Since February of this year, U.S. oil production has topped and has remained over 10 million barrels per day (mmb/d), a level of output we haven’t seen since 1970. This is primarily driven by the climbing oil prices that have occurred since the beginning of 2016. When oil prices are above $60 per barrel, it makes sense for the shale oil industry to increase the outputs for profit. If including natural gas liquid, the U.S. is the largest liquid energy producer in the world. Since 2012, U.S. oil production has grown more than 50%. However, on a net basis, the U.S. is still an oil importer.
The Brent Oil benchmark (white line of the chart) is the most popular oil price benchmark and is compiled based on 15 different oil fields around the North Sea area. It is referenced by two thirds of the world’s oil contracts. Another oil benchmark often referenced is the West Texas Intermediate (WTI). It represents the price of oil produced in the U.S. Since WTI oil has better quality than Brent oil, WTI oil should technically be priced at a premium. But since 2011, the relationship has been the opposite, thanks to a combination of the U.S. ramping up outputs, OPEC cutting outputs and geopolitical conflicts in Libya, Venezuela and Iran. The WTI to Brent spread is around -$10.8 as of June 8, 2018 (blue line of the chart, LHS).
Another point worth mentioning is the Midland crude oil differential (green line of the chart, LHS). It refers to the price difference between oil from the Permian Midland Basin and the WTI benchmark. The Permian Basin is the current driving force of the U.S. oil production growth. In 2017, the drilled but uncompleted (DUC) wells in the area increased more than 100%. In 2018, more than 50% of the U.S.’ newly added rigs are in the Permian Basin. Permian Basin production is projected to reach 6.4mmb/d by 2023. The differential reflects the fact that the takeaway capacity has fallen behind the production growth. The spread has been trending wider since the beginning of this year and is standing at -$9 as of June 8, 2018. Combined with the WTI-Brent spread, the sweeter Permian Midland Basin oil is almost $20 cheaper than the Brent oil.
Not only is time needed to build all of the takeaway infrastructure for the Permian Basin, but significant capital investment is required. Since it would likely take a long period of time to recoup any investment, investors face uncertainties such as how long will oil prices maintain at the level which makes sense for production growth, how soon will renewable energy more broadly replace fossil fuels, and the potential hurdles from environmentalists and/or political policy making.
Key TakeawaysAlthough U.S. oil production has reached a new record level this year, U.S. oil prices are lagging behind world oil prices due to the insufficient takeaway capacity. The issue is more prominent in the Permian Basin, which is the driving force of the U.S. oil production growth. Investing in takeaway infrastructure may look attractive in the short term. In the longer term, many factors will play in to influence the supply and demand relationship of the world oil market.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.
