The growing worldwide oil surplus is a prelude to another price drop, and prices will continue to remain suppressed until there is evidence that the glut is shrinking, according to an IHS study released July 31.

Of course, the oil and gas industry has not been able to escape a difficult conundrum: Since the oil price collapse, global oil production has gone up, not down. Since the November 2014 OPEC meeting, aggregate production from the U.S., Saudi Arabia, and Iraq has increased 2 million barrels a day (MMbbl/d). That production number is far more than the global demand, IHS said, and in return the global glut has increased.

Prices in the U.S. have not yet fallen far enough, or for a long enough period of time, for an appreciable supply adjustment to occur. Yet IHS says such an equilibrium may not be far off, particularly if oil prices fall further with the availability of additional Iranian supplies.

But what will it take for production to decline enough to counteract the global surplus? First, IHS says, prices will have to fall even further from recent levels. With lower prices, U.S. crude oil production in the second half of 2015 would be poised to record its first significant decline in more than seven years. A severe drop in prices lasting several months, according to lead researcher James Burkhard, would bolster the likelihood of a significant price increase in 2016-17.

Production growth from the rest of the world, including Saudi Arabia and Iraq, is unlikely to keep pace with demand growth if U.S. production falls appreciably, according to IHS.

“The United States inadvertently became the world’s swing oil producer last November when OPEC decided not to cut production to prop up prices,” Burkhard said. “The gut-wrenching drop in oil prices that followed was just the beginning of oil-market turbulence. Now it is time to hold tight for another drop in prices, followed by an equally unsettling rise later.”

Expect A Downward Trend In Rig Count

U.S. production growth would need to fall to about 9 MMbbl/d—or lower—to even begin an erosion of the global supply glut, according to the IHS study. As recently as April, U.S. crude oil production was 9.7 MMbbl/d.

IHS says that a drop to 9 MMb/d would mean that the U.S. oil-directed rig count falls to about 600 by the fourth quarter, and then to 400–450 rigs in 2016. This is the lowest since 2009, before the great revival of American oil production.

The drop in U.S. production is already under way, IHS said. But how low would prices need to fall to translate to a significant decline in U.S. crude oil output? The past may provide some clues for the future.

In 2014, production from wells with a break-even cost of about $60 WTI produced enough oil to offset declines from pre-2014 wells and keep U.S. production flat with 2013.

“The rest of last year’s incredible growth came from higher-cost wells. But costs are lower this year—by about 20%—so that a break-even cost of $60 in 2014 is now in the upper $40s per barrel for WTI,” Burkhard said. “For U.S. output to fall enough to appreciably erode the global surplus, this means prices in the low $40s to even $30s for a time. Such price levels would reduce cash flow even further, forcing an additional reduction in capital expenditures, and likely diminish even further the willingness of the capital markets to fund U.S. upstream companies.”

Contact the author, Mike Madere, at mmadere@hartenergy.com.