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OPEC+ breakdown could cause US shale output to decline

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Smaller shale operators most at risk

Output could drop 3.2 million b/d in worst-case scenario

Producers may start cutting capex

Houston — The breakdown in OPEC+ negotiations for deeper output cuts in response to reduced oil demand stemming from the COVID-19 virus could send push oil prices below $40/b, causing US shale oil production to decline later in the year, analysts said Friday.

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OPEC+ had recommended that its existing 1.7 million b/d production cut be extended through 2020 with an additional 1.5 million b/d cut implemented by the end of June. However, Russia Friday refused to go along with the proposal, causing crude futures to fall 10% in one day.

NYMEX front-month crude settled at $41.28/b Friday, down roughly 30% since January 20, when the coronavirus first began to rattle oil markets.

US shale producers, whose booming output growth in recent years has begun to decline in the last several months, may end up cutting back activity more than expected as a result, James Williams, president of WTRG Economics, said.

"If OPEC doesn't get any agreements for production cuts [before the end of March when existing production cuts of 1.7 million b/d expire], we're looking at a trading range of $35/b-$45/b," Williams said.

"Certainly by midyear US oil production then starts to decline again, just like we saw after the 2016 price collapse," when both Brent and WTI briefly dropped below $30/b owing to overproduction, he said.

Moreover, in a lower oil price scenario, Williams and others believe smaller upstream operators may be especially hurt as their capital budgets are strained and they have less access to funding in a current tight lending market.

Worries for small- to mid-sized E&Ps

At sub-$50/b or lower prices, those producers' concerns will center around "whether they can make a profit and if there will be money to return to shareholders," Williams said.

Oil prices that had plummeted in late 2014 to around $50/b caused a pullback in shale activity the following year. But production still rose from booming activity months before and hit what were then record highs of 5.6 million b/d in first-half 2015, according to the US Energy Information Administration.

The resulting oversupply caused crude prices and eventually shale oil output to fall, hitting 4.4 million b/d in late third- and early fourth quarters 2016.

Shale oil output is currently around 9.1 million b/d.

Analysts have curtailed global oil demand outlooks and projected possible crude output scenarios.

Under a worst-case average WTI price of $35/b for 2020, US crude production would drop to 9.75 million b/d in 2020 on the year, from a current reference case of 12.95 million b/d and $54/b WTI, according to S&P Global Platts Analytics, a loss of 3.2 million b/d.

That would result in the first yearly oil output decrease since 2016,

Even at an average $40/b WTI, oil output would drop to 11.050 million b/d this year, Platts Analytics said, down 1.9 million b/d.

Marginal oil plays first affected

"As expected, marginal oil plays (high-cost conventional/unconventional oil plays) would be the first ones to be affected if prices drop below $50 for an extended period of time," Platts Analytics said Friday.

If the present scenario of lower oil prices persists, US shale producers could cut back capital budgets again, building on already expected activity reductions modeled earlier in the year, Rob Thummel, managing director for Tortoise, said.

"Given the significant change in the environment, every company will reevaluate their plans," Thummel said. In that case, "I'd expect lots of capex cuts in April," released during first-quarter earnings reports.

The US oil and gas rig count, which totaled 838 this week, has bounced around roughly in that range since late last year, according to rig data provider Enverus. Rig counts have been inching down since November 2018's high of 1,237, typically from well and operational efficiencies.

Operators will give the market "a little time to shake out," Thummel said. "But it's clear most need to reassess."