Tuesday, July 17, 2012

Drill, Baby, Drill (But Slower)

As the presidential election approaches, we likely will hear the familiar refrains of "drill, baby, drill" from certain quarters, but those cries are pretty irrelevant these days as we see a glut of domestic oil building, especially given infrastructure constraints in getting oil to refineries.  The chart below should look eerily familiar to gas fans as crude oil supply grows and prices have been falling for several months.

Crude prices are in the $88/barrel range right now, so there is no imminent crisis at hand, but given the prowess of domestic drillers to extract oil from shale, one  has to wonder if the oil industry isn't going to be looking like the glutted gas industry soon.  Platts reports on a Raymond James analyst report projecting that West Texas Intermediate crude will drop to $65/barrel by 2013 on the supply issue, suggesting that $65 might be the break even threshold  (with 10% minimum return) for most new plays, but the Eagle Ford Shale might be profitable at $50.

The question remains, will oil producers be able to control themselves in the face of falling prices, especially in the Eagle Ford?

This year, the "drill, baby" political rallying cry has been replaced by the cries for the Keystone XL pipeline from Canada, but adding more (foreign) supply to the glutted system is hardly helpful.  With the southern half of the XL being built from Cushing, OK hub to the Houston refineries, a little pressure will be relieved, but with the drilling prowess of U.S. producers, more oil will rush into the system to fill the void.  It will be interesting to watch WTI oil prices over the next year to see if $65/barrel really does become reality and if so, how producers will react.

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