What OPEC is Up Against

American oil production has surged in recent months. U.S. drillers once again got their feet under them after a petrostate production cut helped induce a minor bump in global crude prices, and as a result prices have once again fallen well below $50. This is the pendulum swing of supply and demand, and sure enough, now that we’re back to bargain prices again, analysts are expecting American drilling activity—or more accurately, the number of U.S. rigs in operation—to take a hit through the end of the year. The FT reports:

For 23 consecutive weeks, the number of rigs seeking US crude has climbed. The latest tally from services company Baker Hughes, due on Friday, is likely to bring the streak to two dozen. With the West Texas Intermediate oil price at $45 a barrel, the rig count will probably plateau, if not decrease, in the second half of 2017, analysts say. However, investors bullish on oil should pause before betting US output will soon retreat.

We’ve been through this before, back when the U.S. rig count crashed in the wake of the crude price collapse three years ago. Back then, some observers were surprised to see American oil output stay relatively high, relative to the amount of rigs operating in the country’s shale fields. But much of this discrepancy can be put down to a structural problem with using rig count as a metric for predicting output: during tough times, the worst performing and highest cost rigs are shut off first, effectively culling the herd and leaving the big gushers still in operation. If America’s rig count is due another drop, we can expect a similar pattern to occur, with the strongest and most productive projects continuing to churn out the crude.

Then, too, there’s the issue of our so-called “fracklog” of drilled but uncompleted wells, also called DUCs. Though bargain prices have forced a number of shale firms to shut down projects, they haven’t sat idly by, and instead have prepped future fracking operations by drilling the necessary wells ahead of time, awaiting an upturn in prices before they actually get down to business. The upshot of that is that, if and when global supply and demand start to rebalance and prices rise again, U.S. shale producers will be primed and ready to take advantage of that rebound, and will quickly be able to boost their production. As the FT notes, that “fracklog” has grown in recent months:

One measure of the latent supply is the number of DUCs, or “drilled but uncompleted” wells. These holes await the attention of a hydraulic fracturing crew to release oil from shale rocks. The DUC population in the four main US shale oil regions increased by 22 per cent to 5,005 between December and May, according to the Energy Information Administration.

This is the new oil reality. It’s characterized by cheaper prices, true, but today’s market also now relies on U.S. shale companies to be the new global swing producers, supplanting what has long been OPEC’s role at helping balance supply and demand. The key difference today is that it’s market forces—not strategic thinking from the cartel—that are moving the arm of this pendulum. That, and the fact that oil prices have now stabilized at a price less than half of what they were just a few years ago. It’s a brave new world.

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