The recent news out of the shale patch has not been good. Permian operators have been facing a number of operational struggles that are beginning to cut into their ability to generate cash. Rising sand costs (though relief could be coming) combined with higher than expected gas output from liquids wells in the most productive parts of the Permian are hurting the stock prices of the most effective regional operators like Pioneer (down almost 20% Since Aug. 1.)

Rising completion costs in the shale patch have been a persistent concern since OPEC agreed to cut production in November, and these costs continue to call into question the ability of operators to break even at current prices. Key service sector players have warned profusely about the impact of excess capital infusion into an industry that is turning to even more exotic capital configurations to ensure going concern. Despite these issues, Lower 48 production levels remain relentless:

Last week, we commented on the likelihood that E&Ps will underperform the commodity and we stick by this call. We also believe that, as early signs point to a potential struggle within even the most productive parts of the shale patch, this increases the odds of an OPEC deal extension beyond March of 2018, which is not our current reference case assumption.

Our logic for increasing chances of an OPEC extension is as follows:

  • Demand expectations are ramping, reducing concerns that the market will be unable to absorb some incremental supply.
  • The market remains rightfully fearful that shale continues to be able to fill in the supply gap created by OPEC at current prices. If it becomes clear that operators are struggling to break even at current prices and hedging opportunities remain limited, OPEC will be less concerned that an extension will lead to market share erosion.
  • If inventory levels continue to fall as they have been doing for much of this year, OPEC will be able to declare victory in their overall strategy. The risk, however, remains around non-OECD inventory levels, and to what extent OPEC has manipulated their export flows to drive more bullish weekly data out of the EIA Weekly Petroleum Status Report.

Ultimately, these early signs of operational weakness will need to manifest themselves in the form of falling production and even bankruptcies before OPEC is convinced that an extension will prevent further market share erosion to shale. However, if production levels remain buoyed by capital infusion and greater cost cutting measures, OPEC will struggle to justify an extension of the existing deal.

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