The structural shift toward a lower price environment will have profound and long-lasting consequences for non-cartelized production. With prices recently trading below the $30/bbl mark, our expected 10 percent cut in 2016 global capex is starting to look modest. Current production from mature fields is set to decline at higher rates as maintenance capex has been cut too. Net, we now expect total non-OPEC supply to decrease to 56.4 mn b/d in 2017 before rebounding to 57.5 mn b/d in 2020, near 2015 output levels.
No incremental projects
A recovery in non-cartelized production rests upon a medium term recovery in oil prices. True, several fields in the US Gulf of Mexico, Canada and Brazil initiated before the price crash will come online in the next three years. Yet, all of them have breakeven costs above current prices. Should spot prices remain in a $30-40/bbl band or forward prices stay below $50/bbl, no incremental conventional or unconventional projects will be sanctioned. Still, USD strength should provide some relief on operating cost structures.
The bottom line is that non-OPEC conventional production now looks set to drop across the board by 2020, regardless of spot or forward prices. Shale may offer a silver lining, as the investment cycle is shorter than for conventional production. Given our expected upward price trajectory from here, the US rig count should increase again by 2H2016. As such, we see US shale output falling by 470 thousand b/d in a $40/bbl WTI environment, while growth returns at $50/bbl. Above $60/bbl, growth stands above 400 thousand b/d.
With the US the only country able to ramp up its production materially in non-OPEC by 2020, the cartel may have to provide the incremental barrels. We estimate that OPEC needs to increase production by 4.1 million b/d in the next five years to “balance the market”. Can Saudi’s self-reported 2.1 million b/d of spare capacity fill half of this gap? Could cash-strapped OPEC countries like Iran, Nigeria, or Venezuela expand their capacity? And what will happen to embattled Libyan and Iraqi production in this period? Our medium-term supply forecast has to uncomfortably assume OPEC has 2020 vision.
Currency moves, in particular USD strength, have been a net negative for all commodities. Simply put, global GDP in USD terms at market exchange rates is stagnant. If the CNY drops to 6.9 against the USD, as our FX team forecasts, downward pressure on cyclical commodities would build further.
Continued USD strength could force Saudi either to cut oil production modestly and push Brent back to $50 or depeg the SAR, our black swan event, which could lead Brent to collapse to $25/bbl.
China’s GDP is changing, with services overtaking industrial activity and construction as a driver of growth. Negative for metals and mining, but a potential tailwind for oil.
WTI and Brent crude oil
Conditions for a floor on oil are coming together: spot prices are near cash costs, CNY is depreciating, WTI matched Brent, and a bumper US driving season is approaching. Yet it is early to call a bottom on the risk of further CNY weakness and a continued oil price war within OPEC. We recently revised down our average 2016 forecast for Brent to $46/bbl (from $50) and WTI to $45/bbl (from $48).
After an 800 million barrel surge in global petroleum stocks since 1Q14, we project much healthier S&D balances in 2H16 and beyond. The latest OPEC meeting resulted in a rollover of the existing policy, but was acrimonious. We believe that Iranian output could go up by 600 thousand b/d over a period of six months when sanctions are lifted, mostly intermediate and heavy grades.
We project non-OPEC supply to contract by 750 thousand b/d in 2016, compared with an average 20-year expansion of 660 thousand b/d. Light-heavy oil spreads may widen on a forward basis as light crude output declines relative to heavy over the next 18 months. The change in the crude oil slate comes from a contraction in light non-OPEC supply against an expansion of OPEC medium-heavy barrels.
It all started 14 months ago when Saudi announced a change in strategy… The structural shift towards a lower price environment will have profound and long-lasting consequences for non-cartelized production. OPEC’s decision in November 2014 to let prices collapse in order to regain market share from non-OPEC suppliers, namely US shale, is now starting to pay off. Non-OPEC production growth peaked in 4Q14 at 2.7 million b/d year-on-year, or 4.9 percent, the highest rate ever recorded, driven largely by the US. Since then, growth has faded and reached only 0.2 million b/d in 4Q15, and production is poised for an outright annual decline this quarter.
