U.S. SHALE RISK
FT - Members of President Donald Trump's cabinet have a new catchphrase for how they see the future role of the US: not just "energy-independent", but "energy-dominant". As Ryan Zinke, the interior secretary, put it at an industry conference in Houston last week: "Dominance is what America needs."
It would be tempting to dismiss that talk as hype, except that every week the US energy sector is coming up with evidence to justify that ambition. The latest round of earnings reports from US exploration and production companies, the leaders of the shale revolution, has shown fresh evidence of their resilience and growth potential.
The resurgence of the US shale industry after the oil slump of 2014 was a key factor in how crude prices fell sharply last week, to back below $50 per barrel. The market is concerned about whether efforts by Opec, the producers' cartel, to tackle a supply glut by curbing output will be undermined by reinvigorated US shale companies.
These companies are proving that they are able not just to stay in business, but increase production as well, with oil prices close to today's levels of about $47 per barrel for benchmark US crude.
The great weakness of the shale industry has always been that the companies have typically not generated enough cash to pay for their capital spending, and have relied on debt and equity sales to finance their growth. But producers have typically cut their costs by about 40 per cent in the past three years, and many are now at or close to the point where they are covering their spending from operating cash flows.
Before the oil crash of 2014, Harold Hamm, the billionaire majority owner and chief executive of Continental Resources, used to say that prices below $70 per barrel could not be sustained for any length of time, because neither Saudi Arabia nor the US shale industry could bear it.
Now Continental is planning for 20 per cent annual production growth financed by its own cash flows with oil at $50 to $55, and says it can invest enough to keep output stable even with crude in the low $40s.
Mr Hamm told analysts on a call last week: "The United States has retaken its place as a world energy leader, and we will compete effectively in this new regime."
Across the shale industry, drilling activity is increasing even faster than it did in the final stages of its first boom, up until 2014.
The number of active rigs in the US drilling the horizontal wells used for shale oil production has more than doubled over the past 12 months, from 248 to 598 last week, according to Baker Hughes, the oilfield services group. In the Permian Basin of Texas and New Mexico, the red-hot heart of the new boom, the number of rigs running has already hit the levels that were expected for next year, says Benjamin Shattuck of Wood Mackenzie, the research firm.
"We thought activity was coming back, but it surprised us that it happened so quickly," he adds. "I don't think anybody expected that."
Several companies have suggested the pace at which they are adding rigs would slow down.
Jack Harper, chief financial officer of Concho Resources, which operates in the Permian, said that while the company's plans showed a rising number of rigs in use in the next three years, "it doesn't move up in a hugely dramatic fashion".
However, as companies build up experience working in shale, the wells can be drilled faster and each is on average more productive. This month 662 barrels per day will be produced from new wells in the Permian for every rig that is running there, according to the US government's Energy Information Administration. That is triple the rate of 217b/d per rig at the end of 2014.
Jamie Webster of the BCG Center for Energy Impact says that on average across the shale industry, each additional rig coming back into service can be expected to result in 2.5 times as much oil as when activity started to drop off in the autumn of 2014.
As a result, many shale producers are predicting production growth this year. Pioneer Natural Resources is the star performer, forecasting growth of 15 to 18 per cent for 2017, and an annual average of at least 15 per cent out to 2026, but many others have projected solid increases.
For example, Marathon Oil thinks that between 2017 and 2021 it can achieve 10 to 12 per cent annual growth, excluding its troubled operations in Libya, with US crude at $55.
Not every US exploration and production company is expecting short-term growth, but enough are predicting expansion to support the EIA's forecast that US oil output will hit a record above 10m b/d next year.
So far, there are few signs that the recovery in the industry is stoking cost inflation that would stop the increased production being translated into higher earnings. EOG Resources, one of the largest shale producers, said on Monday that even though suppliers' charges were rising, it had cut the cost of drilling and completing wells by 6 per cent in the first quarter compared to the average for 2016, through improved efficiency and signing new service contracts at lower prices.
It seems right now that the greatest threat to the US shale industry is its own success. Adam Sieminski, a former head of the EIA now at the Center for Strategic and International Studies, a Washington think-tank, draws an analogy with the Tragedy of the Commons. Rapid growth that is rational for the individual producer could turn out to be collectively disastrous by flooding the market.
"One sheep eating the grass on the commons works," he says. "But an entire flock soon turns the grass into mud. You overwhelm the system. Who is going to buy all that light [US shale] oil globally? Is there a market for it?"
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