What happened
After hitting a one-month high last week, oil prices tumbled during this shortened week of trading. Brent crude oil prices are down to $48.11 a barrel after closing trading last week at $49.80 per barrel.
The big driver this week for the slightly somber mood has to do with the strength of the U.S. shale-drilling market. Even the OPEC nations' agreement to maintain cuts -- and Saudi Arabia and Russia's renewed pledge to bring oil inventories back within five-year averages -- weren't enough to ease concerns that continued growth in the U.S. would quickly offset those cuts.
Image source: Getty Images.
So what
It seems that for every cut from OPEC or for every news piece that says production declines are taking hold in certain fields across the globe, there is another press release that shows U.S. production continuing to grow -- fueled by shale drilling. On May 31, the U.S. Energy Information Administration released its most recent oil and gas production report, which showed that March 2017 production grew for the sixth straight month and is up 500,000 barrels per day since September 2016.
This kind of resiliency is going to make several Wall Street analysts question their preconceived notions that continued -- or even steeper -- production cuts from OPEC would be the panacea for the oil markets' ills. If the U.S. can essentially backfill these production cuts in a matter of months, it will take that much longer for any significant uptick in oil prices to take effect.
The gravity of this situation hit some oil stocks pretty hard this week, as shares of independent oil and gas producers Whiting Petroleum (WLL), Denbury Resources (DNR), SM Energy Company (SM 0.40%), and Halcon Resources (HK) all declined double-digits.
One thing that is worth pointing out concerning these four oil and gas producers is that none of them are big-time players in the Permian Basin, America's sweet spot for shale drilling. SM Energy and Halcon Resources both have acreage in the region, but they are marginal positions that won't drive tremendous growth. Whiting's holdings are in the Bakken shale formation in North Dakota and the Niobrara Basin of Colorado. Denbury, on the other hand, focuses on a completely different oil-extraction method and has no shale-drilling assets.
This is likely why these companies happened to be some of the worst performers for the week. Well economics in the Permian are pretty good at today's prices, especially for larger companies that can benefit from efficiencies of scale. Outside the Permian, though, the proposition of producing oil at current prices isn't as attractive, and Wall Street appears to be punishing these stocks particularly hard for their lack of Permian exposure.
Now what
For those wondering how much longer the U.S. can continue to add production to the global market, do keep in mind that we are producing about 600,000 barrels per day less than peak production in April of 2015. So there is a very real chance that this tit-for-tat relationship between the U.S. and the global oil market will continue for some time.
As far as all of these companies are concerned, there wasn't any news that moves the needle. Halcon announced the results of its first operated well in the Permian Basin, and Denbury Resources announced a minor acquisition of a mature, producing oil and gas field that will be ideal for its CO2 injection technique that cajoles more oil out of old reservoirs.
For those looking at the longer term for oil and gas, this week doesn't change much. Shale was inevitably going to be the source of production that would quickly ramp back up because of fast development times; it's just that shale growth has exceeded expectations and kept prices low. Eventually, though, shale growth won't be enough to keep up with increasing demand and declines elsewhere, and when that happens, we will likely see prices rise again.
