Post by
RasoolMohammad1 on Apr 24, 2020 10:59am
Simmons Energy-Worsening Outlook
CONCLUSION We are updating our US oil supply model and now estimate an 85+% reduction in the oil rig count combined with a steep decline in completion activity (-50% to -75% in Q2/Q3 vs. Q1'20) as well as production curtailments/shut-in's due to logistical constraints associated with storage limits. This results in US oil production declining from 12.7 Mb/d in Q1'20 to 10.3 Mb/d in Q4'20 and 9.4 Mb/d in Q4'21. While this decline eventually sows the seeds for tightening market balances, we cannot emphasize enough that there is an exceedingly wide range of outcomes impacting the outlook, highlighted by: OPEC+ spare capacity as well as the pace of demand normalization on the other side of the pandemic curve (given the challenges incurred with returning to normal activity, our 2H'20-2021 demand estimates are likely too high and, accordingly, our assessment of market balances over the course of the next year too optimistic).
• Steeper and Swifter Decline for Oil Rig Count: We are now modeling a steeper and swifter decline in the oil rig count than our previous estimates. Specifically, we are calling for an 85%+ reduction in oil rigs (vs. 70-75% previously and prior down cycles: 55-80%) and for the oil rig count to bottom in early Q3 (vs. the end of Q4 previously). These modeling changes are supported by exceedingly weak spot oil prices, producer reactions and the pace of rig declines over the past few weeks (HZ oil rigs have declined 116 rigs or nearly 20% in just the past 3 weeks). Given that Covid-19 represents the most severe demand shock any of us have confronted in our professional lifetimes, it stands to reason that the magnitude and pace of inventory accumulation and, correspondingly, rig count declines should also be unprecedented. As illustrated in Exhibit 1 below, the HZ oil rig count averages 80 in Q4'20E down from 597 in Q1'20E (87% decline). In our model the oil rig count bottoms in early Q3'20, and we begin adding rigs back at a moderate pace in Q1'21 and continuing on through 2022 (although confidence in the 2021+ forecast is muted given the numerous possibilities surrounding OPEC+, international non-OPEC and demand). In addition, to the oil rig count declines we are assuming a ~60% reduction in completion activity in Q2'20 and ~75% reduction in completion activity in Q3'20 relative to Q1'20 activity levels.
• US Oil Production Drops Significantly: We expect a sharp reduction in US oil production. Specifically, we are employing a different framework to determine how much US oil actually needs to be produced based on refinery demand, imports/exports, etc. (please see the section below for further detail). The difference between actual demand and unrestrained oil production goes into storage until that outlet is full. Once storage is full, US oil production will need to be curtailed via a combination of shut-ins and choke management. Assuming oil production remained unrestrained (Exhibit 2), our model would expect oil production to decline in Q2 (-0.1 Mb/d y/y) and then severely fall off in Q3 (-1.3 Mb/d y/y) and Q4 (-2.5 Mb/d y/y) due to our assumption of a frac sabbatical during Q2/Q3. However, US oil production should be restrained due to demand and storage limitations and as such, we expect oil production to decline more assertively in Q2 (-0.8 Mb/d y/y) and Q3 (-2.0 Mb/d). As stated earlier, the possibilities beyond 2020 are wide due to multiple factors, but we assume US total oil production will decline 3.3 Mb/d from Q1'20 to Q4'22 based on our activity expectations moving forward.
• New Methodology Driving US Oil Production Limitations: For this report, we have incorporated new analysis which helps us better inform and limit our US oil production expectations, as limitations in crude and product storage, and significant run cuts from US refiners (we assume ~65%-70% utilization in Q2) will force reductions in US crude production well below the level suggested by our usual analysis of rigs, completions and well productivity (i.e., the unrestrained production model referenced above). Based on our current estimate of global demand (79/89/95 Mb/d in Q2/Q3/Q4 2020, with a trough of ~75 Mb/d during Q2), and the implied US refining utilization of 67%/76%/81% in Q2/Q3/Q4), we estimate that the available market for US crude will decline between 3.0-5.5 Mb/d during the second quarter. Assuming crude exports are cut in half (to ~2.0 Mb/d), US crude production would need to be limited to ~9.3 Mb/d during Q2 (~3.4 Mb/d below Q1'20 levels), with ~650 kb/d met by natural declines and the remaining ~2.8 Mb/d met by a combination of shut-ins/choke-backs and some limited storage build.
