NRGU - U.S. Oil Production Just Hit An All-Time High: A Harbinger Of Short-Term Pain

2024-01-09 15:31:43 ET

Summary

• WTI crude prices are down 5.2% over the past year, with a 24.4% drop from their peak.
• US oil output has reached an all-time high, indicating potential weakness ahead.
• Despite short-term bearishness, the long-term trajectory for oil prices remains bullish, with forecasts of a price range of $75 to $85 per barrel.

There's an old saying that is often attributed to the Chinese that goes, "may you be cursed to live in interesting times." Although the origin of that quote is contested, I do think that it rings true in many respects in almost any era. Recently, one thing that has been particularly interesting has been the movements in the oil space. Over the past year, WTI crude prices are down 5.2%. But from their peak over the past year, they're down as much as 24.4%. Just recently, news broke that Saudi Arabia had decided to cut their oil prices by $2 per barrel, in a move that sent crude prices tumbling about 4% on Jan. 8. All combined, this seems to indicate that weaker demand is around the corner.

While I understand the concerns that investors have, I would like to point out that there are other data points in the oil space that give a conflicting picture. For starters, US oil output just hit an all-time high. This also could be a sign of additional weakness ahead. In fact, I would be surprised if we don't see some. However, investors need to be mindful of the long-term picture. Because even though the crude market is likely to see more down days ahead than up days in the near term, the long-term trajectory for the space is still bullish.

A move toward "energy independence"

The goal of this particular article is not to focus much on political matters. But I do think it's worth mentioning that one of the most loaded phrases used by politicians on both sides of the aisle in the US is "energy independence." Whether it's because of matters of national security, economics, or other issues, Americans would love it if the country would become truly independent of other nations from an energy perspective. The sad truth is that, for as long as we utilize fossil fuels as a major source of energy, true energy independence will never occur. This doesn't mean, however, that we haven't made steps in that general direction.

I say this because, at the present moment, the US is producing more oil than it ever has. Using weekly data , the prior peak was around the February to March window of 2020 when the nation was churning out 13.10 million barrels of crude per day. The pandemic took a massive bite out of crude output. But since then, there has been a sizable rebound in output. The nation finally surpassed that prior all-time high in October of last year. And by late December, crude production had grown to 13.30 million barrels per day.

If we use monthly data , the picture looks a bit different. Unfortunately, this data only covers through October. I also would argue that this is the more accurate data since the weekly data is truly the earliest estimate we get as to what production is. Well, in the month of September, US crude output reached an all-time high of 13.252 million barrels per day. That tops the 13 million barrels per day that we previously peaked at in November 2019. There was a small dip in October. But in all likelihood, crude production is going to continue growing in the near term.

This rise in output, combined with broader economic concerns and the decision of Saudi Arabia to cut their own pricing, is sure to make investors a bit skittish. Interest rates have been elevated for some time now, and while the economy here at home remains strong, there are signs of weakness abroad. The weakness is most evident in China. Just last month, the World Bank projected that China's economy would grow at a rate of only 4.5% this year. That's down from the 5.2% estimate reported for 2023. A weak real estate sector, combined with high debt levels and a population that continues to age are cited as "significant risks" for the nation. In the European Union, the picture is even worse. In November of last year, the European Commission estimated that GDP growth in 2023 would be a paltry 0.6%. That's 0.2% lower than what they had forecasted last summer for the year. Though current forecasts do call for growth of around 1.3% for this year.

Given that oil is a truly global market, the performance of major economies is undeniably important. The fact that the US economy is doing really well is far from the only thing that matters. In terms of the short term, I wouldn't be surprised if we see additional downside in the oil market. After all, commercial OECD inventories were recently estimated by the EIA (Energy Information Administration) to be 2.829 billion barrels. That translates to 61.65 days worth of consumption. Generally, a glut is anything in excess of 60 days. Although this may not seem like much of a difference, it translates to excess inventories across OECD nations of about 75.6 million barrels.

Long term, however, I do think that prices will go back up. There are a couple of reasons for this. For starters, using data from the STEO (Short-Term Energy Outlook) compiled by the EIA each month, the global oil supply in 2023 averaged 101.62 million barrels per day. That's well above the 101 million barrels per day in global demand for the same year. That small difference translates to about 226.3 million additional barrels of crude oil over the course of a single year. However, for 2024, global supply is forecasted to be 102.19 million barrels per day, while global demand should be around 102.34 million barrels per day. That should help reduce global inventories by 54.75 million barrels, with OECD inventories dropping to 2.807 billion barrels.

Another area of improvement involves some data provided by OPEC itself. According to the group, in the third quarter of 2023 alone, there was a daily shortage of crude totaling 0.84 million barrels per day. The group does not give any estimates for its own production on a forward-looking basis. But we do know that they were forecasting a need for 31.12 million barrels of crude per day in the fourth quarter of last year. This is the amount of oil that the group itself would need to produce if their global demand forecasts are correct and if their supply estimates for nations that are not in OPEC are also accurate.

According to the group's own estimates, OPEC nations produced an average of 27.866 million barrels per day in October and November of last year. So if that holds true for the final month of the year, it would imply a shortage of 3.25 million barrels per day. What's more, the group is forecasting demand in 2024 coming in 2.25 million barrels per day higher than what was forecasted to be produced for 2023. On top of this, the amount of oil at sea is falling nicely. According to OPEC, inventories at the end of 2022 totaled 1.399 billion barrels. After growing further in the first quarter, they pulled back substantially to 1.220 billion barrels. These numbers are separate from the commercial OECD inventories.

Outside the estimates provided by both the EIA and STEO, there's one more data point that is worth looking at. This is also provided by the EIA and should be considered a good indicator of longer-term output. This is the number of DUCs, or drilled but uncompleted, wells that the agency keeps track of. A tremendous amount of cost goes into the initial drilling of a well. Estimates vary. However, it's believed that around 73% of the costs associated with oil and natural gas wells in the US involve the actual drilling of them. Only about 9% involve the completion of those wells. So in addition to having additional time to drill more wells, a decline in DUC inventories means that the cost of oil and gas exploration and production companies will increase at some point in order to replenish said inventories.

The most recent data provided by the EIA shows that the country only has around 4,415 DUCs right now. That's the lowest level that we have seen in more than 10 years. If oil prices stay too low for too long, especially as US output achieves new highs, it could result in a shortage of production here at home that could be rather painful. And with interest rates still elevated, that can make further investments in the space prohibitive in the near term. The end result could ultimately be a supply shock on the US side if OPEC and other nations do not step in to offset this. And frankly, those countries do not have an incentive to do so.

Takeaway

At this time, I understand that the market is rather bearish on oil prices. I would not be surprised to see crude prices drop another $5 to $15 per barrel. At the end of the day, however, I view this as a short-term thing even though US output is at an all-time high. Even if we ignore the more bullish OPEC data, the data provided by the EIA, both in the form of the STEO and Drilling Productivity Report, shows that any sort of prolonged decline in prices will only increase the risk of a subsequent surge. As I have mentioned to others in the past, I remain of the opinion that the long-term outlook for oil prices should be somewhere around $75 to $85 per barrel. Anything significantly outside this range, especially if it lasts for an extended period of time, should be viewed as unsustainable.

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