Shale Producers Stay on the Sidelines as Oil Crisis Deepens
- After initially saying markets had “plenty of oil,” Fatih Birol proposed a record emergency oil stock release as tanker traffic through the Strait of Hormuz effectively froze following the war.
- Despite higher prices, U.S. shale producers are not rushing to increase drilling,
- prioritizing capital discipline and assuming the disruption may be temporary.
- Even with $100 oil, shale could add only around 600,000 bpd this year.
Less than a week ago, the head of the International Energy Agency said there was “plenty of oil” in the market, and there was no need for an emergency release. This week, Fatih Birol proposed an emergency release of hundreds of millions of barrels, the largest ever. Meanwhile, the U.S. oil and gas industry seems to be in a wait-and-see mode—and it’s hard to blame them.
The launch of strikes by the United States and Israel on Iran prompted retaliation that resulted in something few expected would ever happen: the effective freeze of tanker traffic in the Strait of Hormuz, meaning a fifth of global oil exports had suddenly become unavailable. Some tankers do pass the Strait – if they are Chinese-flagged or Iranian-flagged, but most Persian Gulf oil is staying in the Persian Gulf for now.
Besides an emergency release from the OECD stockpiles, a response to the spike in oil and gas prices could have come from producers outside the Middle East, most obviously the United States. Most of the country’s oil comes from the shale patch, which could be ramped up and down fast, so why are they not doing it?
For starters, U.S. shale oil drillers have matured significantly since the early 2000s, when they basically drilled for drilling’s sake—and for the sake of repaying their debt—just to see how much more the shale rock would yield. Those times are over. Now, shale producers are much more careful with their production plans. As Wood Mackenzie noted in a report this week, “E&Ps have so far been suggesting that they are not yet committing to increased activity, in case the higher prices prove to be temporary.”
Argus’s Stephen Cunningham also pointed out the shale industry’s corporate policy evolution over the past decade, with capital discipline taking priority over fast response to changes in market balance. Reversing that, Cunningham argued, would “require a sea change in boardroom strategy.” What’s more, the recent consolidation in the U.S. oil industry has resulted in Big Oil dominance—and Big Oil does not knee-jerk to sudden changes in oil prices resulting from severe supply disruption. Especially when its stocks are suggesting investors and traders all expect the disruption to be dealt with fast.
“The market is anticipating a swift end to the closure of the Strait of Hormuz and a subsequent collapse in oil prices back to normalized levels,” the head of energy research at Melius Research told Reuters this week. “The rally in oil prices is primarily contained to near-term spot prices rather than longer-dated crude oil futures.” This explains why Big Oil shares have risen quite modestly compared to benchmark oil prices and why the industry does not really have much incentive to respond to the supply shock with more production. Instead, it could simply reap the benefits of higher prices while they last.
In gas, however, things are a little bit different—and more concerning for consumers. The United States is the biggest producer of natural gas and the biggest exporter of the commodity in liquefied form. Yet U.S. LNG producers are already at capacity and physically cannot boost production to respond to the gap in supply that opened when QatarEnergy shut down its production facilities.
Wood Mackenzie notes that there will be new LNG capacity coming on stream later this year on the Gulf Coast, but added that this new capacity “will be only about 20% of what has been lost from the shutdown of QatarEnergy’s Ras Laffan.” And this, in turn, means that we could reasonably expect a prolonged gas squeeze in Europe and Asia, with the latter switching to coal and the former possibly forced to reconsider its ban on Russian gas.
The irony in the current situation is that while U.S. producers are entirely justified in adopting the wait-and-see approach, the longer the supply disruption continues, the longer it would take to bring Middle Eastern production back online—and the longer prices would remain elevated, potentially motivating a response from the shale patch. But that response would immediately pressure prices, eliminating most of the gains shale producers could expect.
Not only this, but U.S. shale drillers cannot close the oil supply gap alone, just like LNG producers cannot cover all lost Qatari supply. This should be a worrying thought because it is related to actual, physical oil supply. Indeed, Wood Mac estimated that even if oil trades at $100 per barrel over the next six months, U.S. shale drillers could only add about 600,000 bpd by the end of the year—and it is unlikely for oil to trade at $100 over a period of six months.
In such a situation, the industry is doing the smartest thing for its own good. And it just got proven right as oil prices slumped to below $90 for both Brent crude and WTI after the news broke that the IEA and G7 will be discussing the largest ever emergency release of oil.
By Irina Slav for Oilprice.com
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