[Deep Dive] Oil: What a Fracking World

OPEC, geopolitics and fundamentals are driving the oil uptrend

Executive summary:

• Oil prices rallied on the back of the OPEC agreement
• The refill of SPR will act as a bullish factor
• The drop in horizontal rig count, oil well productivity, and drilled uncompleted wells also contribute to the bull case
• Soaring labor and drilling costs in the US make shale oil less competitive to oil producers around the globe
• Oil market is overdue for a correction before its uptrend

Part 1: Oil Fundamentals

This is the third deep dive in our commodity series, this time focusing on the oil sector. Oil prices have rallied since June of this year when OPEC and Saudi Arabia continued to maintain their 1 million barrels per day (bpd) production cut. See detailed information on the OPEC cuts in Slide 1. Every month since they have rolled over this agreement, pushing oil prices higher.

Slide 1: OPEC Agreement

Source: https://www.ogj.com/general-interest/economics-markets/article/14294745/saudi-arabia-to-further-reduce-output-as-opec-sticks-to-2023-production-cut-target

Slide 2 shows the historical crude oil production of the major oil producers in OPEC. There was a substantial drop in production during Covid, when global oil demand plummeted. Prior to Covid, OPEC's strategy was to pump at capacity and keep prices in a constrained price range to encourage oil demand. Covid forced OPEC to adjust this strategy and they cut production in a dramatic fashion. They had been slowly increasing oil production since 2020, until the recent new quota agreement.

With the Biden administration realigning the US energy policy and the Russian invasion of Ukraine, the political landscape has also changed. Both of these factors have been drivers to the oil price rally.

Slide 2: OPEC oil Production

Source: https://peakoilbarrel.com/2023/09/

There are a host of other factors driving the oil price higher along with the OPEC agreement and geopolitics. The focus of our research will be to dive into these other factors and explain how each is doing its own part in driving oil prices higher.

Chart 1 shows oil prices bottomed during the depths of the 2020 Covid outbreak, during the 2nd and 3rd quarter, as global demand fell with the shutdown of global economy. The market has been in a major uptrend since, with a market correction in 2022 and early 2023.

Chart 1: WTI Oil Futures November NYMEX Futures

In Chart 1, the sideways price action from April 2022 until the summer of 2023 was primarily caused by the release of over 350m barrels of oil from the Strategic Petroleum Reserve (SPR) — see Chart 2. We could try to argue that higher interest rates globally would also impact energy demand, but the data is not verifying that, as global travel has been quite strong.

The SPR peaked at just over 700 million barrels, with some released during Covid, but the majority of the release started in April 2022 and ended in August 2023. The Biden administration was trying to subdue higher inflation by driving down oil prices, the release of the SPR was their attempt to cap oil prices.

At the end of August 2023, the SPR now has 350m barrels in storage. While the release put the bull market on hold, liquidating half the storage — intended for emergency use — has now put the US at risk if there is indeed a price spike due to a bigger geopolitical or exogenous event.

Refilling the SPR if indeed it is done, will now act as a price pushing factor, as the supply demand dynamics are enormously skewed to the upside. The original plan by the braintrust in Washington was to push the price lower and then buy the oil back — that plan has now put the DC elites on their backs, as they have added enormous risk to the oil profile going forward. This puts the next potential wave of higher inflation for the US and global economy front and center as we head into 2024-2025.

Chart 2—Strategic Petroleum Reserve in Thousand Barrels

Source: EIA

The Biden administration has made it quite clear that they want to wean the US economy off of oil and coal — this signal, along with regulatory actions, have had enormous impact on the oil drilling/fracking regions of the country. If you are not familiar with where oil is found in the US, Slide 3 using EIA data shows the main oil plays, led by the Permian Basin. The Permian has been the largest contributor to oil growth in the US over the past 10 years, and will continue to be the “play” going forward. It currently produces nearly 40 percent of all shale oil production in the US.