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COLUMN-EIA forecasts temporary peak in US oil output in May: Kemp
January 14, 2015 / 12:50 PM / in 3 years

COLUMN-EIA forecasts temporary peak in US oil output in May: Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

By John Kemp

LONDON, Jan 14 (Reuters) - U.S. crude production is set to rise by another 300,000 barrels per day to a temporary peak in May, according to the U.S. Energy Information Administration, before declining over the summer.

The forecast is contained in the latest edition of the EIA's closely watched Short-Term Energy Outlook (STEO), released on Tuesday (www.eia.gov/forecasts/steo/).

Most of the commentary on the STEO has focused on forecasts for yearly average output, which the EIA sees climbing by 640,000 barrels per day (bpd) in 2015 compared with 2014, and then another 220,000 bpd in 2016.

But in a context where oil production rates are changing rapidly, focusing on the annual averages gives a very misleading picture of oil supply.

Production climbed from 8.02 million bpd in January 2014 to an estimated 9.15 million bpd in December, so an “average” figure of 8.67 million is not helpful in understanding the impact of supply on market prices.

The monthly production forecasts contained in the STEO are much more illuminating and tell a more nuanced story about the outlook for U.S. oil production and prices over the next two years.

STEO forecasts production will climb from 9.15 million bpd in December 2014 to reach a temporary high of 9.47 million bpd by May 2015 (link.reuters.com/dyz73w).

But the EIA expects output to fall through the summer months to just 9.14 million bpd in September, essentially unchanged from the start of the year, before growing slightly to end the year on 9.24 million bpd.

This production profile is consistent with what is already known about drilling, well completions and decline rates on shale wells from other sources such as North Dakota’s Department of Mineral Resources.

The large backlog of wells drilled but not completed as a result of record drilling in the first 10 months of 2014 should be enough to keep production rising throughout the first few months of 2015 as these wells are finished and put into production.

But once the backlog is cleared, the reduced number of rigs operating since the start of the year should mean fewer completions from April or May onwards.

At that point, the decline rates on the existing stock of wells should start to pull production lower. The EIA forecasts that production will decline by 330,000 bpd between May and September.

The forecast reduction is consistent with North Dakota’s projections for falling output by the middle of the year based on reduced drilling rates and wellhead prices below breakeven levels.

The EIA predicts output will rise again modestly in the final three months of the year to end slightly higher than at present.

However, the forecast is critically dependent on a fairly substantial recovery in oil prices. STEO projects WTI prices will rise to $51 a barrel in May and $67 by December (link.reuters.com/gyz73w).

Without that price rebound, the fall in output during the second and third quarters is likely to be deeper and longer, and the expected recovery by the end of the year might not materialise.

STEO carefully notes the conditionality between prices, drilling and production. “Many companies have begun redirecting investment away from marginal exploration and research drilling and focusing on core areas of major tight oil plays,” it explains.

“Oil prices remain high enough to support some development drilling activity in 2015 in the Bakken, Eagle Ford, Niobrara, and Permian Basin, albeit lower than previously forecast.”

STEO goes on: “With projected WTI crude oil prices starting to rise in the second half of 2015, drilling activity is expected to increase again as companies take advantage of lower costs for both leasing acreage and drilling services ... However, this forecast remains particularly sensitive to actual prices available at the wellhead.”

This seems a reasonable forecast. Oil prices are already below breakeven rates for many of the less mature shale plays as well as peripheral parts of established plays like Bakken and the Permian Basin. Drilling is slowing and will probably fall below replacement levels in the next few months.

As output starts to plateau and then fall, incipient production declines should steady prices and result in a modest recovery, which will in turn help avert deeper falls in production in the second half of the year.

The adjustment is likely to be very bumpy, however, not least because of the lengthy information lags in the system, intense uncertainty, and pressure on production companies to conserve scarce cash.

But the basic production profile projected by the EIA looks about right. More importantly, STEO has highlighted the critical dependencies between breakeven rates, decline rates and fresh drilling which will be the most important analytical challenge for the oil market in 2015.

Without some rebound in prices, U.S. oil output will be falling rapidly by the end of the year and finish 2015 below current levels. (Editing by Dale Hudson)

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