Crude oil prices have climbed to their highest level for more than two years as U.S. shale producers have added only a limited number of extra rigs and production, opting to push for higher prices and profits instead.
In the current phase of the cycle, prices are rising mostly because of the declining responsiveness of the shale sector, rather than official production restraint from OPEC and its allies in the wider OPEC+ exporters group.
Front-month Brent futures prices have hit the highest level since April 2019 while U.S. crude futures are at their highest since October 2018, signaling the need for more drilling and production.
The number of rigs drilling for oil in the United States has already more than doubled from its cyclical low in August 2020, according to oilfield services firm Baker Hughes.
Since the middle of February, however, the rate at which rigs have been added and total number employed have both started to lag behind previous recoveries.
The number of active rigs has grown by an average of just 3.5 per week over the last 15 weeks, down from an average of 6.2 per week over the previous 20 weeks. The number of rigs active last week (359) was far below the number in January 2020 (670) and April 2019 (825), when prices were at a similar level.
As a result, U.S. production is likely to grow more slowly than previously expected in late 2021 and the first half of 2022.
The shale sector’s muted response, so far, to higher prices implies a larger production-consumption deficit later this year, a faster drawdown in inventories, higher spot prices and a larger backwardation.
Over the last decade, U.S. shale producers have normally captured market share from OPEC+ whenever prices have been above $55-60 per barrel.
But shale’s limited response has emboldened OPEC+ to maintain its own output curbs, temporarily removing the threat of lost market share and accelerating the upward pressure on prices.
U.S. drilling rates normally respond to increases in prices with an average delay of four to five months, while production takes even longer to respond with an average lag of nine to 12 months.
Recent price increases should still lead to an uptick in drilling rates by the end of the third quarter and the start of the fourth, with extra output in first-quarter 2022.
But if drilling rates continue to lag behind previous recoveries, downward pressure on inventories and upward pressure on prices will remain.
Shale producers have publicly reiterated their new commitment to output restraint in interviews as well as calls with analysts and investors.
Following the epidemic and price crisis last year, shale production has been consolidated among a smaller number of firms.
Top shale leaders have repeatedly stressed the importance of focusing on raising margins and profits rather than increasing the number of wells and output.
OPEC+ and shale leaders have both stated their desire to avoid a repeat of the boom-bust cycles associated with the first shale boom (2011-2014) and second shale boom (2017-2019).
As a result, there is a broad consensus among OPEC+ countries and the U.S. shale industry on the need for slower output growth, higher prices and wider profit margins.
So long as that consensus holds, and the uptick in U.S. drilling remains slow, prices will continue to climb.
Eventually, if prices continue rising, they will start to elicit a stronger production response from within the shale sector, or from non-OPEC non-shale producers, creating conditions for the next cyclical downturn.
For now, though, OPEC+ and its shale rivals are enjoying a truce and higher prices for everyone, after fighting two expensive but inconclusive volume wars in the last seven years.
John Kemp is a Reuters market analyst. The views expressed are his own.
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