As we move into 2018, the factors that determine future crude oil prices are setting up almost exactly as they did going into 2017. The single biggest puzzle piece went into place on November 30, when OPEC and Russia agreed to extend their joint export limitation agreement through the end of 2018. That move alone will have a tremendous stabilizing effect on the oil markets. But before we look at other factors that will influence oil prices for the year, let’s review where we were a year ago, and what happened during 2017 that led us to this point.
As we entered 2017, the price for WTI hovered in the $53 per barrel (BBL) range. OPEC had begun to implement its new export limitation agreement, and market signals — other than oil inventories in the U.S., which remained persistently high — were generally bullish.
As a result of the strengthening price for crude that took place throughout the fourth quarter of 2016, the large independent corporate producers who drill the overwhelming majority of shale wells in the U.S. put strong drilling budgets in place for the first half of 2017. As they began to execute on those budgets starting in January, the U.S. rig count began to rise rapidly. By the end of February, U.S. producers had activated about 200 additional drilling rigs, and they added another 100 by the end of April. As I wrote at the time for Forbes.com, producers who had held back their drilling plans as the crude price collapsed from 2014 through 2016 could not wait to get back to drilling at the first sign of stronger prices.
Of course, all that drilling of U.S. shale wells very predictably had an impact on the crude price; and that impact was to move it steadily back down to around $44/BBL by April, which is the month when these corporate producers typically plan their drilling budgets for the second half of the year. The upstream industry has always been and always will be price-sensitive. Thus, the significantly lower crude price in April 2016 led inevitably to scaled-down drilling budgets being implemented for the second half of 2017.
On June 19, I wrote a piece for Forbes.com in which I said the following:
“The mid-year review processes … are now coming to conclusions, and as a result of those reviews, we can expect the domestic rig count to level off and even perhaps decline slightly over the second half of 2017. Indeed, should the price for WTI fall below the $40/bbl level for any significant period of weeks, as some analysts are projecting, the rig count could fall fairly significantly, by ~100 rigs or slightly more. But the appetite within the mid-size and large independent producers to keep drilling remains strong after two solid years of drilling almost nothing other than leasehold obligations, so we should not expect a huge dip in the rig count and the job-losses that would entail. We should also expect to see the large monthly increases in overall U.S. oil production begin to tail off during the second half of this year.”
And that’s exactly what happened. The Baker Hughes oil rig count, which had reached above 760 during the first half of 2017, leveled off starting in July; and then slowly declined to around 730 in early November. Drilling activity remained fairly strong, but not as strong as during the first half of the year, enabling overall U.S. production to continue rising at a slower pace as well.
In the meantime, OPEC countries’ compliance with the export limitation agreement steadily increased as the year progressed; and by October, market analysts were starting to reach a general consensus that the global crude oil market had finally re-balanced after three years of a persistent glut of supply. This re-balancing of the market in turn has led to reductions in crude oil inventories not just in the U.S. but all over the world. In early November, reports of crude in floating storage were even beginning to fall, a strong indicator that the global glut had been resolved.
The end result of all that activity, combined with the extension of the OPEC-Russia export limitation agreement, was a steadily rising crude price throughout the fourth quarter of 2017. As we enter 2018, most analysts are generally bullish on the prospects for stronger crude prices to endure throughout the year.
But, you might ask, won’t U.S. shale producers just respond to this stronger price picture exactly as they did in 2017, with stronger drilling budgets and more and more newly activated drilling rigs? The answer to that question is most likely yes, but not exactly.
I know that may sound confusing, so let me clarify. Yes, we should expect shale drillers to respond to this stronger price picture as they did a year ago. Upstream companies will always respond to higher prices with more drilling. That is, after all, what they are in business to do.
But we should expect that response to be somewhat muted this year, due to a couple of significant factors:
Factor 1: Lower tension level. We have to remember that as we went into 2017, most producing companies were experiencing an intense pent-up internal desire to start drilling wells again, after having gone through 30 months of slashing drilling budgets in response to what had felt like an unending decline in crude prices. This pent-up desire to drill wells likely led to drilling budgets for the first half of 2017 that were higher than advisable or necessary for many of these companies.
Factor 2: Renewed focus on enhancing investor returns. As we entered 2017, companies were under tremendous pressure from creditors and the markets to begin increasing production and reserves again after the previous two years. This was another big reason why we saw a 40 percent increase in the number of active rigs during the first 10 weeks of the year. But as we moved into the third quarter of 2017, management teams at corporate producers found themselves under pressure to shift focus from increasing production to enhancing returns to investors. As a result, we saw more and more companies begin to shift capital away from drilling wells and into things like stock buy-back programs. This was a major driver of the declining rig count during August and September, and why that rig count moved only slightly upward as oil prices rose dramatically during October and November.
So, in other words, the difference we can expect between the first half of 2017 and that of 2018 is one of magnitude. Yes, shale producers’ drilling budgets will rise in 2018, but not as much as they did in early 2017. Yes, the rig count and drilling pace will increase during the first few months of this year, but not at the same rate they did in the first quarter of 2017.
And yes, this increased drilling activity in the U.S. will inevitably place downward pressure on the price for crude, but not the same level of pressure we saw in early 2017.
Bottom line, expect 2018 to follow a similar progression as we saw in 2017, but in a significantly more stable way. That should be good news for everyone.
About the author: David Blackmon is the Associate Editor for Oil and Gas for SHALE Magazine. He previously spent 37 years in the oil and natural gas industry in a variety of roles, the last 22 years engaged in public policy issues at the state and national levels. Contact David Blackmon at [email protected].