Is American tight oil really now the world’s swing supplier?
You can almost guess how the crude market moved in the last couple of months by looking at Baker Hughes's weekly rig data. More rigs in play? Oil firmed. Fewer? Crude dropped.
American tight oil's remarkable rise in recent years transformed the global supply picture. But, along with Opec's reluctance to cut production to prop up prices in the past two years, tight oil also changed ideas about energy security.
Before tight oil boomed, balancing the market was the job of Saudi Arabia. In an emergency-a sudden supply shock-or during a damaging price spike, the unwritten agreement between the International Energy Agency (IEA), whose members maintain an emergency inventory to cope with an interruption, and Opec, was that the latter would get the first shot at fixing the problem. Saudi Arabia was the world's swing supplier, able to plug a sudden gap or smooth out a price surge.
These days, many think tight oil can do the same job-not at the behest of an oil minister, but guided by the market's invisible hand and the American oil patch's animal spirits.
Tight oil certainly reacts to prices when they fall. From a high point of 5.02m barrels a day in January, production has dropped steeply with the oil market. It is now just 4.55m b/d. No central command mandated this, unless you count Mr Market. If so, he decided that prices were too low to justify extracting the oil. So drillers idled their rigs. Plainly, tight oil is able to swing lower when it needs to.
The bigger question is whether it can swing higher too-quickly enough to fill any looming supply gaps. We don't know for sure yet, because tight oil is still young, and hasn't been through a post-crash price recovery, and global supplies, including stocks, remain buoyant. But it doesn't look likely.
For one thing, despite its stellar performance in recent years, tight oil just doesn't have the volume.
Consultancy Wood Mackenzie estimated recently that as much as 70% of new drilling in both US tight oil and conventional plays would be commercially viable with Brent prices under $60/b.
On one hand, this is encouraging stuff-a few years ago, only half of that oil would have been commercial at the same price. In output terms, this makes 9m b/d of US supply available at current prices. Wood Mac says this supply will be crucial in the coming years as the big drop off in upstream spending translates into slower global production growth.
But of this 9m b/d, only 5.4m b/d is tight oil-the supply source that can react most quickly to price changes. And a rise in tight oil supply from current levels can't, on its own, even deal with projected global demand growth. In just the next two years, after all, the world will burn an extra 2.5m-3m b/d (even while non-Opec production is forecast to fall, losing 0.9m b/d, according to the IEA).
Which producers will cover the short-fall? Opec.
"In the heady days when US shale production was moving upwards very fast it became fashionable to talk of lower reliance on traditional suppliers," the IEA wrote recently. "In fact oil output from [the Middle East] rose to a record high in June, with production above 31m b/d for the third month running." The Middle East's market share of global production, the agency noted, was now 35%, its highest level since the 1970s.
The main problem with the idea of tight oil as a swing supplier is its lack of a supply buffer, itself a reflection of its relatively small volume.
"When you talk about Opec and [production] flexibility it's about spare capacity," says Jamie Webster, a fellow at the Center on Global Energy Policy. "And I don't see that with US shale. Tight oil output is around 4m b/d, whereas Opec's is around 30m b/d. That's not sufficient to balance the market."
Opec's spare capacity, presently about 3m b/d, on its own equates to about 65% of total US tight oil output. That leaves the group's buffer close to the level that pushed oil prices up above $100/b before. But it's still more than tight oil has. "US shale output just doesn't have that ability to ramp up."
That might seem counterintuitive-after all, tight oil did indeed ramp up, almost from nowhere, in just a few years. The point, though, is that it can't as a sector immediately draw on much extra in the case of emergency, as Opec can.
Webster argues instead that tight oil will operate mainly as a bridge between storage-capacity additions and new, longer-term upstream projects coming on stream. Less a swing supplier, more of a topping-up merchant.
In fact, he says, storage capacity additions themselves will be much more important to market rebalancing than tight oil output. Responsive as the tight oil rig count might be to price changes, storage draws and injections are even more so.
Between September 2015 and March this year, the US added 34m barrels (around 6%) to working crude oil storage capacity-the biggest expansion of commercial crude oil storage capacity since the US government started tracking such data.
The ability to suck oil back out of those hefty stocks, not tight oil's capacity for endless expansion, is where the market's notion of swing supply has shifted somewhat.
"The analytical community has got shale wrong a couple of different times and I don't have any indication we've got it right this time," Webster says.