U.S. crude oil production was essentially flat in May compared with April – a sign lower prices and a slowdown in drilling activity are finally causing output to peak and turn down.
Crude and condensates production for the Lower 48 states excluding federal waters in the Gulf of Mexico rose by just 19,000 barrels per day compared with a month earlier.
Production was still up by more than 1 million barrels per day (+9%) compared with the same month a year earlier (“Petroleum supply monthly”, U.S. Energy Information Administration, July 31).
But the rapid increase is the legacy of high prices caused by Russia’s invasion of Ukraine, and G7 sanctions imposed in response, which pushed WTI prices above $90 per barrel in real terms between February and August 2022.
At this level, inflation-adjusted WTI prices were in the 60th percentile or higher for all months since the turn of the century, encouraging a significant expansion of drilling and output.
Buoyant U.S. production combined with releases from the strategic reserve and the economic slowdown to keep crude stocks high despite several rounds of output cuts by Saudi Arabia and its OPEC⁺ allies since October 2022.
The context has already begun to shift, creating conditions for the next cyclical upswing in prices later in 2023 and into 2024, provided the major economies do not fall into a full-blown recession.
Experience suggests drilling rates turn down about 4-5 months after futures prices and production rates turn down about 12 months after prices.
Inflation-adjusted WTI prices peaked at almost $120 per barrel in June 2022 (82nd percentile) and had slipped to less than $71 (43rd percentile) in June 2023.
The number of active rigs drilling for oil peaked at an average of 623 in December 2022 and had slumped by more than 14% to an average of just 534 in July 2023.
If the usual pattern holds, the drilling slowdown should cause output to turn down from the third quarter of 2023 and continue declining into the first half of 2024.
The combination of slower U.S. production growth, even outright declines, with deeper and longer output cuts by Saudi Arabia and OPEC⁺ will lead to a significant depletion of inventories, provided recession is avoided.
In this sense, Saudi Arabia’s unilateral output cuts have thrown a lifeline to U.S. producers, averting an even bigger build up of inventories, steadying prices, and avoiding an even more severe contraction in U.S. drilling activity.
Traders have already begun to anticipate a production deficit later in 2023 and in 2024 with front-month WTI futures prices averaging over $80 per barrel (54th percentile) so far in August.
The WTI calendar spread for the fourth-quarter has tightened into a backwardation of $1.50 per barrel, up from flat at the end of June, implying traders expect a significant depletion of global crude stocks.
On the gas side, dry production climbed to a record 3,196 billion cubic feet in May, an increase of 5% compared with the same month a year earlier (“Natural gas monthly”, EIA, July 31).
Total production in the first five months of the year hit a record 15,462 billion cubic feet, an increase of 7% compared with 2022.
Like oil, gas production has continued to increase in a lagged response to very high prices during the second and third quarters of 2022.
In real terms, monthly average futures prices peaked at more than $9 per million British thermal units in August 2022 (78th percentile for all months since 2000) but had slumped to almost $2.20 (2nd percentile) in April 2023.
As prices fell, the number of drilling rigs targeting primarily gas-bearing formations fell from an average of 162 in September 2022 to an average of 132 in July 2023.
Gas production growth is set to slow sharply in the second half of 2023 and into the first half of 2024 which should erode excess inventories during the winter of 2023/24.
U.S. working gas inventories in underground storage were +222 billion cubic feet (+8% or +0.67 standard deviations) above the prior ten-year seasonal average on July 28.
But the surplus had shrunk from +297 billion cubic feet (+11% or +0.81 standard deviations) on July 1, the most significant narrowing since the exceptionally cold weather in December 2022.
Provided winter temperatures are roughly in line with the recent average, the slowdown in production growth should eliminate the surplus over the course of winter 2023/24.
Prices have started to rise as traders anticipate a production deficit and the depletion of inventories in winter 2023/24.
Inflation-adjusted prices have risen sequentially in each of the last three months to an average of $2.30 (2nd percentile) in May, $2.47 (2nd percentile) in June and $2.63 (6th percentile) in July.
However, prices remain very low by historical standards, which implies that drilling activity is likely to continue contracting in the near term.
John Kemp is a Reuters market analyst. The views expressed are his own
(Editing by David Evans)