Wood Mackenzie: US tight oil market too robust to bust

Wood Mackenzie

70% of US reserves would remain economic with global oil prices at $75/bbl

Today, at the American Fuel & Petrochemical Manufacturers (AFPM) annual conference in Orlando, Florida, Wood Mackenzie says there are a number of ways the North American tight oil boom can go bust as the industry continues to wonder how long this trend will last. A drop in global oil price levels (a collapse in the price of Brent due to emerging market down-turn for example) or a significant widening of the differential between global oil prices and inland realizations are some of the reasons the energy research firm highlights.

"There is not much US producers can do to influence global oil prices," says 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." Almost all proven reserves of U.S. Light Tight Oil (LTO) are viable at today's prices explains York.

"With Brent crude oil pricing in the late-2013 range of $108 per barrel of oil (bbl) in early 2014, almost all tight oil proven reserves are commercially viable, even if global oil prices fell toward $75/bbl, over 70% of US tight oil reserves would remain economic," adds York. 

Thus Wood Mackenzie says that sustainable break-even prices depend more on the basis differential between the relevant pricing point (e.g., 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 realize a higher netback by selling their crude oil in to a refining centre with higher transportation costs," says 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 6 million barrels per day (mmbd) 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 Light Tight Oil (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," explains 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 on-stream."

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," states 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)." says York.

Wood Mackenzie says that when looking at export policies, 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 programs, 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 breakdown.


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