• New Methodology Driving US Oil Production Limitations_Part II: Based on available US onshore commercial storage capacity (see section below for more detail) of 169 MMbbls, we would fill commercial onshore storage likely in late May/early June, resulting in the need for production curtailments/shut-ins for the remainder of Q2 and through Q3'20 (~2.8 Mb/d of curtailments for remainder of Q2'20 after storage is filled and 700 kb/d of curtailments in Q3'20), before transitioning to inventory draws during Q4'20. This analysis has a number of assumptions and at the core assumes the US is a closed system, which it is not. Given that foreign barrels will compete with US barrels for US onshore storage space, the magnitude of the production curtailments/shut-in's could be greater than we are modeling. What is clear, however, is that whether by "top down" political agreement or price/logistics-driven realities, Q2/Q3'20 will see significant forced curtailment of US production, whether producers want to or not. For a very helpful report on potential production shut-in's/curtailments, please see our latest Large Cap E&P note (Covid-19 Driving Oil to Shelter in Place).
• New Methodology Driving US Oil Production Limitations_Part III: In summary, Exhibit 2 details what US oil production should be based upon drilling and completions activity, well productivity, service efficiency gains, etc., whereas Exhibit 3 details unrestrained US production graphed with underlying crude demand based on refinery utilization. The gap between unrestrained US oil production and underlying crude demand reflects crude production that will need to be stored and/or curtailed/choked-off.
• Thoughts on Oil Storage Capacity: Utilizing EIA working oil storage capacity (see Exhibit 4), the US has the ability to store onshore an additional 169 MMbbls in commercial storage. If we include the headroom in the SPR (based on the max ever stored in the SPR), this adds 92 MMbbls or a total of 261 MMbbls. It is uncertain at this time whether or not the SPR will be used for storage (the recent $2T CARES act did not include funding for the DOE to fill the SPR). There is some discussion around unused SPR capacity to be leased to the industry for storage. As previously mentioned, we expect US onshore crude storage to fill within the next ~60 days.
• Can Potential OPEC+ Production Cuts Save Us? We believe that given the magnitude of the demand implosion, it is unlikely that OPEC+ can meaningfully redefine the challenges confronting the oil markets. As detailed in a recent note (Energy Ruminations-Fundamental Challenges), in the event Saudi/Russia/non-OPEC agreed to reduce production, "we viewed this as a quixotic quest given the prodigious saturation of the global crude markets due to the depth of the current economic shock (oversupplied by ~20 Mb/d in Q2) and the exceedingly uncertain economic normalization path on the other side of the pandemic curve." At this point, production cuts are a necessity due to storage limitations and any cut will be too late to change the narrative of reaching tank tops in Q2. Furthermore, while a production cut could prove beneficial to balances in 2H'20 and beyond, the level of global spare oil production capacity would provide a damper on any price improvement
• When Do Oil Supply/Demand Balances Tighten? Based on Exhibit 5 below, oil s/d balances tighten (and the call on OPEC crude increases meaningfully) in 2H'21 at which time we would start drawing down inventories, but rather than this being a clarion call for bullishness there are a few key items to consider. 1. The coming draws will be off of a prodigious level of inventory. 2. Our demand estimate (unchanged from our last macro update on 3/18/20) likely has a downward bias given the challenges of demand normalization on the other side of the pandemic curve (most disconcerting are the dislocations on the non OPEC demand front given C-19 challenges impacting rudimentary health systems in broader EM). 3. We left our OPEC production assumptions unchanged (we might have a better sense of what those might be after this weekend). Bottom Line: there is an exceedingly wide range of outcomes. Final note: Exhibit 5 reflects US oil production with limitations driven by storage considerations, refinery utilization and production curtailments/shut-in's.