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OPEC won't stop US oil production growth

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U.S. oil production could increase next year to levels not seen since the 1970s, despite OPEC's efforts to muscle out American shale producers.

While U.S. oil production is predicted to rise by another million barrels a day during 2015 from the current 9 million barrels a day, forecasts are coming down on expectations that OPEC's unwillingness to cut production will keep a lid on prices well into next year. Lower prices limit new drilling and hit high-cost wells first.

Saudi Arabia may continue to stay away from cuts even if prices continue to move lower: OPEC's biggest producer now expects Brent crude to stabilize at around $60 a barrel, which is a level the Saudis could withstand, according to a Dow Jones report.

But analysts say the U.S. industry, which has turned around its fortunes with new technologies in less than a decade, is expected to drill the most-efficient wells, and production will continue to grow—even with lower prices. There is also a gusher of new offshore oil production coming online in the Gulf of Mexico.

An oil and gas well site outside Williston, N.D.
Getty Images

The Fed in its last Beige Book made note of the fact that drilling activity in shale production districts remained steady even with a sharp drop in crude prices. North Dakota showed an increase in November, and the Fed said officials there expect production to continue increasing over the next two years.

Citigroup analysts also expect production to rise, and in 2015, it should be in line with the 1 million barrels a day of production growth this year.

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"Production is going to continue to grow. Could we see another million barrels a day of growth next year over this year? We happen to think so," said Edward Morse, global head of commodities research at Citigroup. Morse expects an average Brent crude price of $80 per barrel next year, but if it's lower, he says U.S. oil production could still add 800,000 barrels per day.

The rapid growth of U.S. oil production has helped create a surplus of oil, particularly in the Atlantic Basin, and it has already edged out West African imports the U.S. once relied on.

The expectation is that now with sharply lower prices, some shale wells will no longer be economical, and many that were planned will not be drilled. Already, applications for drilling permits have fallen sharply, down 40 percent to just more than 4,500 in November from October's levels, according to a Reuters report quoting industry data firm Drilling Info.

Fadel Gheit, senior energy analyst at Oppenheimer, said U.S. shale production will keep growing, but the question is how much, and it will be the price that determines it.

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"The lowest will be that production will increase by a half million (barrels a day). The highest will be 1.5 million. I would say 600,000 to 700,000 would not be out of line, and we could even have 1 million barrels a day of production growth. Some of these plays will continue because they are cash cows," he said.

Gheit said there are more than 200 companies drilling U.S. shale, and much of the data on their margins and production levels aren't known. He said the price of West Texas Intermediate could remain in the $70s next year, and conceivably see a much sharper, but temporary drop.

WTI was at about $65.84 per barrel Friday, its lowest close in more than five years and nearly 40 percent below its June peak. The latest leg down came after OPEC last week followed the lead of Saudi Arabia and declined to cut production in order to stabilize prices. Saudi Arabia has said it would not go it alone with production cuts and is aiming instead to hold on to market share during the price slump, while shaking out the weakest producers.

"No matter how low oil prices go, there will be no (shale) production shut in. The cash component (cost) will be, say, $15, $20, $25," Gheit said, noting the expenditure for land and drilling has already been made. "Oil prices will have to go below $30 for some of these wells to be shut in, and even then the owners need the cash to survive. They will milk the cow until the cow drops dead."

Morse said one factor that could keep the U.S. shale industry drilling is that there are a high number of incomplete wells that could easily be turned into productive wells. He estimates that there are thousands of such wells in Texas, Oklahoma, North Dakota, Ohio and Wyoming.

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"There are a very large number of incomplete wells that have been drilled, and they're the cheapest ones to bring on. So, if companies are going to be strapped for cash, the best way to get cash is to complete wells ... the average for that completion is $5 a barrel to complete a well that's already been drilled," he said.

Morse said wells are much more efficient than they were just a few years ago.

"Each well currently being drilled in the main shale plays produces more than 550 barrels a day," he said, noting that it was 150 barrels on average just several years ago. Now those wells run for three months before the decline starts, and costs are much lower, at $35 to $45 per barrel, in the Bakken of North Dakota and Eagle Ford in Texas.

Dominic Haywood, Energy Aspects crude and products analyst, said he expects first half production growth to be strong, but then it could start to slow as the impact of less capital expenditures is felt. But there are some benefits to drillers from falling oil prices.

"I think the key thing is you have to look at with falling prices, you're getting cheaper oil service contracts. If you're getting cheaper oil services contract that's helping the cap ex," said Haywood.

Gheit said the industry has also learned to be more efficient very quickly.

"Only five or six years ago, wells used to take 70, 80, 90 days to compete. Today they take two weeks. That in itself is a huge accomplishment. The same rig instead of drilling one well, can drill four. Companies now know how to drill faster than ever before. They learned it in trial and error. Companies don't need as many rigs to drill as many holes in the ground and that in itself is a cost saving," he said.

Companies that benefit from lower oil prices
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Companies that benefit from lower oil prices

Industry production has repeatedly beaten forecasts as wells are drilled, Gheit said. "This is across the industry," he said.

OPEC is unlikely to be able to exert enough pain to stop the shale producers. "They are not staying in place. ... You're not going to stop the shale revolution. The genie is out of the bottle already. You can't put it back in," he said.

But companies will look to reduce costs, and they will cut back on new production. "The question is at what rate (production will grow). Technology will accelerate this rate even if we have lower oil prices. Usually companies become more creative with lower prices," Gheit said.

U.S. oil production has been about 9 million barrels per day in November, and while other analysts may not share expectations for a million barrels, they see continued growth for U.S. production.

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"It's going to keep rising, but at a lower growth rate as we get to the second half of 2015," said Andrew Lipow, president of Lipow Oil Associates. "I think the million barrel increase is going to be revised downward somewhat. ... There are less permits being issued for drilling, but you're just not going to see some of that effect for four months. That's the trajectory."

But Lipow said another 500,000 barrels a day of oil is expected to be produced in the Gulf of Mexico over the next two years, taking production there to 1.9 million barrels a day, a record high level.

Just last month, Hess saw the first flows at its majority-owned Tubular Bells offshore field.

"That's going to be the big surprise. I think the market in general outside of the oil industry thinks that all of a sudden the taps are going to shut and everything's going to be horrible, but that's not going to be the case," said Lipow. "It's the next tranche of investment that won't happen."

Morse expects oil prices to recover with Brent, the international benchmark, averaging $80 per barrel in the first quarter, and West Texas Intermediate at $72. His base case is that OPEC should give up and cut production levels in the April and May period. Morse said he expects prices to be supported by seasonal winter demand but then slump, and that could force OPEC's hand in the spring.

If OPEC does not cut production, he expects Brent to fall to $65 and WTI to fall to $58.

"The problem for OPEC is if they don't blink, and let's say they do shut down the rate of production growth in the U.S., and they get a price back to where they like it to be, U.S. production growth starts again," Morse said.

Morse agrees it will be exploration that will be affected by lower prices, and that would shape production growth in the future.

"It will affect the amount of oil in 2017 but not 2015 and 2016," he said.

But then there will be other sources of oil coming online, he said, "Mexico is going to open up and there will be lower prices but nobody can afford not to be in Mexico."

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