U.S. oil production is what matters - not OPEC, Russian production cut.
Shale producers ready to rumble.
Another 21 oil rigs added in the U.S.
U.S. shale taking over the direction of the market. source: Stock Photo
I don't care what OPEC or Russia decide to do at the upcoming meeting, what U.S. shale producers do is much more important, and adding another 21 oil rigs this last week points to them readying themselves to ramp up production, which will definitely test the resolve of OPEC and Russia. There are now 498 oil rigs operational in the U.S., according to Baker Hughes. I expect that to continue to climb.
Some think the major reason for the increase in rigs and completed wells in the U.S. is because of the proposed OPEC and Russia production cut, but this has been trending upward for months, and it is primarily because of the increased efficiencies and productivity of leading U.S. shale producers, which with their premium wells are able to generate a profit at most price points.
It's important to understand the why of the rapidly increasing U.S. oil rigs, because to misunderstand the reasoning behind it would be to wrongly attribute the cause to OPEC, which in turn would imply it remains the swing producer of the world, when in fact it has transferred to the U.S. U.S. production is what's important
What matters most in the oil sector is where the production level in the U.S. is at, not what OPEC or Russia decide to do. They and others continue to scramble to solve the U.S. shale problem, and to this day, they aren't able to figure it out, and they won't ever be able to. It's here to stay, and it will continue to grow in influence and supply levels in the months and years ahead. No competitor can do anything about that.
If shale producers weren't adding more rigs I wouldn't be quite as confident, as I would think they are holding back because they may have been overly optimistic in their data. But there is no doubt in my mind they've removed a lot of the costs out of production and are able to compete with almost anybody in the world now.
Both OPEC and Russia are close to the ceiling of their potential. They could add more oil, especially Saudi Arabia, and also Nigeria and Libya because of internal strife that has disrupted production. Russia has surprised to the upside as well, but it's close to topping off.
The U.S. on the other hand has nowhere to go but up with its oil supply, and after OPEC did its best to crush the shale sector, it has resorted to past tactics that were limited in impact as they were, and now with U.S. shale, are close to meaningless.
Now it's a race to see how quickly U.S. shale producers can ramp up production and how quickly global demand for oil rises. The production cut deal, even if it is actually implemented, is nothing more than an interesting but irrelevant side show. Shale producers well positioned to strongly compete
The big mistake OPEC made by increasing global supply is it forced shale producers to find ways to cut costs, improve technology and methodology, and increase productivity. They have been wildly successful in all those areas, even as they continue to make advances.
This has and will continue to frustrate any efforts to slow them down, and it's why they are more than ready to rumble with OPEC, Russia, or any other competitor. It's also why they keep adding rigs and completing wells.
It's not news that the proposed OPEC cut has supported prices, and those prices are good for shale producers. Again, what's important to understand is this isn't the impetus behind the increase in rigs and completed wells. That's vital to how investors view shale producers and the market in general. It's also why it's so important to understand OPEC no longer has the ability to control the global oil market, and the U.S. shale market specifically. To assume it is the reason shale producers are increasing output would be a mistake.
U.S. shale producers, through their expertise and experimentation, have carved their own competitive advantage in the oil market, and that is what is driving their output decisions, not OPEC.
That's not to say the pace they're completing wells isn't affected by OPEC, as in the short term it is. By that I mean they can't count on OPEC to support the price of oil for a prolonged period of time, and so aren't fully completing wells at a market-driven pace, and instead, in my view, are holding back some to see what the real price support they'll be dealing with will be at in the future.
If they were to go all in with the OPEC deal, OPEC could pull the rug out from under them and remove all quotas and supply the market at high levels as they have over the last couple of years. Under that scenario they could have a lot of production in play because of expectations of a higher price. For that reason they have to sure they are making rig and well decisions based upon how they view the future market, whether or not OPEC keeps some type of cut in place. Apache and EOG will do well in this environment
Neither of these two shale producers needed OPEC to generate earnings with their premium wells, but they won't complain about the temporary support oil prices will get from the production cut deal - whether it's really implemented or not.
Both companies have increased production outlooks heading into 2017, and with each one adding more wells and selling into a higher environment, it should result in Apache Corp. (NYSE:APA) and EOG Resources (NYSE:EOG) turning a profit, as they've gradually moved in that direction by cutting costs and improving productivity.
In the latest quarter Apache said its production in North America will come in at the high end of onshore production, and for its international and offshore production guidance, it'll come in at the mid-point.
Year-over-year Apache was able to improve its cost-per-share loss from 9 cents a share in the same period of 2015, to 3 cents per share in the third quarter of 2016.
EOG also had good news on the production side. It raised its full-year guidance to 278.5K-282.1K barrels per day, up 3 percent from its last guidance.
That and its upward revision of its resource potential in the Delaware to 6 billion barrels, an increase up 155 percent, further solidifies its lead in the U.S. shale industry, and positions it for long-term growth and profitability as will benefit from its low-cost moat. Once it balances its portfolio to reflect almost all premium wells (which it projects to occur in 2018), it will be a earnings monster for years.
At this time EOG can generate about 30 percent when oil is at about $40 per barrel. Apache is closer to generating about the same with oil closer to $45 or a little higher.
Assuming oil can maintain a $50 per barrel level, EOG has said it should be able to boost production at a 50 percent clip through 2020. If oil were to climb to $60 per barrel, it'll accelerate that rate to about 25 percent compounded on a yearly basis. I have no doubt Apache would also accelerate its production rate as well if the price of oil finds support near those levels.
My view is that if it does, it'll be from global demand catching up with supply, not from OPEC and Russia cutting production. Conclusion
I don't see the trend of increasing rigs and completing more wells by U.S. shale producers ending any time soon. That won't be determined by anything OPEC does, but the pace of global demand, and how much more they can lower costs and increase margins and earnings.
The price of oil will determine their profit of course, but shale producers are confident and committed, and while somewhat cautious because of the uncertainty concerning OPEC, it's only on how many rigs and wells to add or complete, not whether or not they're going to continue to increase production.
Based upon media reports, you would think OPEC is the key to the oil market, but as I've shown, U.S. shale is now the dominant force, and that's not based upon who can produce more in the present, but who will produce more in the near future. With Russia and OPEC near the ceiling of their production levels, they don't have a lot more to add. Saudi Arabia could probably max out with another 2 million barrels a day or so, but won't do that unless it reaches full panic mode. It's not in that place at this time.
Even if they did, they would be putting more pressure on themselves to quickly diversify their economy to protect it from siphoning off too much oil, too quickly. It would also crush the price of oil if it did, which would further eat into its cash reserves.
Shale is the future of oil, and the United States is by far the leader in that segment of the market. They control the future direction of oil, and OPEC, for a very short time, has made the last move it has before that becomes an overwhelming reality.
My belief is shale producers are about to turn the tables on OPEC and return the favor of ramping up production in order to put pressure on those countries. After what OPEC attempted to do to them over the last couple of years, it'll be enjoyable to see when shale producers succeed. It's not that far away.
