What is holding back production in the United States with expensive oil?

Since the beginning of February, prices for Brent and WTI have been steadily holding above $ 55 per barrel, and traders can only guess why there is no increase in production in the US oil industry.

Brent Oil Futures - weekly chart Brent Oil Futures - weekly chart

In fact, both of the top grades are now trading in the $ 60-70 range, and Brent prices recently briefly surpassed the $ 70 level.

WTI Crude Oil Futures - weekly chart WTI Crude Oil Futures - weekly chart

In recent years, when prices have risen to this level, the production of oil, in particular shale oil in the United States, usually increased. Then why can't we see it now?

According to a report by the Energy Information Administration of the Department of Energy (EIA), the average level of oil production in the United States has not changed at a value of 10.9 million barrels per day for some time. This figure is up from 9.7 million barrels per day last August, but still remains below the average of 13.1 million barrels per day that was observed in the same period last spring. The number of operating rigs in the US jumped nine last week and has essentially remained in the 300-318 range since January. Even with the increase in well productivity, oil producers still need to drill new ones just to keep production at a stable level.

Based on recent experience, we could have expected that oil companies would increase drilling and production at these oil prices. However, many of these shale companies have no plans to expand this year. The Dallas Federal Reserve Bank recently released the results of a survey that provides an insight into the strategy of US energy companies.

The poll was conducted on March 10-18. Representatives of 155 companies answered questions, of which 104 are engaged in the production of hydrocarbons and the exploitation of oil fields, and 51 companies provide services in this industry. According to the respondents, to cover current operating expenses, it is enough for oil to cost in the range of $ 17-34 per barrel (depending on the region). And in order to profit from drilling a new well, the average price of a barrel of oil must be at least $ 52. Thus, about 80% of companies can drill at a profit at the spot price of WTI oil at $ 61, which was fixed on March 19. It would seem that the current prices should have led to an increase in production.

The other answers, however, came with certain surprises. Despite the rise in prices, the number of companies planning to scale up their operations this year has turned out to be relatively small. The majority of CEOs (53%) reported that they do not plan to hire new employees in 2021. And another 34% want to expand the state only slightly.

In the pre-pandemic era, with current oil prices, US oil companies would quickly ramp up production to maximize their benefits. However, they are now in doubt.

Several possible causes are listed below.

1. Consolidation of the industry. When oil prices plummeted last year, many small producers went bankrupt with small profits or sold their assets to larger ones. The industry has gone through several periods of consolidation in recent years, but last spring was the end for a few small and weak companies. The remaining companies are larger, with higher capitalization. And they see no reason for the rapid growth of production. They don't care about competition from smaller firms, they don't need revenue right now. They'd better wait and watch the development of events.

2. Problems with funding. Even if the oil producers can drill a well at a profit at current prices, they will still prefer external funding for this. However, banks may be reluctant to lend money to oil producers for new wells for various reasons, one of which is the position of the new White House administration. The banks' caution stems from the fact that the mood in Biden's team does not seem to favor oil production. Plus, Saudi Arabia has the potential to crash the market as it did last spring.

3. Pessimistic forecasts. According to the Dallas Federal Reserve Bank survey, most companies in the industry have rather pessimistic forecasts regarding oil prices. The majority of respondents (56%) assume that by December 2021, WTI oil prices will be in the range of $ 50-62 per barrel. Another 25% estimate this range at $ 62-68 per barrel. Thus, most of the companies believed that oil prices will be cheaper than in mid-March, when the survey was conducted. Companies doubt the feasibility of increasing drilling operations amid falling oil prices.

4. Restrictions on the part of the federal authorities. At the moment, the Biden administration's moratorium on new leases for oil and gas production in federal lands has not yet become a significant factor. After all, this moratorium did not affect the operating wells. However, it is clear that companies are worried about the prospects for their future growth. Most CEOs expressed concern that government regulation could make their business unprofitable. These concerns were reflected in the comments to the survey of many executives. Given such pessimistic forecasts, it is not surprising that companies question the justification of significant capital expenditures. This is holding back rig growth and dims the likelihood of increased production until sentiment changes.

Johannes Röll

Johannes Röll was born 1978 in Brilon,Germany. Graduated RWTH Aachen University. Over the past ten years he worked as Head of the plastic card team, where he was mainly responsible for the development of the distribution, Head of sales Department and Financial Analyst,where he got experience in planning and support sales figures for branches. For the present he works as freelancer

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