US shale producers to gulp Saudi market share of oil

After OPEC lead by Saudi Arabia and Russia arrived at a consensus to contain oil production, I wrote that the real threat for Saudi Arabia was not Iran but the US shale producers. Some of my critics said that I suffer from US-phobia and try to portray whatever happens on the earth as part of US conspiracy.

This morning when I read a news from Reuters about increasing number of rig counts in the US, it gave me a feeling that I was not mislead by the western media but right in saying that with the hike in crude oil price, rig count in the US would jump dramatically.

According to the Baker Hughes, US energy companies have added oil rigs for an eighth week in a row as crude oil prices rose to a 17-month high. During the week ended 23^rd December 2016 the total rig count went up to 523, the most since December 2015.

The report also said that by May this year rig count had plunged to 316, from a record high of 1,609 in October 2014. This decline could be attributed to crude oil price that plunged to US$26/barrel in February 2016 from US$107/barrel in June 2014.

The report also indicated that oil and gas rigs count would average above 500 in 2016, around 750 in 2017 and above 900 in 2018. This confirms the news that while other oil producing countries curtailed fresh investment, US shale producers continued production without filing bankruptcy under Chapter 11.

The Reuters news should be an eye opener for oil producing countries, particularly Saudi Arabia, Iran and Iraq. They should not be the first to cut production and let the crude oil price go up. If they want to keep US shale producers under pressure, they will have to keep crude oil price below US$35/barrel. This may be pains taking but the only option to bring down the number of active rigs in the US. They should also keep an eye on E&P companies filing bankruptcy under Chapter 11.

In response to this I have received following response from Mark S. Christian, ​President, Chris Well Consulting.

I read your article, "US Shale Producers to Gulp Saudi Market Share of Oil". This article implies a skyrocketing North American rig count, but the U.S. did not add 523 rigs during the week ending December 23, 2016. In fact, the rig count in the U.S. is growing only modestly at the moment. Last week the U.S. added only 16 rigs in total - 13 rigs exploring for oil, and 3 rigs exploring for natural gas. This brings the total rig count to 523, but your article implied 523 rigs were added during this past week, and that is not correct. Maybe it was an editorial mistake by the publisher - which said: "During the week ended December 23, 2016 the total rig count went up by 523, the most since December 2015".It should have said ..."the total rig count went up to 523", implying the aggregate total reached this number.

I have been in the well-servicing business for more than 30 years and during this time operated workover rigs.​ A well service company provides well completion and maintenance services and​ demand for rigs go up and down with the oil price. When the oil price recently fell below $30USD/Bbl - my​ workover rigs were sitting idle. Oil companies could not afford to work on their wells, so they let them go offline. As prices moved above $45/Bbl, oil companies started calling again - and our workover rigs slowly began moving back into the field. The same holds true for American drilling rigs. Higher prices = higher U.S. rig utilization.

This supports your hypothesis that - 1) the U.S. rig count is a threat to the Saudi-led production cuts and 2) American shale may be a longer term threat to OPEC's market position.  Your warning to Iraq, Iran, and Saudi that raising prices via production cuts is not in their long-term interest, is correct, although I surely hope they do not change course.

Saudi guided OPEC into underestimating the staying power of shale-focused oil companies in the United States who were built on junk bonds and high-interest debt. Most were developing fields that were not economic below $60/bbl - and the Saudi's knew this. Riyadh miscalculated by expecting these financially weak companies to fold up quickly once prices fell below lifting costs. That did not happen, many went into Chapter 11 bankruptcy which allowed them to discharge their bond debt and emerge with a cleaner balance sheet.

El Naimi expected very steep decline curves for U.S. shale production, however, this did not materialize and North American shale production turned out to be more resilient than even the American oil companies forecasted. El Naimi also expected the shale market to collapse on itself as he viewed U.S. shale production to be inefficient. It was - until market forces went to work and held the unconventional resource market together much longer than the Kingdom's cash reserves or El Naimi's ideas were able to bear. 

In November 2014, the bottom fell out of the US oil market and caused U.S. service costs to deflate - my rig rates fell 30% in 60 days. What most outside the U.S. don't understand about the American market is when things are good we can ramp up drilling and well completion quickly​, but when things turn bad - cost cutting and a lazer-focus on efficiency enable us to sacrifice profits and survive until the market rebounds.

El Naimi's low-price strategy forced American E&P's to cut wasteful spending and exercise more discipline over their profit and loss. This helped​ U.S. production become more efficient - and lowered U.S. lifting costs. Now fields that were unprofitable when crude prices fell below $60/bbl are profitable at $45/bbl.

The big question that everyone wants to know, (and relate directly to your warnings to OPEC in your recent article) is: How long will it take the​ U.S. to ramp up production enough to offset OPEC's production cuts? Can American production actually grow large enough to begin driving global oil prices down? If that happens, OPEC will no longer be the swing producer we have relied on for so many years to correct bubbles in the market.

If the U.S adds 16 rigs per week over the next 52 weeks - the resulting increase of 832 new rigs in the next year will not affect America's oil production to an extent it will make a noticeable change to the global oil market. Over the years I have noticed that the U.S. market needs 2-3 years of booming exploration and development activity before the global market takes notice. I do agree with your assumption that production growth in the U.S. may swallow up Saudi's recent production cuts, but it will take 24-36 months before many people take notice.