American Oil and Gas Reporter - January 2017 - 40

Outlook 2017
no problem growing 1.5 MMbbl/d at $60-$65/bbl for a long time.
That would make the United States the world's swing producer of oil. The difference is that the United States is not a real-time
swing producer because it still has to drill the holes, fracture the
wells, install the equipment, etc. All that takes time and means
the production response will lag the price move by roughly a year.
It is not like the old days, when all OPEC had to do was turn some
valves. There will be a substantial lag factor in response to demand because the investment has to be made to drill and complete wells before supply can grow.
As far as the geopolitics, about all one can do is speculate. I
believe Saudi Arabia and other countries pushed production to unsustainable levels as part of what I call a "fake surge" ahead of
the OPEC annual meeting so they could use those artificially high
numbers as the base from which to negotiate production cuts. I
think much of OPEC's "stated" production capacity simply does
not exist. An example is the Saudis' claim they can produce close
to 12 MMbbl/d in short order. If it has all of this excess capacity, why has the Saudi oil rig count more than doubled over the last
five years while its oil inventories have collapsed around 15 percent over the past year? That logic doesn't make sense.
My unprovable theory is that Saudi Arabia was producing at
or near capacity this summer, and was not comfortable trying to
sustain 10.8 MMbbl/d indefinitely. The Saudis were going to cut
oil output anyway! Saudi Arabia already had won the price battle. By the time OPEC met, low oil prices had seriously degraded U.S. service infrastructure, and its archenemy, Iran, had recovered its oil production to presanction levels. There was no
longer a reason to keep oil prices artificially low.
Also, one has to consider the implications of low oil prices on
Saudi Aramco's initial public offering. The bottom line is there
were a lot of reasons for why it was in Saudi Arabia's interest to
cut production and raise oil prices. It probably was going to cut
anyway, so why not get others onboard to broker an agreement?
As far as non-OPEC countries, I don't think their announced
cuts are very meaningful. Russia, for example, is cutting from an
absurdly high, unsustainable number. It essentially is reducing
output to what is sustainable. Mexico's cuts are simply natural
declines that are going to happen anyway. So that leaves OPEC
cutting about 800,000 bbl/d from what is a more sustainable production level.
We think compliance will be high with two-thirds of the cuts
coming from Saudi Arabia, the United Arab Emirates, and Kuwait.
Those countries usually always abide by cuts. We probably won't
have a good indication of compliance until the six-month period is halfway over anyway, but I suspect those three will do exactly what they have agreed to do.
The intriguing one is Iraq. I would not have thought Iraq would
have agreed to a significant cut. The magnitude of its cut tells me
Iraq probably didn't have the capacity to maintain production at
its previous level, either, so that probably ends up being another cut that was going to happen regardless.
International Energy Agency data showed that global sup-

Q: ply and demand had moved into balance by the second half

of 2016. The "oversupply" problem has come down to an inventory problem, with commercial stocks around the world estimated at nearly 3 billion barrels in December. What trends are you
40 THE AMERICAN OIL & GAS REPORTER

seeing in inventory withdrawals/additions? What is your overall outlook for U.S. oil inventories in the months ahead and the
timeline for depleting the overhang?
ADKINS: We think U.S. inventories are going to continue declining meaningfully. In fact, we see quarterly oil inventory drawdowns within Organization for Economic Cooperation and Development countries every quarter next year. Inventories should
look bullish, but it hard to predict the timing of exactly when
OECD inventories will return to normalized levels (i.e., sufficient
to meet 30 days of demand). My guess is that OECD inventories
will get back to normalized or even below-normalized levels just
after mid-2017.
The tough part about global inventories is that only half the
world's inventories are measured and publicly reported. These are
OECD oil inventories. Even then, with the exception of real-time
U.S. inventory data, finalized OECD oil inventory reports tend to
lag reality by two or three months. In addition, there are seasonal and price-induced periods where global oil inventories "slosh
around" into or out of the United States and OECD countries. This
sloshing-around effect can make the numbers misleading.
We believe global demand has been stronger than most people realize. That is why we saw meaningful drawdowns outside
the United States in 2016, which showed up in IEA numbers in
the third quarter. If inventories are falling, the market is undersupplied. It's that simple! That is what our model suggested and
that is what I believe the IEA oil inventory data confirm.
I think we will look back and see inventory drawdowns in late
2016 and the first half of 2017 as the key catalyst that moved oil
prices higher. With higher prices, OPEC will ramp up production as best it can to a sustainably high level by the third quarter, but the market still will be undersupplied because the response
time in the United States will be slowed by diminished service
and supply capacities. The end of the inventory overhang means
the market will be subject more to the forces of real-time supply and demand, but it also means the inability for supply to respond to increased demand on a real-time basis.
The full impact of the downturn on U.S. oil production is

Q: not yet fully known, but from April 2015 to the end of third

quarter 2016, EIA data indicated that domestic output fell roughly equivalent to OPEC's 1.2 MMbbl/d announced cut. As unpleasant as the past two years have been, what has the industry learned
about the economics and sustainability of tight oil plays? Are the
dramatic break-even cost reductions seen in these plays permanent? What insights have been gained on decline curves and productivities? What pricing point will ensure U.S. oil production
growth without creating another oversupply situation?
ADKINS: The market is coming to grips with the fact that there
is a lot more capacity to grow U.S. oil supply than anyone thought
possible, and the price at which it can be extracted economically keeps moving lower. The United States has transitioned from
being the highest-cost producer a decade ago to arguably the lowest-cost producer in the world today (if social costs are included).
There is no question that oil service pricing is going to bounce
back in a significant way in 2017; oil field pricing has been at

American Oil and Gas Reporter - January 2017

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