Record US oil output challenges Saudi mastery

U.S. crude oil production set a record for the second month running in September, highlighting the challenge to Saudi Arabia and its OPEC⁺ partners as they cut their own production to boost prices.

Repeated OPEC⁺ output cuts since the fourth quarter of 2022 have thrown a lifeline to U.S. producers, averting a deeper slump in prices and conceding more market share to them.

U.S. crude and condensate production increased by 224,000 barrels per day (b/d) to 13.24 million b/d in September from August, according to the U.S. Energy Information Administration.

Crude and condensate production had increased by 342,000 b/d over the previous three months (annualised growth of 11%) and was 750,000 b/d higher than a year earlier (an increase of 7%).

The large increase in domestic production has contributed to the accumulation of crude inventories and softening of prices since the start of the fourth quarter.

In the most recent month, production increased in the federal waters of the Gulf of Mexico (+108,000 b/d) and Alaska (+19,000) as well as in the Lower 48 states (+97,000).

Lower 48 production climbed to a record of 10.8 million b/d, surpassing the pre-pandemic peak of 10.5 million b/d set in December 2019.

Lower 48 output had increased by 210,000 b/d over the previous three months (an annualised rate of +8%) and 750,000 b/d over the previous year (an increase of +7%).

^{BOOSTING DRILLING EFFICIENCY}

There are few signs Lower 48 production growth is slowing despite the slump in prices and fall in the number of active drilling rigs over the last year.

Inflation-adjusted front-month U.S. crude futures prices have fallen from an average of $121 per barrel in June 2022 to $90 in September 2023 and further to $77 in November 2023.

Drilling activity usually turns down around 4-5 months after prices and production turns down 10-12 months after prices fall.

Roughly in line with this, the number of rigs drilling for oil dropped from an average of 623 in December 2022 to 510 in September 2023 and 498 in November 2023.

Nonetheless output has continued to increase as drillers boost efficiency by focusing on the most prospective sites and boring longer horizontal well sections to maximise contact with oil-bearing rock.

U.S. producers have also benefited from repeated OPEC⁺ cuts that have stabilised prices at a relatively high level and blunted the price signal to cut drilling further.

Front-month prices averaged $90 in September 2023, which was slightly higher than $87 the same month a year earlier after taking inflation into account.

By November, prices had fallen to average of $77 but that was almost exactly in line with the inflation-adjusted average since the start of the century.

The market is being rebalanced through OPEC⁺ cuts and increases in the group's collective spare capacity rather than changes in prices and U.S. production.

_{EMBRACING RIVAL PRODUCERS}

Saudi Arabia, together with its closest OPEC⁺ partners, has reluctantly resumed its traditional role of swing producer balancing the market by its own output.

Meanwhile, U.S. shale firms and other non-OPEC non-shale (NONS) producers have stepped into the same role as free riders as North Sea producers in the 1980s.

Free riders have been the primary beneficiaries from Saudi Arabia and its allies' determination to avert an accumulation of crude inventories and lift prices.

Enlarging the control group has always been Saudi Arabia and OPEC's preferred strategy for dealing with free riding.

In the 1980s, there was a (failed) attempt to reach out to the United Kingdom and other North Sea producers to share the burden of supporting prices.

Since the 1990s, there have been repeated attempts to bring in Russia and other former Soviet states, culminating in the Vienna Agreement and Declaration of Cooperation in 2016.

U.S. antitrust laws prevent U.S. shale producers from being part of any formal cooperation arrangement with OPEC⁺.

But OPEC has already reached out to other non-OPEC non-shale producers such as Brazil to try to bring them formally or informally into the coordination system.

The outreach to Brazil, and probably eventually to Guyana and the other NONS, fits with the historic pattern of embracing fast-growing rival producers.

For a production-control arrangement to work, it must control a sufficient share of global production, with free riders playing only a moderate role.

If lifting prices causes too much unrestricted growth outside the cartel, there must either be a volume war and price slump to restrict uncontrolled producers, or they must be brought inside the control system.

For now, Saudi Arabia and its OPEC⁺ partners have opted to try to get rivals into the system rather than launch another volume war.

_{U.S. GAS PRODUCTION}

Like crude, U.S. gas production hit a record seasonal high in September of 3,126 billion cubic feet (bcf), according to the Energy Information Administration.

But unlike crude, there are pronounced signs production growth is decelerating in response to very low prices and in the absence of a swing producer to hold them higher.

Gas production had increased by only 55 billion cubic feet (+1.8%) in September 2023 compared with the same month a year earlier.

Production growth has slowed consistently since the middle of 2022 in response to the sharp fall in prices.

Real prices have fallen from an average of more than $9 per million British thermal units (79th percentile) in August 2022 to just $2.23 (2nd percentile) in April 2023 and were only $3.06 (12th percentile) in November 2023.

While growth is slowing, the lags involved have ensured surplus inventories have accumulated.

Working inventories in underground storage had climbed to 3,836 bcf on Nov. 24, the highest for the time of year since 2020 and before that 2016.

Inventories were 186 bcf (+5% or +0.67 standard deviations) above the prior 10-year seasonal average and the surplus has shown no signs of disappearing so far this year.

In the central and eastern Pacific Ocean, El Niño conditions are strengthening, with the current episode on track to be one of the strongest in the last 40 years.

A strong El Niño is associated with warmer-than-normal temperatures across the northern tier of U.S. states between December and February and a reduction in nationwide heating demand of around 7%.

So although rebalancing of the gas market is well underway, prices may have to remain very low for a few more months to ensure excess inventories are depleted.