The latest crude oil production forecasts from the U.S. Energy Information Administration (EIA) project that U.S. oil output will surge to new records over the next two years. After output of 9.3 million barrels per day (bbl/d) in 2017, the agency forecasts that production will rise to 10.7 million bbl/d in 2018 and 11.3 million bbl/d in 2019. If these numbers pan out, the U.S. will be the world’s top oil producer for the first time since the 1970’s.
This is partially due to an existing arrangement between other oil-rich nations. In November 2017, OPEC and other major oil producers (including Russia) agreed to extend oil production cuts through the end of 2018. According to the EIA, Russia and Saudi Arabia were the top oil producers in the world as of 2017, producing 10.58 bbl/d and 10.13 bbl/day (preliminary estimates, based on 11 months of data), respectively. However, if these countries keep to their promised production cuts in 2018, the U.S. will overtake them both.
Note: The volumes in the table represent crude oil and lease condensate
What is Driving the U.S. Oil Production Surge?
Higher oil prices over the last few months may be responsible for some of the increased output, but that’s not the whole story. Oil prices plummeted in 2014, with West Texas Intermediate (WTI) dropping from a high of $106 bbl to a low of $53 bbl at the end of the year; since 2015, prices have averaged around $48 bbl. The U.S. oil industry took a big hit from the rapid drop in oil prices. However, we’ve seen a gradual increase in oil prices over the last six months or so. WTI was priced at $43 bbl in June 2017, and so far in 2018, prices have averaged just under $63 bbl. Is this increase enough to significantly incentivize producers to pump more oil? Probably not.
The bigger factor at work here is the rapid increase in productivity of US drilling. Increases in the use of horizontal drilling and hydraulic fracturing (or fracking) have led to dramatic increases in U.S. oil production. In fact, according to a 2016 report from the EIA, oil production from fracking made up about half of U.S. crude oil production in 2015; this share is likely much higher today.
According to data from Baker Hughes, the number of oil rigs in the U.S. bottomed out in mid-2016 after oil prices hit new lows and have risen since, with the modest recovery in oil prices. The oil rig count fell to 316 in May 2016 and has recently come in at just below 800. Historically, the relationship between the rig count and oil prices lines up, but this is no longer the case for oil production, which is now on a completely different trajectory. While the oil rig count plummeted by 80% in response to the 76% dip in oil prices (peak-to-trough changes), oil production fell 11% but has since surged back to all-time highs.
There are also recent government policy developments, some still unfolding, that could play a role in the U.S. oil industry’s production dominance over the next few years. In December 2015, as part of a bi-partisan budget agreement, Congress voted to lift restrictions on U.S. oil exports imposed during the 1970s in response to the OPEC oil embargo. The results from this change were swift, with exports more than tripling in the 24 months since the restrictions were lifted. The U.S. still imports far more oil than it exports, but the volume of exports was one-fifth that of imports in December 2017, compared to a ratio of 1% just five years ago. This policy change was implemented to give a boost to the domestic U.S. oil industry, but higher prices are the real driver in producers’ investment decisions.
The other major policy development in January 2018 was the proposal by President Trump to open a significant portion of the outer continental shelf to oil drilling, an area protected from development under the Obama administration. These submerged offshore areas lie between state coastal waters and the deep ocean, and U.S. oil companies are anxious to drill there. However, U.S. senators and governors from states along both the Atlantic and Pacific coasts have requested exemptions from the proposal along their states’ shores, citing the potential for irreversible damage to their tourism and fishing industries. The president’s proposal is still being reviewed by the U.S. Department of the Interior, and it could be some time before a final decision is made.
What Does This Mean for Oil Prices?
These developments are having conflicting impacts on oil prices. While strong global economic growth and the continuation of production cuts by OPEC have supported prices over the last few months, surging U.S. production is limiting the upward price momentum. In fact, U.S. supply projections appear to be dominating sentiment around oil prices, with the inverted futures curve indicating downward pressure on prices over the next 18 months.
The U.S. has always played a key role in global oil markets; however, over the last five years that role has shifted away from being a major consumer to that of an important consumer and producer. While technological improvements and favorable government policy are spurring U.S. oil production, the result is downward pressure on global oil prices, which is not in the best interest of U.S. oil companies. Strong and widespread global economic growth is helping to buoy oil prices for the time being, but any hint of slowing demand, particularly in the U.S. or China, could put further downward pressure on prices.