US shale producers are the new ‘swing producers’ in the oil market, as many analysts have noted, but the status of swing producer is hugely misunderstood.

It is often portrayed as if it confers power and control. In fact, it often means the opposite. The swing producer often becomes the passive absorber of shifts in market supply and demand.

Between the 1930s and the 1970s, the role fell to small, independent well owners of Texas, who were forced to limit their production to balance the global oil market.

Prorationing orders issued by the Railroad Commission of Texas and conservation commissions in other states compelled owners to restrict output to a fraction of the well's maximum, and it was not a comfortable experience for the US domestic oil industry.

Saudi Arabia found itself cast in the role of swing producer in the early 1980s, an experience that traumatised the kingdom's policymakers, and which they vowed never to repeat.

One reason prices have crashed since mid-2014 is because Saudi policymakers, having been burned before, refused to shoulder the burden of balancing the market and have forced it upon the shale industry and other high-cost producers.

The swing producer role has now fallen to the U.S. shale sector, which will find it as uncomfortable as the Texas independents and the Saudis did previously.

Swing status will ensure oil prices stabilise at a level that brings forth just enough shale production to be consistent with the global oil market balance.

Following the 50 per cent surge in prices over the last eight weeks, there are indications prices have risen to this level, allowing shale production to be sustained or grow slowly, but avoiding the rapid growth reported before September 2014.

NORTH DAKOTA

North Dakota's shale producers, together with those in Texas, have become the critical swing producers.

North Dakota's oil production of 1.19 million barrels per day (bpd) in March was essentially unchanged from the last six months, records from the state government show (https://link.reuters.com/puk74w).

There is not yet enough data to conclude that production has peaked following the near-halving of oil prices since the middle of 2014. Production growth often flattens during the state's harsh winter, which makes drilling, well completions and other maintenance difficult.

One or two months more data will be needed before it is possible to say prices rather than a seasonal slowdown are responsible for output stalling. Nonetheless, there is a high probability that North Dakota's oil production has indeed levelled off as a result of the sudden collapse in oil prices.

The number of rigs drilling in the state has more than halved since early October, according to the Department of Mineral Resources (DMR). There are currently 83 rigs active in the state, the lowest number since January 2010, the DMR wrote in its latest monthly report ("Director's Cut" May 2015).

Earlier this year, the DMR's chief told state legislators producers needed a wellhead price of between $55 and $65 per barrel to maintain output at around 1.2 million bpd.

In practice, there is no direct way to measure the price producers actually receive for their oil at the wellhead but it is possible to specify a range.

The best price producers could receive would be the futures price for US domestic crude (WTI), which ignores quality and location discounts.

The worst price would be the posted price for the Williston Basin area, which assumes they are charged the full cost of tanker collection from the site.

DMR estimates typical wellhead prices by averaging the futures price for WTI with posted prices for Williston Sweet crude.

In March, the averaged wellhead price touched a low of just $35 per barrel but it has since jumped to $55 per barrel.

With posted prices by buyers such as Plains Marketing now at almost $50, most North Dakotaproducers will be receiving $50 or better for their oil (https://link.reuters.com/ruk74w).

Wellhead prices in North Dakota are now at, or very close to, levels the DMR identified as being able to sustain production around the current level of 1.2 million bpd.

If US oil prices were to remain at current levels, or climb by only another few dollars, it is reasonable to assume that output from North Dakota and the other major shale plays would stabilise.

There might be a brief decline over the summer as the lagged effect of critically low prices in February and March works its way through, but in the second half of the year production should be broadly flat.

RESUMING GROWTH?

Some shale producers have begun to talk about reactivating rigs, completing more wells and resuming production growth if prices hold at current levels or slightly higher.

"If oil prices recover and stabilize at the $65 level, EOG Resources is prepared to resume strong double-digit oil growth in 2016 with balanced capital spending and discretionary cash flow," the company told investors on May 4.

Other major shale producers have made similarly optimistic comments about their ability to continue growing production if prices remain at current levels or climb only a little higher.

There is an element of bravado in the claims. The same producers dismissed the threat from OPEC in September and October last year and spoke confidently about being able to weather the downturn in prices without having to cut production plans at all before being forced to cut their capital budgets sharply.

Shale companies must be able to convince investors and lenders they can maintain and raise output profitably through a combination of strict cost controls and improved production efficiency, so they tend to talk up their prospects. Nonetheless, they are probably correct in thinking prices have increased to a level that is just about sustainable.

The prospect of further price increases, however, is more uncertain. The global oil market appears comfortably supplied.

There is no clear need for lots of extra shale output to meet current and prospective demand, which suggests prices will settle for a while around current levels, sufficient to maintain shale production but not grow it very fast. - Reuters