The US is increasingly influential in price formation for crude and global gas markets. But tight oil and shale gas, through LNG exports to Europe, are likely to be cap and collar in their respective markets for the next few years – tight oil setting the ceiling price, US gas the floor.
The big three – Saudi Arabia, Russia and the USA – have jostled for position as the world’s leading oil producer since the start of the new millennium. The astonishing growth path of tight oil propelled the USA to top dog 2015, ousting by a small margin Saudi Arabia, No.1 since the early 1990s. In the background, Russia, like the USA, built production up. Last year, all three produced 12 million b/d (including NGLs), give or take, and each is currently producing at or close to all-time-record levels.
The competitive sparring of the last few years is about to end, and in this fight there will be only one winner.
Our latest Macro Oils Long-Term Outlook shows the extent to which the USA outpaces the rest in the near future. We forecast that by 2025, US liquids volumes will increase by over 50% to 19 million b/d; Saudi Arabia will be broadly flat, whereas Russia faces gentle decline.
The global oil market becomes increasingly dependent on the US, which will contribute almost 20% of supply by the middle of next decade. No country has so dominated global supply since the US itself in the early 1970s.
US production growth becomes increasingly influential in price formation through this period. The ‘supply gap’ is key to our fundamental analysis of the oil market. We quantify the break-even price of the new volumes needed to meet the supply gap – future global demand growth net of declines from existing production (see chart). These volumes will be sourced from new drilling in US L48 tight oil, conventional pre-FID projects, non-OPEC reserve growth, and growth in OPEC capacity.
Cheap US tight oil meets almost all incremental demand in the next three years to 2020, keeping a lid on oil prices. But through 2025, the picture changes.
The ‘supply gap’ by 2025 is 17 million b/d, of which the US will provide 10 million b/d (or 60%) and nearly all tight oil (0.5 million b/d combined from Gulf of Mexico and Alaska).
It’s not all quite so cheap by then. The ultra-low-cost Permian sweet spots won’t last forever and operators will need to reach into tougher Permian geology, as well as higher-cost plays in the Eagle Ford and Bakken. New conventional pre-FID projects also come into the equation. We think Brent needs to rise to US$70/bbl real, perhaps higher for a while, to incentivise investment in the early part of next decade and ensure the supply gap is closed.
US gas is going global. Massimo Di Odoardo, Head of Global Gas Research, argues that Henry Hub will soon play a central role in price formation. US gas prices are poised to fall as the gigantic shale resource expands, associated gas from the Permian drilling boom the latest major addition; and as infrastructure is rolled out. We expect Henry Hub to average US$3.43/mmbtu this year but just US$2.9/mmbtu from 2019 to 2024.
Current prices in Europe and Asia are US$5.4/mmbtu and US$6.90/mmbtu respectively. US LNG volumes ramp up in the next few years, competing in an increasingly oversupplied LNG market.
We expect European and Asian prices to fall to the delivered cost of US LNG – US$ 4.1/mmbtu and US$6.90/mmbtu through 2018-23. Below these levels more US LNG volumes fail to cover cash costs (Henry Hub plus the variable cost of liquefaction, shipping and regasification) and will be shut in. Henry Hub will effectively set the floor.
Oil supply gap in 2025: volumes and break-even prices