After all, global oil and gas capital expenditures dropped by 26 percent in 2015, and we expect another round of cuts this year to the tune of 10 percent globally. Capex is a function of prices, and with prices recently below the $30/bbl mark, the actual 2016 cut is likely to end up larger than these expectations. In that respect, some companies have started to announce their 2016 plans and it seems that US producers are keen to cut as much or even more than last year. Continental Resources, Noble Energy and Hess just announced spending cuts of 63 percent, 49 percent and 41 percent, respectively, for this year compared with 2015. With largely reduced activity, many producers now see their 2016 production declining. Meanwhile, non-OPEC non-shale output should start to feel the pain in 2017, as the full investment cycle is around three to five years.
Global oil and gas capex dropped by 26 percent in 2015, and we expect another round of cuts this year to the tune of 10 percent globally.
Non-OPEC non-shale output should start to feel the pain in 2017 as full investment cycle in conventional production is 3 to 5 years. Lack of current capex also leads to higher decline rates from mature fields Not only has the list of upcoming new projects already slimmed down, but current production from mature fields is also set to decline at higher rates as maintenance capex has been cut too. Our analysis shows that decline rates increased significantly last year compared with 2013-14 levels. For example, UK decline rates accelerated from 9 percent in 2013 to 11 percent in 2015. The same story applies to other non-OPEC countries such as Vietnam, Australia, Norway, Mexico and India. In contrast, decline rates in countries like Russia are holding up much better at this point, a trend that is likely to reverse, in our view, unless spending resumes. In aggregate, our weighted non-OPEC production decline rate analysis suggests an average jump of nearly 0.6ppt, from 4.2 percent in 2014 to 4.8 percent in 2015, a level consistent with decline rates observed in 2008 and 2009. Net, total non-OPEC supply is set to decrease to 56.4 million b/d in 2017 before rebounding to 57.5 million b/d in 2020, close to 2015 production levels.
UK, Vietnam, Australia, Norway, Mexico, India
The bottom line is that non-OPEC conventional production looks set to decline across the board in the next five years, regardless of spot or forward prices. Shale may offer a silver lining for non-OPEC supply growth in the medium term, as the full investment cycle is much shorter than in conventional production. With our price forecasts for WTI at $45//bbl this year and $59/bbl in 2017, the US rig count should increase again by 2H2016, albeit the expected pace of investment is likely to be much gentler than during the shale revolution. After all, breakeven costs on a basin level range from $37/bbl to $81/bbl, with most of the large basins standing at sub-$60/bbl. Shale output will return to growth in 2017, in our view.
Will shale production grow again at the same level as in the 2011-14 period? We are doubtful, even with a long-term WTI price estimate of $75/bbl (our base case). Rather, we believe that the damage done in the past 18 months to the shale investment cycle is sticky. As the shale industry is de facto highly levered, we believe future lenders will limit credit lines in a meaningful way, even when prices recover. We conducted a price sensitivity analysis on US shale production growth, based on current breakevens. We estimate that US shale production declines by 470 thousand b/d in a $40/bbl WTI environment, while growth returns at $50/bbl. Beyond $60/bbl, growth stands above 400 thousand b/d. Linking this analysis with our price assumptions in the next five years suggests that US shale production grows by 80 thousand b/d in 2017 and growth accelerates throughout the end of the decade.
4.1 million b/d needs to be added by OPEC by 2020, namely Saudi, Iran and Iraq. In sum, the US is the only country which is able to ramp up production among non-cartelized players by 2020, so OPEC has to come to the rescue to provide the required incremental supplies. In last week’s report, we estimated that demand will grow by 5.9 million b/d in 2015-20 (Chart 23). With the market oversupply of 1.8 million b/d in 2015, OPEC needs to increase production by 4.1 million b/d in the next five years to “balance the market”. Of course, Saudi can make up for half of this given its 2.1 million b/d of spare capacity, and we believe it intends to at least increase its market share. Other OPEC countries will expand their capacity in the next five years, namely Iran, UAE and Nigeria (Chart 24). As for Libya, the current turmoil needs to come to an end, while the scale of any Iraqi long-term output increase remains the biggest uncertainty.