ATFX - Will U.S. crude oil production decline? Oil market supply could tighten further

atfxThe latest data released shows that drilling activity in the United States is slowing, which will lead to a decrease in its crude oil production, and traders are starting to bet that global crude oil inventories will be significantly reduced.

Compared with April, U.S. crude oil production was essentially flat in May.This suggests that falling oil prices and slowing drilling activity eventually caused the country's crude oil production to peak and begin to decline。

According to a report released by the U.S. Energy Administration (EIA) on July 31, crude oil and condensate production in 48 U.S. states, excluding the Gulf Coast, increased by only 19,000 barrels per day from the previous month. Compared with the same period last year,Production still rose by more than 1 million barrels per day, an increase of 9%.。

But the rapid rise in oil prices is a legacy problem of high oil prices caused by the Russian-Ukrainian conflict and sanctions imposed by the Group of Seven (G7) for this purpose, which pushed the real price of WTI crude above $90/bbl between February and August 2022.

Since the turn of the century,WTI crude oil prices above that level, adjusted for inflation, were at the 60th percentile or higher in all months, which stimulated drilling activity and led to a significant expansion in production。

Despite several rounds of production cuts by Saudi Arabia and its OPEC allies since October 2022, robust U.S. production, the release of strategic reserves and a slowing economy have kept crude inventories high.

However,Things have started to change.This creates the conditions for the next cyclical price increase later in 2023 to 2024.Provided that the major economies do not fall into a full-blown recession。

Experience shows that drilling rates decline about 4-5 months after futures prices fall, while production decreases about 12 months.

Inflation-adjusted WTI crude oil prices peaked at nearly $120/barrel in June 2022 (82nd percentile), falling to less than $71/barrel in June 2023 (43rd percentile).

The number of active oil rigs peaked at an average of 623 in December 2022.By July 2023, it had declined by more than 14 percent, averaging only 534 units.

If the usual pattern holds, the drilling slowdown should cause crude oil production to decline starting in the third quarter of 2023 and continuing through the first half of 2024.

If the economy can avoid a recession, while U.S. crude oil production growth slows or even declines outright, coupled with deeper and longer production cuts by Saudi Arabia and OPEC,Global crude oil inventories are expected to be significantly depleted.

In this sense, Saudi Arabia's unilateral production cuts have provided a life infra for U.S. producers, avoiding further increases in inventories, stabilizing prices, and avoiding a more severe contraction in U.S. drilling activity.

Traders have already started anticipating a production shortfall later in 2023 and 2024At present, the average price of WTI futures in recent months exceeds $80 per barrel (54th percentile).

WTI crude oil's fourth-quarter calendar spread narrowed to a spot premium of $1.50 a barrel, up from a flat level at the end of June.This means traders expect a significant decrease in global crude oil inventories.

On the natural gas front, U.S. dry gas production climbed to a record 319.60 billion cubic feet in May,An increase of 5% compared to the same period last year.

Total production in the first five months of the year reached a record 15.462 trillion cubic feet, up 7% compared to the same period in 2022.Like oil, natural gas production continued to grow in the second and third quarters of 2022 in a lagged response to high prices.

In real terms, the monthly average price of natural gas futures prices peaked above $9 per million British thermal units in August 2022 (the 78th percentile for all months since 2000), but fell to nearly $2.20 (the 2nd percentile) in April 2023.

As prices fell, the number of rigs primarily targeting gas-bearing formations fell from an average of 162 in September 2022 to an average of 132 in July 2023.

As a result, gas production growth will slow sharply in the second half of 2023 and the first half of 2024, which will weaken the excess inventories in the winter of 2023/24.

Natural gas inventories in U.S. underground gas storage stood at about 222 billion cubic feet as of July 28, higher than the seasonal average over the previous 10 years. But they are down from 297 billion cubic feet as of July 1.This is the most significant contraction since December 2022。

If winter temperatures this year are roughly in line with recent averages, the slowdown in production growth should eliminate the oversupply from the winter of 2023/24.

Gas prices have started to rise as traders expect a production deficit and depleted inventories in the winter of 2023/24.

In the last three months, the price-adjusted average price of natural gas in the United States has gradually increased, reaching $2.30 (2nd percentile) in May, $2.47 (2nd percentile) in June, and $2.63 (6th percentile) in July.

However, senior energy analyst John Kemp said,Gas prices remain very low by historical standards, which means drilling activity is likely to continue to contract in the near term.