Sovereigns, Corporates


Oil & Gas


Analytical commentary

Contributed to The Oil and Gas Vertical periodical, #1-2, 2017

As the year 2016 ticked away, the world was abuzz with the news of the December OPEC agreement between the member and several non-member countries to cut back on oil production. Now time has come for following up on last year’s commitments and evaluating the potential outcomes.  

It is reasonable to expect that a small oil supply deficit will form on the global market in 1Q2017 — all the more so as the growing production in the uncommitted countries will only minimally sway the market equilibrium. The growing demand will also fuel these producer-friendly tendencies, and if the December agreement is extended till the year-end, the results will be even more profound.

The main risk for the market is often considered to be a potentially explosive growth of production in the U.S. if the oil prices climb above the current level. For one thing however, they will not climb until such time as the WTI crude oil price reaches USD 65 per barrel. Secondly, in order to stabilize production in the mainland, U.S. producers would have to boost their drilling volume by 1.6 times, which again is only feasible if the oil prices continue to go up.

Even if the OPEC agreement is extended through the end of 2017, Russia will cut back on its oil production just ever so slightly. Concurrently, the relatively stable oil prices will stimulate the development of several brand new large-sized fields (the only problem is that Russia has very few of those left).

The unique trait of the world oil market this year will be that it will have to face the pledge to curb production volumes taken by the OPEC countries and their non-member counterparts. The question then becomes how this will affect the overall market situation and the Russian oil industry in particular.

Swaying the market equilibrium

The December agreement by OPEC and several non-member countries (including Russia) on curbing oil output will act as an important stabilizing factor for the global oil market. While formerly a global market equilibrium was expected to be reached by year-end 2017 at the earliest, now we have every reason to believe that a supply deficit will form in the first quarter of this year.

The total reduction of output stipulated in the December agreement will amount to 1.76 mln bpd (1.8% of the estimated 2017 demand), of which the OPEC countries will contribute 1.2 mln bpd and the non-member countries – 558,000 bpd (including Russia’s 300,000 bpd). The agreement will remain in effect for six months and may be potentially extended for the second half of 2017 by the decision of the next OPEC meeting, to be held on May 25, 2017.

Increased oil production in the uncommitted countries will have a minimal impact on the market equilibrium. The only two major uncommitted players capable of significantly boosting production in 2017 are Canada and Brazil, while China, the U.K., the U.S., and Norway will continue to experience a downswing (Figure 1).

Figure 1. Production dynamics of crude oil and oil condensate in uncommitted countries (the 2017 estimate vs. 2016), mln blpd

Source: The IEA

It should be noted that the production decline in these countries will be occurring against the backdrop of a rising demand: by 1.3 mln bpd this year following in the wake of a 1.4 mln bpd surge in 2016. In this new economic reality, we expect the oil market deficit to amount to 570,000 bpd in 1Q2017 and 810,000 bpd in 2Q2017, thus keeping prices high.

If the December OPEC agreement is extended for the second half of 2017, the oil market deficit will amount to 1.67 mln bpd in 3Q2017 and 1.82 mln bpd in 4Q2017 (Figure 2). Still, we believe that it is in the OPEC’s best interests to uphold the current production restrictions for as long as oil trades under USD 65 per barrel.

Figure 2. Global oil market equilibrium forecast, assuming that the OPEC agreement is extended through YE 2017, mln bpd

Source: The IEA, ACRA

Exaggerated fears

The OPEC’s key motive to increase production and maintain an oil market surplus is its winning in its tug of war with U.S. shale oil producers, and now the main risk faced by the market is that explosive production growth will resume in the U.S. in case prices begin to rise.

The restoration of drilling volumes in the U.S. that began in June 2016 and has since led to a 57% penetration growth (Figure 3) is often passed off as a confirmation that U.S. production turnaround is just around the corner. However, we believe that as long as the WTI crude oil trades below USD 65 per barrel, no recovery will take place.

