Impact of low oil price is significant on U.S. oil production

[dan_s]

Sharp cuts in U.S. oil-directed rigs

A sudden and substantial slowdown in U.S. field activity is underway. This slump is increasingly validating our “substitution not addition” analysis for a capital-intensive U.S. shale industry that needs $68 WTI equivalent to clear the marginal cost of capex. If this all-important price threshold is not met, investment screeches to a halt on the margin as banks pull credit lines and private equity owners shut down the affected portfolio companies. The Baker Hughes data show four more U.S. oil-directed rigs were cut last week (May 30), bringing the cumulative drop to –28 rigs (–5.7%) since April 4. Laydown of these rigs also cuts the associated gas supply. The associated gas supply left in the ground becomes skipped gas molecules for which there is no offsetting OPEC+ cavalry coming to replace.

We continue to project the foregone U.S. impact is about 500 thousand b/d in oil and 2.5 Bcf/d in natural gas, inclusive of NGLs (e.g., ethane). These are losses in capex that would have partially backfilled natural decline rates in the productivity of U.S. wells. The effect is strongly bullish for U.S. natural gas prices.

It is now highly likely cash Henry Hub gas prices will exceed $5 per MMBtu in winter 2025/26, if not sooner. In oil, the economics limit the upside for WTI to $68 unless there is a reversal in OPEC+ production policy or until there is a renewed call for higher-cost light tight oils. However, the economics do not constrain a material run higher by oil product prices that are already historically cheap against all other real prices in the global economy.

The setup strongly favors the leading U.S. natural gas producers (EQT, EXE, RRC, AR) and oil refiners (MPC, VLO, PSX). We do not want to overlook these commodity economics and the associated significant outperformance and momentum in these names.

Take note that EQT (+20% ytd) is beating 91% of the S&P 500, while EXE (+17% ytd) is beating 87% of the S&P 500. MPC (+15% ytd) is beating 84% of the S&P 500. It is still early in this commodity cycle. We expect outperformance by U.S. gas producers and oil refiners to sustain as they unlock material commodity value moving forward.

Understanding what OPEC+ said

The pledge to restore another +411 thousand b/d of oil supply activates capacity voluntarily idled by these eight OPEC+ members under a November 2023 side agreement for an “additional adjustment” (–2.20 million b/d) on top of the OPEC+ full group production cuts (–2.00 million b/d) announced in October 2022. The eight-nation cohort also agreed to a separate adjustment (–1.65 million b/d) in April 2023. Altogether, total OPEC+ pledges to idle capacity between October 2022 and April 2025 amounted to –5.85 million b/d, of which 95% were pledged by the eight members who met this weekend.

On December 5, 2024, OPEC+ announced it would gradually activate more than 2 million b/d of voluntarily idled capacity starting on April 1, 2025. Before this weekend, specific targets were systematically rolled out on March 3, April 3, and May 3 in support of this plan. Cumulatively to date, OPEC+ has pledged to restore more than 1.3 million b/d by July 1, or 22% of total voluntarily idled capacity.

But production quotas and actual production levels are different beasts.

This reality means actual supply effects can and do differ, sometimes widely, from headline promises on “required production” quotas. Consider just two examples to substantiate this idea.

Example One: Kazakhstan has already been producing +375 thousand b/d above its OPEC+ production target. Output is +25% above its quota. This non-compliance is supposedly one reason why the eight nations elected to restore their capacity faster than an earlier plan. Whether that reason truly was part of the rationale, the Kazakh non-compliance proves OPEC+’s “production cuts” were never fully implemented in the first place. Over and under compliance is rife across other members’ actual production levels. These deviations from plan help explain why market prices react differently than one might expect on headlines alone, even if a pledged supply return is fully implemented. And to that point, full implementation has not occurred to date, which brings us to our second empirical observation.

Example Two: We now have preliminary data in hand for OPEC+ production in April 2025 and May 2025. On headlines, the eight nations pledged to restore 549 thousand b/d of production over those two months. In fact, data from OPEC and Rystad indicate actual production increased by about 210 thousand b/d, or less than half (38%) of the straight read of the headline promise. Moreover, in terms of net effect on the global supply and demand balance, this 210 thousand b/d tranche offsets the 200 thousand b/d of Venezuelan supply removed from the global market by President Trump’s cancelation of Chevron’s sanctions waiver with an effective date of May 27. We read the sizing and timing of these events as non-coincidental.

We do expect OPEC+ to continue to bring back supply gradually. But we shall see how much supply returns as of any certain date. Often overlooked in discussions about OPEC policy is this express statement from the group: “The gradual increases may be paused or reversed subject to evolving market conditions. This flexibility will allow the group to continue to support oil market stability.”

In other words, OPEC+ will restore whatever capacity suits its interests.

Conclusion
We view the OPEC+ strategy as opportunistic and rational. It was the global demand shock unleashed by U.S. trade policy, not OPEC+ supply action, that forced the WTI price below $68. This sudden change ended the WTI pricing regime that had been in place and had supported higher-cost U.S. shale producers for the prior decade (2015-25).

Once that price break had occurred—and prodded by President Trump to deliver oil supply and help reduce prices—OPEC+ stepped into the breach to accelerate its long-planned return of voluntarily idled supply. This action cements the break into the new cost regime, forces immediate cuts to U.S. capex, and takes share from U.S. shale producers. Some private firms will not survive.

Today, the WTI price now on our screens (CL1 on Bloomberg) is not a low WTI price in the old price regime; it is a rangebound price in a new price regime born between April 2 and May 3 in 2025.

Our baseline forecast for the 2025 yearend WTI crude oil cash price is now $61.25. We estimate a 23% probability of a yearend price below $50 and a 17% chance of above $80 (Slide 2 below).

By definition, each barrel of voluntarily idled capacity that OPEC+ activates will reduce the buffer of global spare oil production capacity, making the global market increasingly more vulnerable to the ever-present oil supply shocks (e.g., war, hurricanes, wildfires, accidents).

Moreover, each dollar trimmed off the WTI price forces further cuts to U.S. capex, making the global market increasingly more vulnerable to sweet-sour spread economics and the underlying natural depletion rates that are a fact of physics not fiscals.

As OPEC+ brings medium sour crudes to market, we expect the group’s leadership has concluded a sub $60 WTI price is undesirable, as it will only increase the probability of an unwanted light sweet oil price spike on the other side that will displease consumers and the man sitting in the White House.