Booming U.S. Oil Production Is a Problem That OPEC Can Fix

The beaten-down oil industry just can't catch a break. After comments from Russian and Saudi Arabian oil officials propped up the commodity earlier this week, a round of bearish data has sent traders running for the hills, again. Global benchmark Brent crude futures and West Texas Intermediate light sweet crude futures had fallen roughly 3.5% and 3.8% to $47 a barrel and $44.70 a barrel, respectively, shortly after 4 p.m. 

With that, the stocks of U.S. oil producers on the S&P 500 closed down on average about 2.8%. Oil and gas producers Murphy Oil (MUR) , Chesapeake Energy (CHK) , Anadarko Petroleum (APC) and Devon Energy (DVN) were leading the retreat Wednesday, all down between roughly 3.9% and 5.4%. Contract drillers and offshore drilling service providers were also suffering the effects of oil's dip Wednesday with Transocean (RIG)  closing down more than 5% and Helmerich & Payne (HP) down a just over 3.6%. International oil majors Exxon Mobil (XOM) and Chevron (CVX) also suffered stock price blows of more than 1%.

Oil's plummet began early Wednesday with a report from the Paris-based International Energy Agency that said new production from rivals of the Organization of the Petroleum Exporting Countries, or OPEC, will be more than enough to meet growth in demand in 2018, despite the so-called oil cartels best efforts to cut its own production to return the commodity's supply and demand to balance. 

IEA's report followed by just a few hours a Tuesday evening release from the American Petroleum Institute, which said U.S. crude oil inventories rose by 2.8 million barrels during the week ended June 9, much to the disappointment of analysts who were expecting a draw of 2.3 million barrels.

Conversely, the U.S. Energy Information Administration's Wednesday morning report indicated a draw of 1.7 million barrels of oil. The EIA's data is widely viewed as the official tally, but the lower-than-expected draw in crude inventories only served to deepen the commodity's losses Wednesday. 

"The EIA data was bearish in our view as composite inventories increased to above the five-year high and the draw in crude inventories was lower than the consensus estimate [week over week]," KLR Group analyst John Gerdes wrote in a Wednesday research note.

Jeff Quigley, director of energy markets at consulting and analytics firm Stratas Advisors, agrees, arguing in an interview with TheStreet that the market continues to trade on sentiment. 

"All this bearish data just reinforces the recent trend because some people are still worried about too much product in the market," he said. "Fundamentals are still better than sentiment, but we need to see some big upside surprises before you see any real upside in the market."

Indeed, the bearish data out this week is almost suffocating. The IEA said Wednesday that global oil supply rose by 585,000 barrels per day in May to 96.7 million barrels per day as both OPEC and non-OPEC countries produced more. Total output stood 1.25 million barrels per day above a year ago, the highest annual increase since February 2016, according to the EIA, which said gains were dominated by non-OPEC producers, particularly the U.S.

As Quigley explains, however, lagging data has been supportive of higher oil prices. Crude inventories are dropping on a long-term basis, demand is rising and OPEC is committing to its production cuts, which the organization recently extended through March 2018. Still, sentiment in the market is so bearish that weekly data is continuing to have a negative impact on prices. Earlier this week, OPEC leader Saudi Arabia even went so far as to signal that it would address extending and strengthening later this year if its oil cuts if the current agreement did not have the anticipated effect.

Moreover, Stratas is not convinced U.S. shale production can keep ramping at the pace the market expects it to, Quigley said. The EIA is calling for U.S. production, which is now at record highs, to average about 10.2 million barrels of oil per day by the fourth quarter of 2018, while Quigley's firm is predicting domestic production levels of 9.7 million barrels per day by that time. 

The firm expects less out of U.S. shale partly because U.S. producers' hedges have run off, which should reduce production in the second half of the year, and partly because productivity gains due to rig efficiencies and cost cutting has flattened. 

"You're not seeing gains in rig efficiencies that you were seeing, and we're now seeing diminishing gains on productivity," Quigley said. The EIA's productivity report released Tuesday did indicate a decline in oil rig productivity in most U.S. basins, with a decline in rig productivity in the dominant Permian Basin of west Texas expected to accelerate to -2.4% month over month. 

If Stratas is correct and U.S. shale production slows, and OPEC fully takes control of the market by extending its production cuts through 2018, as it has to power to do in Quigley's opinion, a market correction could come down the road. But in the meantime, there are several risks that could prevent oil prices from climbing above $60 per barrel by 2018 as analysts predict. 

"OPEC has the control if they want it, obviously the challenge is Libya and Nigeria being not included in the cuts," Quigley said. "I think a year ago OPEC was in trouble because U.S. shale. Then the incremental shale barrel was getting cheaper because productivity going up and cost was going down. Now, not so much, OPEC can actually control the market now. The ball is in their court. They just need to execute; they can't dither." 

--This story has been update to reflect closing stock prices.

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