Kissler: Producers Might Want to Chill, Baby, Chill

With crude oil global supply at or near par to demand, some oil producers fear that the market will become oversupplied, especially as tariffs and a weaker stock market could push demand lower, while the Trump administration’s “drill-baby-drill” approach would push supply higher.

Altogether, this combination is keeping producers’ pencils sharpened as to breakevens and when to expand drilling programs.

On one hand, the Trump administration’s “drill, baby, drill” sounds great to both producers and end-users. On the other hand, bills have to be paid and investors are looking for positive rates of return.

To be sure, drilling technology has increased dramatically in the last five years and efficiencies have helped oil companies produce more oil with fewer rigs (think 3-mile-plus laterals). That being said, there comes a breaking point. This breaking point, in my opinion, is $60/bbl WTI prices. Anything below that will slow global production, not speed it up.

This means that, for “drill, baby, drill” to happen, I believe WTI prices will have to be north of $75/bbl; otherwise, the incentive for producers to drill more simply won’t be there.

Moreover, in some areas, that price point is probably closer to $80/bbl. However, the back end of the crude futures curve is discounted approximately $5/bbl to the front end, as of this writing. Drilling and producing at WTI prices near or below the $60/bbl area doesn’t pencil all that well, so as good as “drill, baby, drill” may initially sound, it may not make sense for producers.

Many moving parts

And there’s the global perspective to consider. According to the International Energy Agency (IEA), global oil production may exceed supply by 600,000 bbl/d this year. While the margin of error is easily disputed, global oil production is high, largely driven by U.S. producers.

Meanwhile, global demand remains questionable. Although the China National Petroleum Corp. (CNPC) expects China’s oil consumption to rise slightly this year, the IEA believes that China’s oil demand has plateaued. There’s also the potential impact of a slowing U.S. economy to consider, even if there isn’t a recession.

All this is to say that the “what-if” for oil prices going forward has a lot of moving parts.

The biggest part, in my opinion, is the Russia-Ukraine war. A peace deal would very likely include Russia being able to return all of its oil products to the world market, which would increase the global supply even more. That increase, along with a slowing global economy, could flip the scales quickly to an oversupplied status and bring prices down with it.

At the same time, there are some factors that support higher oil prices. For instance, crude storage and inventories remain well below five-year averages, especially at the Nymex hub in Cushing, Oklahoma.

Driving season began in April, though there is the chance that consumers’ concerns about the economy could reduce road trip activity. OPEC also has been fairly attentive to keeping excess supplies off the market. The Trump administration has also done a good job so far of battling inflation and lowering energy costs to the consumer.

However, even those elements don’t necessarily justify dramatically increasing oil production. And so, the excitement of “drill, baby, drill” is great for the press; however, for the producer, for whom a price point below $60/bbl is not very enticing, the sentiment may be “not so fast.”

To be sure, there is a lot of runway in front of the oil business, but dramatically increasing production will have to be price-verified. At the price levels as of this writing in mid-April, I don’t see much verification.