OREANDA-NEWS. September 16, 2015. In this week’s Oilgram News column, At the Wellhead, Herman Wang  looks at how the resilience of shale and the proliferation of US oil production has pushed the US into a new role as the world’s swing producer.

OPEC’s spare capacity will shrink to 1.6 million b/d this year as Saudi Arabia produces at multi-year highs in pursuit of its market-share strategy, according to the US Energy Information Administration.

That normally would indicate a tight market—anything under 2.5 million b/d would imply tight conditions, the EIA says. But the risk premium for oil has apparently shrunk to almost nil and prices have plunged, due in large part to global inventory builds and US shale production.

Barrels in storage and the resilience of US shale, where drilled and uncompleted wells, or DUCs, can be restarted quickly, have become sources of de facto spare capacity, rendering OPEC spare capacity more or less irrelevant in current market conditions as the US takes over as the world’s swing producer.

RBC estimated last week there were about 4,200 DUCs combined in the Bakken, Eagle Ford, Permian and Niobrara shales.

“Although OPEC’s real spare capacity is down, shale oil producers are capable of drilling an oil well within two to three weeks if prices are reasonable, thus adding an dimension to spare capacity,” said Ehsan Ul-Haq, a senior consultant with KBC Energy Economics. “Therefore, OPEC’s surplus capacity has lost its mojo at least for a couple of years, although the organization continues to try hard to influence the market.”

EIA defines spare capacity as “production that can be brought on within 30 days and sustained for at least 90 days.”

DUCs would appear to fall under this definition, given how much drill times have decreased, if one assumes that labor and capital are readily available.

But maybe spare capacity as a concept is pointless to track, if everybody, from Bakken operators to Saudi Arabia, is operating by market principles and not dictating supply to control swings in prices.
Not so fast, experts say.

Global stock builds could be fleeting, if world demand rises and non-OPEC production growth slows. OPEC itself seems to be betting on that strategy, defending its market-share strategy in its latest bulletin by saying if projections of demand growth hold true, “then it is just a case of riding out the storm and waiting for calmer waters to return.”

And obviously OPEC could make its spare capacity relevant again by shifting its strategy and ordering a supply cut, as some members, notably Venezuela and Iran, have pushed for.

The current oil glut “can only realistically be cleared by Middle Eastern producers withdrawing at least 1.0 million b/d and arguably much more from the market,” said Neil Atkinson, head of analysis for Lloyd’s List Intelligence.

As for US shale, viewing it as a permanent source of de facto spare capacity would be a mistake, said Bob McNally, a former energy adviser to President George W. Bush who now runs the Rapidan Group consulting firm.

US shale wells are controlled by hundreds of drilling companies, all responding independently to their evaluations of market conditions.

Given the variability of shale formations, where breakeven costs in one county can be markedly different from the next county down the road, coordinating supply would be difficult, not to mention illegal, due to antitrust rules.

“Living in the day to day, as politicians and the oil industry do, shale oil cannot move fast enough to prevent wild swings in oil prices,” McNally said. “That’s what spare capacity used to be.”

But whether shale oil counts technically as spare capacity or not, there’s no question that laid-down rigs and DUCs have prompted analysts to change how they project future production and prices.

“We have now learned that US producers can cope with far lower prices than we thought,” Atkinson said. “If the US has become a de facto swing producer, we mustn’t forget that you can swing both ways, and any significant sign of higher prices will encourage the shale guys back in, thus resuming the downward pressure on prices.” — Herman Wang