States. But there are other factors that have an impact on supply and demand: US sanctions against Venezuela and Iran, containment of production under the OPEC + agreement, aggravation of the situation in Algeria and Libya. In addition, it is necessary to take into account concerns about the deterioration of the global economy and the negative consequences from the aggravation of trade relations between countries - primarily between the US and China.
However, the situation on the market will be determined primarily by the "marginal" barrel extracted – or not extracted – from the US.