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Crude Prices on the Precipice: What if Oil Goes Sub $40/Bbl?

Back in December 2015, BTU Analytics highlighted the interconnectivity between oil and gas in our blog ‘$30 Crude Leads to $6 Natural Gas Price‘.  Despite announcements to extend OPEC cuts into 2018, oil prices are struggling as growth from the US and others was estimated to be 585 Mb/d in May by the IEA counter OPEC cuts.  This growth offsets one third of OPEC’s target cuts of 1.5 MMb/d and diminishes the impact of production curtailments.  Thus, as the market continues to keep an eye on skyrocketing Permian Basin drilling activity some are becoming increasingly fearful of crude prices returning to sub $40/Bbl.

So what happens if crude prices once again fall below $40/Bbl?  Like the last downturn, there is tremendous momentum in the system.  Should prices fall below $40/Bbl and remain there for several months, we would expect producers to once again defer completions, which would cause a spike in the inventory of excess backlog (DUCs above and beyond normal working inventory) that would need to be worked off once prices stabilized again.

The other impact a collapse in crude prices would be significantly altering the trajectory of the US gas market.  Currently, associated gas is growing and is expected to grow 5.7 Bcf/d by 2019 from a 2016 base.  Much of this associated gas growth is being driven by activity in the Permian, and due to impending gas takeaway constraints in the Permian could, along with the completion of Rover out of Appalachia, upend the gas market in the next 12-18 months (request a sample of our latest Upstream Outlook report for more detailed analysis).  However, if oil prices collapse and rigs fall 30% from where they are today, associated gas volume growth would be a much more muted 1.5 Bcf/d by 2019 compared to 2016.

Should further weakness in crude prices scenario play out, the lack of associated gas pummeling the market would have a positive impact on a gas market that is increasingly trending towards becoming oversupplied.  For example, the slide below shows a chart of incremental gas production from gas plays and oil plays under two different scenarios.  The first is BTU Analytics current outlook published in our Upstream Outlook report and assumes that prices stabilize just below $50 for the remainder of 2017 and into 2018.  In this outlook, associated gas plays are producing incremental gas, and by no small margin.  Comparatively, the second chart shows the changes in gas production from oil plays if current rigs today are decreased by 30% to just over 600 compared to 870 today.

So what’s different this time if prices go to sub $40 and what does that mean for US production?

The last three years have left the remaining US producers much stronger, and the industry as a whole can produce at lower oil prices overall – $60 is the new $90 – but producers’ balance sheets still bear scars from the latest downturn.  This means that if prices fall and if the market outlook remains bearish long-run, meaning that producers can’t attract outside capital or hedge into contango in the forward curve, the market could be in for another round of painful bankruptcies and a second market correction could occur more quickly than the correction that started in 2014.   But, this correction would come with a high cost to both US and global producers.

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Erika Coombs is Senior Manager of Energy Markets at BTU Analytics. She leads the team to deliver energy-market analysis and provides BTU Analytics’ customers with critical information for a variety of energy markets including oil, gas, and NGLs from wellhead to downstream markets. She also oversees BTU Analytics’ oil and gas product suite which includes research on upstream, midstream, breakeven economics, and commodity pricing dynamics. She holds an M.S. in Mineral and Energy Economics from the Colorado School of Mines.

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