Oil price outlook from economist Ed King

Natural decline in North Slope legacy fields expected to be offset by new investment, keeping ANS production at some 500,000 bpd

Ed King

for Petroleum News

Oil traders reacted to positive economic developments in October. Fears of falling consumption growth targets dissipated a bit as positive trade talks provided some relief. As the largest source of current and future demand, traders watch the U.S. and Chinese economies closely. Almost no positive price shocks have been able to penetrate the worries of decreasing demand since the U.S.-China trade dispute began.

It appears that some hope of a trade deal helped oil prices over the last few weeks. Brent and WTI oil traded more than $3 higher than October. ANS posted a smaller gain of $2.14 per barrel. The increase in the differential that opened up in October closed again in November. However, Alaska North Slope crude is still selling at a $2 premium to Brent, which should continue as long as the sanctions in place.

ANS averaged $64.97 in November and has now averaged $63.72 so far this fiscal year. Given where the futures markets are currently trading, it appears the FY20 average will land between $53.69 and $75.93 per barrel, with an average outcome of $64.93.

However, a lot of attention seemed to turn toward a potential supply glut recently. Several projects that were sanctioned before oil prices crashed in 2014 are just on the verge of entering sustained production. By some accounts, more than a million barrels per day of new supply is slated to hit the market within the next few months.

In addition, all three major oil forecasting agencies show significant gains in shale oil production from the U.S. over the next year. With the markets already over-supplied, many analysts fear that piling on more unneeded sources will translate into a drop in prices over the next six months.

That risk is exacerbated by the fact that a few million barrels per day are already off the market due to sanctions on Iran and Venezuela. Should those sanctions be lifted, even more surplus oil would need to find a home.

Naturally, the world’s oil cartel can protect prices by making room for this new oil through production cuts. However, giving up market share to protect value can only go so far. And OPEC is already holding back a lot of production due to the growing U.S. shale supply. When oil prices crashed in 2014, Saudi Arabia protecting market share was one of the primary causes.

We won’t have to wait long to find out what they will do. OPEC is scheduled to meet in December to discuss its strategy. Early indications suggest that further cuts aren’t coming without some assurance that countries other than Saudi Arabia will comply.

Regardless of how things play out this winter and spring, the next leg of the commodity cycle is already visible. It comes from the fact that oil reservoirs naturally decline as reservoir pressure is depleted.

With about 100 million barrels per day of global production, oil companies need to bring over 5 million barrels per day of new production online each year just to maintain current levels. In other words, they have to run as fast as they can just to stay in place.

And so, when the market is oversupplied, it doesn’t require facilities to shut down. Balance is restored by simply putting down the checkbook for a few months. Since 2014, investors have put down their checkbooks. Reserve replacement is currently at a near-record low.

In addition, active rigs in Texas and Oklahoma have been falling for several months. The number of working rigs is down 25% since last year - as investors are hesitant to pump money back into these assets right now. Those rigs that are still working are focusing on completing the backlog of unfractured wells (cutely called a “fracklog”). Completing those DUCs (drilled but uncompleted wells) have pushed U.S. production to record heights despite the falling rig count.

But, a decrease in production levels will occur if new targets are not drilled. While there are plenty of resources to be brought online, investors aren’t likely to expand investment activity until prices rise. So, it’s starting to look like a timing issue could create a supply shortage a little over a year from now. That would mean a jump in oil prices followed by an increase in investment. And, any geopolitical tensions that disrupt supply could accelerate the issue.

In short, don’t expect oil prices to rise a whole lot before the summer, unless something unexpected happens. But, don’t mistake the current situation for the new normal. The fundamentals suggest a long-term price of about $70.

North Slope Production outlook

So far this fiscal year, 72.3 million barrels have been produced from the North Slope - which works out to an average of 473,014 barrels per day. At this point last year, 74.4 million barrels had been extracted (486,527 barrels per day). Therefore, it is starting to look like the final FY20 production number will fall a little bit from FY19.

However, the mean of all the production scenarios I ran still works out to 505,319 barrels per day in FY20. Of course, that number relies on some successful drilling that might not happen, including new wells in Prudhoe and Kuparuk, targets for the new ERD in Colville River, drilling out the new pads in Milne Point and GMT, and adding wells to the now producing Mustang field.

In all, reinvestment should offset the natural decline within the legacy fields for the next three years - keeping production at right around 500,000 barrels per day. From there, things should start to improve with the additions of Pikka, Willow, and all of the other exciting new investment opportunities around the North Slope - that is, if they receive funding. Time will tell.

- ED KING

NOTE ON THIS STORY: This article is an excerpt from the King Economics Group monthly newsletter. For more information about this article; requests for further research, analysis, or consultation; or, to express interest in hiring Ed King for a speaking engagement, send an email to [email protected]