Figure 3. Number of operational oil rigs in the U.S., units

Source: Baker Hughes

According to the forecast made by the U.S. Department of Energy, this year will bring with it a slight decline of oil production in the U.S., while average daily production will move into the growth phase in 4Q2017 (Figure 4).

Figure 4. Forecast of average daily oil production in the U.S., mln blpd

Source: The IEA

However, this growth will not be owed to shale oil: its driving force will almost exclusively be the Gulf of Mexico oil fields. According to the same U.S. Department of Energy forecast, production in the mainland U.S. (with the exception of the Gulf of Mexico and Alaska) will stabilize by year-end 2017 (Figures 5 and 6). 

Figure 5. Average daily oil production forecast for the U.S. in the Gulf of Mexico,
mln bpd

Source: The IEA

Figure 6. Average daily oil production forecast for the U.S. net of the Gulf of Mexico and Alaska, 48 states, bln bpd

Source: The IEA

In terms of exposure to the risk of shale oil regaining its destabilizing status for the oil market, the latter of the above-mentioned indicators – i.e., oil production in the U.S. net of the Gulf of Mexico and Alaska – will play the key role. The U.S. mainland production forecasts should account for the fact that a relatively fast decline in production yields of new shale oil wells after their commissioning requires significant investments just for maintaining the current production levels. At the same time, U.S. shale oil producers continue to rely heavily on external financing, as they did before the 2014 oil price slump, with the share of operating cash flow in capex stable at 60–65%.

The share of external funding in capex being hefty as it is, there is no reason to count on any spikes and surges. We assume that the proportion of external and internal sources of investments will remain at the current level. Therefore, shale oil producers’ capex will continue to be oil price driven, which allows us to prognosticate U.S. drilling and production volumes based on oil prices in the medium term.

Our calculations show that stabilizing oil production in the mainland U.S. would require drilling to grow by an additional 60% against the current level, which is possible only if oil prices continue to climb (Figure 7).

Figure 7. U.S. production in 48 states, depending on the WTI price

Source: ACRA

Consequences for Russia

The Russian oil sector has shown resilience to the crisis, which manifested itself in a record-high oil production growth last year (by 2.4%). Oil companies have not abandoned their business development plans, and we believe that oil market stabilization is helping shape up a benign environment for their further implementation.

It looks as though even despite having to comply with the December OPEC agreement on production cutbacks, Russia will still increase its oil output in 2017. Russia’s cutbacks are calculated against the November 2016 level, which was significantly higher the 2016 average (10.94 mln bpd). Moreover, production will be reduced gradually: starting with 50–100 thsd bpd in January, the target level of 10.947 mln bpd is likely to be reached by April or May.

All in all, even if the OPEC agreement remains in effect through the year-end and Russia’s production volumes are cut gradually, we still expect a slight production growth to occur in 2017: from last year’s 547 mln tons to 549 mln tons (Figure 8).

Figure 8. How the agreement affects oil production in Russia, mln tons

Source: ACRA

In the longer term, commissioning of new large fields in Russia (with an expected annual peak output of over 1 mln tons), which has dramatically accelerated after the 2011–2013 hiatus, will ensure nationwide production growth until 2019–2020 (Figures 9 and 10).

Figure 9. New large oil fields commissioned in Russia, mln t/y

Source: ACRA

Figure 10. Forecast oil production in Russia, mln t

Source: ACRA

It should be noted, however, that Russia is commissioning its last onshore conventional oil deposits. Maintaining production levels after 2020 will require special measures to stimulate production at both mature fields and new, high production cost ones.

Table 1. New large oil fields commissioned in Russia

Source: ACRA
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Vasilii Tanurcov
Director, Corporate Ratings Group
+7 (495) 139 03 44
Natalia Porokhova
Senior Director, Head of Sovereign Ratings and Forecasting Group
+7 (495) 139 04 90
Maria Mukhina
Operating Director
+7 (495) 139 04 80, доб. 107
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