This is the November edition of our North America Quarterly, covering all important aspects of the region, with a particular focus on the growth of shale oil and its impact on regional and global balances for both crude and products. The Quarterly is designed to be the most comprehensive guide to US and Canadian production, shale basins, midstream projects, WTI balances, regional differentials, and the US refining industry.
Inside this edition:
- In Focus: Twelve months on, we return for another deep dive into the finances of 32 shale producers and find several key trends persist even as shale production has advanced, including elevated Capex, rising debt levels and falling bond prices. Because of this, growth rates could slow by around 0.3 mb/d in H2 15 relative to consensus expectations of 1.1 mb/d growth next year.
- In Focus: The recent Republican victory in the US midterm elections has the potential to impact US energy policy and issues such as Keystone XL and EPA emissions rules will feature prominently in congress as the Republicans push their agenda. Crude exports, however, may not receive an immediate boost.
- Outlook for WTI: Incrementally, it will get harder for the US to absorb the domestic crude production growth and 2015 could see the US long 0.1 mb/d of crude. But a super contango in WTI is by no means guaranteed, especially should production growth ease in H2 15.
- Refining: Despite bearish oil market sentiment, the US physical distillate market is tight. High USEC distillate exports may coincide with the period of peak winter demand, leaving the market vulnerable to a significant short covering rally.
- US production: Given plummeting oil prices, we examine how the hedging strategies of 40 independent oil producers have changed. We note that year-ahead hedging volumes for 2015 are 11% lower y/y, which could expose them to downside risks should prices stay at current levels for six months or more.
The North America Quarterly also provides a detailed regular update on pipeline projects, rail capacity, US Midwest balances, product demand, crude imports by grade, shale plays by basin, US independents hedging activity in 2014 and 2015, the latest production data including rig counts and technological and regulatory developments affecting the domestic oil industry.
It is safe to say 2014 has been an eventful year for the oil market, with US tight oil production continuing along its impressive growth path, driven by further innovation in the US oil industry. Efficiency gains by producers have improved profitability and lowered breakeven prices. However, given the near 30% decline in oil prices witnessed in the second half of the year, there has been talk of an impending slowdown in production growth.
In our first In Focus piece on shale finances, we find several key trends persist even as shale production has advanced, including elevated Capex, rising debt levels and falling bond prices. Our analysis shows that a period of sustained lower prices-WTI around the region of $75 per barrel or below-will impact the finances of tight oil producers to the extent that production growth will take a hit. In such a scenario, US tight oil production growth could come off by around 0.3 mb/d in H2 15, or almost 0.5 mb/d if interest rates also rise. This would lower average growth across 2015 as a whole by 0.15-0.25 mb/d.
Given the impact of lower oil prices, we examine how the hedging strategies of independent producers have changed in our section on US production. For the 40 companies we follow, producers were hedged strongly for 2014 at 70% of output. Interestingly, year-ahead hedging volumes for 2015 fall to 58% on average, a y/y reduction of 11%. It seems producers have protected less of their production from downside risks next year, tying in with our belief that output growth will be impacted should we see the current price level sustained.
Currently, the market seems fairly complacent about the scope for any pullback in US production and hence sentiment around the outlook for WTI in 2015 remains bearish. As we discuss in the Outlook for WTI, the phenomenal ability of the US to get rid of the domestic production will diminish incrementally. Growth in refinery runs slows to 0.2 mb/d next year, condensate exports are likely to increase by 0.3 mb/d, those to Canada by another 0.15 mb/d and imports from Latin America could fall by 0.35 mb/d. So, if US crude output were to grow by another 1.1 mb/d, then the US could be long 0.1 mb/d of crude in 2015. But, with production growth potentially slowing to below 1 mb/d, burgeoning US crude stocks and a super contango in WTI is by no means guaranteed, particularly in H2 15.
Another key to the outlook for WTI will be the US decision on crude exports, which we examine in the second of our In Focus pieces about the potential impact of the recent Republican victory in the US midterm elections. We do not believe the Republicans will push strongly for the lifting of the export ban as many are concerned about energy security, although we continue to believe exports will make their way out in the form of condensates, swaps etc. But, other energy issues will feature prominently in the Republican agenda, with congress keen to pass legislation on the Keystone XL pipeline and block the EPA power plant emissions rules.
Turning to the downstream, despite bearish sentiment, physical distillate markets have tightened up, with the US at the epicentre of this tightness. In our Outlook for Refining we point out current high USEC distillate exports come ahead of the period of peak winter demand, so the market may be vulnerable to a significant short covering rally.