Oil Price Rally Falters as US Shale Producers Weigh Reopening

Crude hovers at $40 as stocks build, Chinese demand questionable
June 10, 2020 Updated: June 10, 2020

Oil prices fell to around $40 per barrel in early trading on Wednesday after reports that American Petroleum Institute (API) statistics showed U.S. crude stocks had risen sharply—confounding analyst’s expectations.

Market prices for Brent and West Texas International (WTI) hit three-month highs on Monday—with WTI prices creeping briefly above the $40 mark after Brent fell to a 21-year record low of $16 per barrel and WTI future prices briefly turned negative in April.

The Organization of the Petroleum Exporting Countries plus Russia and others (OPEC+) crude producers’ group had agreed on Saturday to extend supply cuts of 9.7 million barrels per day (bpd) until the end of July. Subsequently, however, a trio of Middle-Eastern oil producers—Saudi Arabia, Kuwait, and the UAE—indicated that they would not be continuing supplemental cuts of approximately 1 million barrels per day.

Norwegian energy analyst Rystad Energy stated that if OPEC and allies refrain from production increases, the market could experience crude oil and condensate supply deficits as soon as the end of June that would continue through 2021—shoring up prices, drawing down brimming reserves and easing U.S. shale producers back into the market.

OPEC+ Influence?

At the 11th OPEC and non-OPEC ministerial meeting held remotely on June 6, the participants reiterated that it was vital that all major producers remain fully committed to efforts aimed at balancing and stabilizing the market. This included continuing through July the production cuts agreed for May and June between OPEC members plus Russia, while ensuring that producers that had not complied fully with the cuts, such as Iraq and Nigeria, would balance out their surpluses with even deeper cuts later in the summer.

Epoch Times Photo
Saudi Energy Minister Khaled al-Faleh (L) and Russian Energy Minister Alexander Novak attend a meeting of OPEC and non-OPEC members to assess compliance with production cuts and to discuss potential long-term cooperation, in Jeddah, Saudi Arabia on April 20, 2018. (AMER HILABI/AFP/Getty Images)

Overall, OPEC+ reported 85 percent compliance with the production cuts.

According to Rystad Energy, “the generous OPEC+ voluntary cuts into July will not only balance the Covid-19-hit global crude and condensate demand, but are deep enough to create a monthly deficit starting from June 2020 and continuing uninterrupted until at least the end of next year.”

The company believes that crude oversupply is a thing of the past “as long as OPEC+ compliance stays strong and the oil demand recovery trajectory isn’t radically altered.”

Demand Recovering—Slowly

Petroleum Association of Japan President Tsutomu Sugimori told Reuters on Monday that he expects oil to continue to trade above $40 per barrel—as long as sufficient economic activity resumes to stimulate demand. Sugimori said he expected supply and demand to move toward an equilibrium.

Responding to the OPEC+ extension announcement, Ann-Louise Hittle, vice president of macro oils at energy analysts Wood Mackenzie, said “The 9.7 million b/d production cuts were already working, extending them an extra month will tighten the market more quickly.”

Hittle says that global demand is also recovering, with figures for May and June reflecting the relaxation of lockdown restrictions around the world. “Wood Mackenzie already expected the supply and demand balance to tighten in the third quarter,” she said in a statement. “With the extension, this rebalancing will accelerate.”

Hittle expects global demand to surpass supply and draw-downs of storage capacity to occur in the third quarter, leading to increasing oil prices from the current $40 per barrel to the $45-$50 range, with Q3 demand 10 million b/d higher than in the second quarter.

US Shale Will Recover, But When?

According to the Baker Hughes rig count, the number of rotary oil rigs in operation across the United States fell by 17 to 284 in the week ending June 5—a fall of a whopping 691 from the same weekend last year.

In a report on shale shut-ins, S&P Global writes that although neither shutting down a well nor restarting production are technically difficult tasks, they are associated with costs. In addition, some of the tiny cracks in the fracked shale may have closed, meaning that some wells will require time and additional measures to return to their previous production volumes—if that’s possible at all.

A pump jack operates at a well site leased by Devon Energy Production Company near Guthrie, Okla., on Sept. 15, 2015. (Nick Oxford/File Photo/Reuters)

According to S&P, “Some producers anticipate bringing shut-in wells online again if West Texas Intermediate oil prices remain above $30 per barrel.” The company quotes Goldman Sachs analysis that shows how WTI prices can change producer behavior. From $30-$40 per barrel, well completions resume, while prices from $40 to $50 maintain production levels. Prices from $45 to $ 60 per barrel would signal a return to expanding production, which most analysts expect will occur first in the west-Texan Permian basin.

According to S&P, however, “Few people, if anyone, expect the end of the great shale shut-in to offset a dramatic decline in U.S. production this year and perhaps in the years following. Oilfield workers have been laid off en masse. More than half the country’s drilling rigs have been idled. Fracking fleets are being decimated.”

“We just tromped on the brake pedal with both feet and slowed down production dramatically, such that it looks like we are going to get through,” veteran oilman Kyle McGraw told S&P. “People shut in at much greater rates because of that fear, a month ago, when we had that negative $37 oil.”

“As fast as we jumped on the brake, how fast will we move our foot over to the gas pedal now?” McGraw asked. “Will we go to the gas pedal with both feet? I think not.”

Words of Caution

While global oil demand has experienced a recovery during May and June, much of that demand has been driven by China. While some analysts have assumed that increased Chinese demand has been an indicator of Chinese economic activity and a return to business as usual, others have cautioned that more sinister motives may have been at play.

Writing at oilprice.com, Tsvetana Paraskova says that the simplest reason is that Chinese buyers have likely chosen to fill as much storage capacity as possible while crude prices have been at record lows, with China’s opportunistic buying even breaking the country’s own monthly import records in May.

However, Reuters quoted the head of China research at the Oxford Institute for Energy Studies, Michal Meidan, as saying that China’s oil hub of Shandong is currently hoping to boost economic activity by shutting down smaller, independen, so-called ‘teapot’, refiners to make way for a massive $20 billion refinery complex. Increased oil stocks would help buffer the shut-down.

The imports may also have been a preparation for other mega-projects and for the Chinese refinery maintenance season. In addition, many smaller Chinese importers may have already used up their import quota allowances, meaning reduced Chinese demand overall in the third quarter.

Analyst Bo Zhuang from TS Lombard told the Financial Times recently that the Chinese Communist Party (CCP) may also be worried about increasing levels of tension with the United States.

The United States and a host of other nations are angry over the regime’s cover-up of the CCP virus outbreak and the communist regime’s failure to honor the terms of the Sino-British Joint Declaration on Hong Kong. Secretary of State Mike Pompeo yesterday denounced Chinese efforts to coerce the UK by pulling out of agreements to supply nuclear reactors over the UK’s rejection of Huawei as a telecoms provider.

“Australia, Denmark, and other free nations have recently faced pressure from CCP interests to bow to China’s political wishes,” said Pompeo. “Free nations deal in true friendship and desire mutual prosperity, not political and corporate kowtows.”

A further breakdown in China’s international relations could conceivably lead to sanctions such as tariffs, which could affect its ability to import goods without impediment. Strongly increased imports now may be a harbinger of reduced demand in Q3, however.

The Financial Times reported that, according to Bo Zhuang, “China wants to fill up its oil tanks and soybean warehouses in case it couldn’t import these materials freely.”