US Producers: Ready…Set…Sell

by Andrew Lebow • Monday, March 28, 2016

In an excellent article, Energy Intelligence concludes that US shale oil is is “not likely to be the main driver of any natural rebalancing. ” The authors of the piece argue among other factors the overhang of DUCs (drilled but uncompleted wells) as well cost rationalizations would lead producers to seek a level of 40 to 50 dollars to increase hedging activity as well as begin to work off DUC inventory. Hedging picks up even more between 50 and 60 dollars working off more DUCs and increasing domestic output. Even with prices around 40 dollars they argue US production may not decrease as much as is forecast by the EIA (760,000 b/d) this year relative to last year. We liked the table they provided to summarize price and the resulting hedging/production action producers may take.

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In all likelihood hedging activity has indeed picked up as WTI futures have rallied. While its impossible to really know, two indicators are fairly useful guidelines -the CFTC commitment of Traders report as well as open interest. Just for convenience sake we took a look at the open interest in the December 2016 and the December 2017 WTI contract as proxy contracts for 2016 and 2017 hedging activity.. Not surprisingly open interest has increased markedly in both December contracts over the past two months.  Since the December 2016 and December 2017  mid-January lows of 34.06 and 37.73 respectively ,the two contracts have seen open interest rise to date by around 13,000 contracts for December 2016 and 20,000 contracts for the December 2017 contract   The price rally incidentally would take December 2016 to a 45.06 and December 2017 to a 47.22 high on March 22.    The rising open interest may by itself mean nothing, but the Commitment of Traders data shows that during the sharp two month price rally period,producer gross shorts rose by around 40,000 contracts while net shorts similarly rose around 40,000 contracts. No real proof of producer selling at higher numbers, but perhaps some compelling evidence nevertheless.

Its probably too premature for some of the DUC inventory to be activated ,but it certainly is worth noting that volumes and open interest in the mid 40 dollar level to upper 40 dollar level most probably attracted short commercial interest. How much and how soon some of this short interest will lead to arresting supply losses in the form of new production would be purely a guess.  But the betting here is that the 8.21 mbd  2016 trough number for US production projected by the EIA  is probably much too an aggressive target.

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