The Next Phase of U.S. Shale Revolution

There is a rich story behind the chart above, which displays the relationship between U.S. crude oil production and rig counts. Apart from the occasional weather-related abnormalities in crude oil output, there used to be a tangible correlation between the two sets of data for a simple reason. Rising rig counts implied a growing appetite for pumping oil with a time lag of a few weeks and vice versa. This relationship, however, seems to have fallen apart in the last year or so as declining rig counts have been coupled with resilient and rising outputs, which reached record highs. Technological advances allowed output to remain elevated without intensifying drilling, while focus shifted to dividends and share buybacks.

The U.S. shale industry is currently undergoing its next phase of revolution. It is called consolidation. Four deals worth $178 billion in less than six months saw publicly traded oil producers playing an increasingly dominant role in the U.S. shale sector by buying up smaller private companies. Drilling for the sake of growth by burning cash is becoming a thing of the past as the next chapter of the U.S. shale revolution will be called a “managed phase.” It means that new major players will display discipline by not necessarily raising output in case of stronger prices. It is worthwhile noting that shale’s break-even price in the Permian Basin, for example, is below 40/bbl.

A few observations can be made to put the ongoing changes in a global context. Firstly, even though domestic production will rise, the growth rate will slow considerably as rig counts are unlikely to increase to levels seen four to five years ago. Secondly, the U.S. will cease to exist as a swing producer. Thirdly, U.S. crude oil exports should remain elevated, particularly after WTI Midland was promoted to the Brent basket. Lastly, OPEC’s efforts to balance the market make the producer group an implausible candidate to re-assume its role as the central banker of the oil market. The upshot is that the U.S. crude oil benchmark should be supported domestically and internationally. Consequently, any dip in WTI backwardation further down the curve will be greeted with a palpable rise in buying interest.

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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