Oil prices have sunk in the first few trading days of August, reflecting growing concerns about the spread of the Delta variant around the world and its impact on the global economy.
The bullish narrative that drove oil prices up to multi-year highs in recent weeks is largely receding, but looking further out, the supply picture appears more complicated.
Delta spreads
The Delta variant has loomed as a threat to the oil market for months, but is starting to have a real impact.
The spread of the highly transmissible Delta variant has loomed as a threat to the oil market for months, but is starting to have a real impact. Of particular concern to crude is the news that China is suddenly seeing some new cases – in very small numbers – across at least half of the country’s provinces in the past two weeks. While the cases are miniscule compared to the U.S., China’s swift decision to begin canceling flights and imposing localized travel restrictions has rattled the oil market.
China National Petroleum Corp. said that the latest jump in cases in the country could erase 5 percent of oil demand, at least temporarily. “There is real concern about China’s Covid-19 situation,” John Kilduff, a partner at Again Capital, told Bloomberg. “If China is having problems, as a key demand center, it’s a major thing.”
The developments come shortly after China posted some relatively downbeat manufacturing data in July.
Needless to say, China is not the only country contending with rising Covid cases. “We still think the oil market is not fully pricing in a significant slowdown in demand in the Asia-Pacific region,” Standard Chartered wrote in a note to clients. The investment bank said its index on mobility data for the Asia-Pacific region went sharply negative in July, reflecting a month-on-month decline, with particular decreases in Thailand, South Korea, and Australia.
As a result, Standard Chartered estimates that the global oil market has slipped back into a supply-demand surplus, undercutting the increasingly dominant market narrative of a substantial deficit, which was helping drive up crude prices. The bank sees a global oil surplus of about 630,000 barrels per day (b/d) in August and 620,000 b/d in September. For all of the third quarter, the bank sees a small surplus of 0.05 million barrels per day.
“The market is now in surplus.”
“While most market commentaries seem to be still describing the current market as very tight, this no longer appears to be the case for either our forecasts or those of the EIA,” Standard Chartered wrote. “The market is now in surplus, and demand risks suggest that the surplus could grow significantly in the coming months.” With the peak summer driving season in the U.S. soon drawing to a close, the upward pressure on the market could dissipate.
Oil companies refrain from new drilling
Demand is raising some red flags, but that is somewhat offset by dramatic developments on the supply side.
Publicly-traded oil companies are by and large holding off on a return to the aggressive drilling practices of the past decade, despite the rise in oil prices. The oil majors – BP, ExxonMobil, Shell, Total and Chevron – are posting enormous increases in quarterly profits due to higher crude prices and strong petrochemical margins. But they are also mostly sticking to the new mantra, imposed on them mostly against their will, of sitting tight and refraining from high spending levels on new sources of oil production.
ExxonMobil’s oil production fell to 3.6 million barrels per day in the second quarter, the lowest level since 1999. The oil super major said that it would use its strong profits to pay down debt, which had ballooned during the pandemic.
Across the board, the oil majors hiked dividends, restarted share buyback programs and paid down debt. There was little in the way of increases in capital expenditures.
The CEO of Pioneer Natural Resources, Scott Sheffield, said on August 3 that U.S. shale was “not going to grow that much” in the coming years, with even the Permian basin only adding 5 percent to production in the years ahead.
The rig count dropped last week, and even the increases over the past few months have been modest at best, despite the sharp rally in oil prices. At 385 oil rigs in the field, the number of rigs in the U.S. is still down by more than half from 2019 levels.
With new drilling still tepid, the industry overall is drawing down on its backlog of drilled but uncompleted wells (DUCs), a sign that the industry is trying to keep production aloft while avoiding big increases in spending.
The DUC count fell to around 4,500 wells in June, down roughly 1,800 over the previous 12 months. But, according to Rystad Energy, there is a large number of “dead” DUCs, which refer to wells drilled longer than two years ago that will likely never be completed. After factoring in dead DUCs, the total number of “live” DUCs stood at about 2,381 in June, Rystad said. That’s the lowest level since 2013.
That is a complicated way of saying that if the U.S. shale industry wants to add new production, it will need to increase spending. “Looking at the number of remaining ‘live’ DUCs, a significant oil supply response from the US onshore industry to the $70-$75 per barrel WTI market is practically impossible before the first half of 2022,” Artem Abramov, head of shale research at Rystad Energy, said in a statement. “Any further increases in fracking, and subsequently well completions, will now require producers to first expand drilling by adding more rigs.”
But so far, that isn’t happening. The combined pressure from investors to keep spending in check, broader ESG and energy transition pressure from capital markets, and the rapidly growing concern about climate change from society at large is forcing drillers to keep their rigs on the sidelines.
Putting it all together, oil analysts see the near-term oil boom narrative starting to lose some of its luster as the Delta variants spreads, but the lack of new supply coming down the pike means there may not be a wave of new supply that crashes prices.
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