At a Glance
- U.S. projected to produce more oil by 2019 than Saudi Arabia ever has
- U.S. producers increasingly exposed to performance of Asian economies
The U.S. is poised to dethrone Saudi Arabia as the world’s largest oil producer as early as February as the shale oil revolution continues to reshape global energy markets.
The U.S. Energy Information Administration (EIA) has increased its estimates of U.S. crude oil production in 2018 by 250,000 barrels per day (b/d) to 10.3 million b/d. In 2019, it estimates that the U.S. will be producing a giant 10.9 million b/d, which would be larger than the maximum production level ever achieved by Saudi Arabia.
This is a remarkable achievement given that, as recently as the late 2000s, most oil industry observers felt that U.S. oil production was in terminal decline. Instead, new technology created a production surge from shale plays in the Permian, Eagle Ford and Bakken regions of the U.S. At the same time, the repeal of U.S. crude oil export restrictions in December 2015 opened up new markets for U.S. crude oil, particularly in Asia.
The combination of these two factors has led to a virtuous cycle. U.S. crude oil production is surging but this is not swamping the domestic refining market and dragging down prices because the additional production is finding an outlet in the export markets. Crude exports surged to a record 1.8 million b/d in October 2017.
The export outlet ensures that, despite the output boom, crude oil stocks at Cushing, Oklahoma – the delivery point for NYMEX WTI Light Sweet Crude Oil futures (WTI) from CME Group – have recorded a steady decline in recent months.
The OPEC group of oil producers agreed in partnership with Russia to support the global price of crude oil during 2017 by restraining their own production. OPEC and its allies were rewarded with prices that steadily rose from the mid $40s up to above $60 in early January.
The downside of the OPEC policy was that it provided renewed impetus to U.S. shale producers, some of whom had been struggling to produce profitably amid lower prices. Today the current spot price levels are comfortably above almost every shale producer’s breakeven point as are the mid-term prices trading on the WTI crude oil futures contract.
These price levels have encouraged new drilling throughout the U.S., leading directly to the boom identified by the EIA. OPEC has successfully managed price levels but at the cost of helping to turn the U.S. into a giant new competitor.
The OPEC nations and their allies are on the horns of a dilemma: if they unleash their full production capacity then they could drag down prices, jeopardizing shale oil’s profitability and reversing the EIA’s bullish estimates of U.S. production.
But humbling the U.S. by lowering the global oil price would come at a major cost to producer countries’ own national budgets. This a particularly challenging prospect for Saudi Arabia, which is currently planning to IPO its national oil company, Saudi Aramco.
If Oil Demand Falls
Even without a reversal of OPEC’s policy of restraint, the prospects for U.S. production are not inevitably rosy. Boosting production by such huge levels could have an impact on prices if global demand fails to keep up with soaring U.S. output. Their growing reliance on exports means that U.S. producers are increasingly exposed to the performance of Asian economies.
The market balance currently favors the suppliers but the rapid and dramatic change in U.S. production in recent years have proved yet again the impossibility of predicting how the global energy markets will evolve. Over time, the only reliable constant in the oil markets is price volatility.
Given the uncertainty over future trends and future prices, participants on both sides of the market have responded by increasing their focus on risk management, principally by hedging their exposures with WTI crude oil futures and options.
Liquidity in WTI futures has surged in line with the growth in physical supply, as evidenced by the 2.6 million open positions in the contract, a near record.
The growing number of open positions – called open interest – is significant. It means that oil companies view the North American benchmark – NYMEX WTI — as the world’s leading crude oil benchmark. This global status is only likely to grow as the new supply dynamics accelerate the arrival of the U.S. as an oil superpower.