US tight oil market too robust to bust

There are a number of ways in which the North American tight oil boom could go bust – for example if there was a drop in global oil price levels following a collapse in the price of Brent due to emerging market down-turn or a significant widening of the differential between global oil prices and inland realisations, according to Wood Mackenzie, presenting at the American Fuel & Petrochemical Manufacturers (AFPM) annual conference in Orlando, Florida, in late March. However, the market analyst believes this is unlikely, as the North American tight oil market is extremely strong, with over 70% of US tight oil reserves remaining economic even if global oil prices fell toward $75/b.

 

‘There is not much US producers can do to influence global oil prices,’ said Dr Harold York, Principal Downstream Research Analyst for Wood Mackenzie. ‘Supply and demand fundamentals and non-market dynamics around the globe keep the price environment well above the break-even economics levels of several US tight oil plays. With Brent crude oil pricing in the late-2013 range of $108/b of oil in early 2014, almost all tight oil proven reserves are commercially viable; even if global oil prices fell toward $75/b, over 70% of US tight oil reserves would remain economic,’ he said.

 

Thus Wood Mackenzie says that sustainable break-even prices depend more on the basis differential between the relevant pricing point (eg, Cushing, St James) and each respective play, as these include elements such as crude oil quality differences and transportation cost. ‘A single play can have multiple refining values and transportations costs, therefore a producer may realise a higher netback by selling their crude oil in to a refining centre with higher transportation costs,’ explained York.

 

The considerable volatility of North American crude oil differentials in the past three years has mostly been driven by logistics constraints and their subsequent relief, raising the question of whether there will be sufficient crude oil logistics capacity to meet the rising production profiles of the US and Canada.

 

Oil production growth is spread across the US and Canada, with 6mn b/d expected by 2025 – most of that growth will take place by 2020. Successful unconventional plays such as the Bakken, Eagle Ford (Gulf Coast) and Permian account for almost two-thirds of US LTO production.

 

‘If sufficient logistics capacity don’t materialise, there is a risk that crude basis differentials could widen to the point of making incremental drilling uneconomic, therefore stalling production growth,’ commented York. ‘However, as we’ve seen in the last 18 months, not all of that volume needs to move by pipeline, as rail has rapidly come onstream.’

 

Wood Mackenzie highlights that a variety of transportation modes should provide adequate capacity to keep crude oil differentials relatively contained. ‘Today, crude markets are becoming complicated with growing price points, changing costs for various modes of transportation and variable qualities of LTO. As the growth in LTO challenges the ability of refinery configurations to absorb more light crude oils, relative price discounts have the potential to grow over time,’ stated York.

 

The magnitude of the United States Gulf Coast (USGC) quality discount can also evolve depending on locations. For example, despite the reversal of the Houston to Houma pipeline, there is insufficient pipeline capacity between the Houston, Texas refining centre and St James, Louisiana to evacuate all the light crude oil destined for Houston from the north (Cushing), west (Permian), and south (Eagle Ford) at low cost. ‘There is potential for saturation of LTO to develop in the Houston/Port Arthur area, resulting in Houston light crude oil pricing at a discount to Brent and also Louisiana light sweet (LLS),’ noted York.

 

When looking at export policies, Wood Mackenzie believes relaxing the crude oil export policy constraint would not necessarily eliminate these basis differentials nor eliminate the ‘quality discount’ of US crude oil pricing. The differential to international crude oils would likely narrow, perhaps substantially, as the discount under a policy of US crude oil exports would be settled by a US and international crude oils arbitrage off the US coasts.

 

It all comes down to whether the US crude basis differentials could deepen enough to disrupt expected drilling programmes, and in line with its outlook, Wood Mackenzie concludes the bust likely won’t happen as the North American tight oil market is too strong to break down.