The oil industry enters a new cycle

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International crude oil prices have been rising steadily recently. Meanwhile, U.S. shale oil production has increased for 10 consecutive months and remains on an upward trend. Factors on the demand side and the supply side will together drive the market to a tight balance (supply and demand roughly equal) in the first half of 2018. Under these circumstances, OPEC together with Russia is likely to end the production cut agreement ahead of schedule. Should this happen, coupled with financing constraints, the U.S. shale oil industry could face a short-term development crisis. Since late June 2017, international oil prices have risen sharply; both the Brent crude price and the West Texas Intermediate (WTI) price exceeded $60 per barrel by the end of last year, representing a increase of 45%. After three years of inventory reduction and capacity cutbacks, the crude oil market was largely rebalanced last year. OECD **commercial crude oil inventories have now dropped to their lowest level since July 2015. The oil industry is entering a new cycle. The main factors driving up oil prices are, first, strong demand resulting from the simultaneous economic recovery in the three major economies of the United States, China, and Europe; second, supply constraints caused by the decision of major oil-producing countries such as OPEC and Russia to cut production; third, potential risks stemming from geopolitical instability in the Middle East and the situations in key oil-producing countries in Latin America. In addition, rapid reduction in crude oil inventories and severe cold weather in the United States have also contributed to rising oil prices. It is worth noting that the rapid growth of the U.S. shale oil and gas industry has been the factor that has had the greatest impact on the structure of the crude oil market over the past 3 years. Benefiting from a significant increase in shale oil production, the United States’ share of the global oil supply has risen substantially. According to the International Energy Agency’s projections, U.S. shale oil production will increase by 390,000 barrels per day in 2017, and this figure is expected to reach 870,000 barrels per day in 2018. However, the current upward phase for the U.S. shale oil industry also faces two challenges. Firstly, OPEC’s production cut agreement has been in effect for a year and is supposed to continue until the end of 2018. But this state is not immutable. During the implementation of the production cut agreement, not only was the market share of the countries participating in the cuts as a whole squeezed by the United States, but also varying levels of compliance within those countries led to numerous disputes. Especially with oil prices rising rapidly and oil production in Iran and Venezuela on the decline, OPEC and Russia are likely to end the production cut agreement ahead of schedule in mid-year, which will put pressure on both the volume and price of shale oil. Secondly, there are also underlying concerns within the U.S. shale oil industry. Financing capacity is the biggest factor limiting investment and production growth in shale oil companies. Unlike traditional oil fields, shale oil wells have a shorter production half-life. In traditional oil fields, the production of a single oil well declines by about 5% per year on average, whereas in shale oil wells, production drops by more than half in the first year after operation begins. The production life of a shale oil well is usually less than 3 years. This means that shale oil companies must continuously invest in building new wells in order to maintain production; more investment is required if they wish to increase production. Currently, the financial conditions of many shale oil companies are not optimistic, with the free cash flow of most of them remaining negative for a long time. The lack of profitability, in turn, further limits the external financing capabilities of shale oil companies. In particular, with the Federal Reserve raising interest rates multiple times over the past two years, the borrowing costs for shale oil companies have increased. In the equity market, shale oil companies have also become significantly less attractive to investors. If financing capabilities are not improved, increasing shale oil production will be no easy task.