The December fall in global crude oil prices from 50 dollars to below 40 USD/Bbl, should it persist at this level, is more important than the fall from 100 dollars in 2014. The price now matches the low-point of the 2008 decline. Cash flow is negative in oil companies and oil producing countries alike, even after several rounds of heavy belt-tightening. The liquidity drain now challenges both investment and operation in strategic assets.
In 2015 we saw rounds of reduction in exploration activity where a number of suppliers were forced to forfeit contractual rights and accept uncompensated early termination. Arctic, deep-sea and oil sand projects are being outright abandoned, accompanied by statements of permanent strategic realignment. Many farm-out attempts attract no buyers whatsoever. Oil companies protected debt service, completion of ongoing investment projects and dividend payout.
As Eikland Energy Perspectives discussed on 5 October 2015 in “An energy liquidity trap” , neither fundamental supply nor demand is likely to drive prices up for some time. The necessary new severe round of belt-tightening will touch exactly those areas, and most likely in the order dividend payout, restructuring of strategic projects with physical and commercial obligations, debt and debt service. Just-approved 2016 budgets based on 60-70 USD/Bbl crude oil prices seem completely unrealistic and may allow liquidity bleed to go on dangerously long.
Should low prices persist into the 2nd quarter and summer of 2016 there is for most no basis for maintaining dividend payout, even among the majors. Recapitalization may be impossible and the next challenging area will be the deferral of ongoing investments, should contracts – and the threat of loss of reputation – allow it. Oil companies will find that long-term buyers and equipment suppliers will not accept contract cancellation or uncompensated changes as easily as drillers and oil-field service firms did. Yet they may not have much choice but to try.
The trade-offs may have indirect effects as important as the primary choice. For example, should Shell persist in its still discretionary – and very expensive – acquisition of BG Group, other projects and initiatives will surely suffer. In fact, Shell may be forced into becoming a nearly pure-play, natural gas operator. Should Shell decide not to go ahead, BGG on its side probably needs a partner or white knight even more than before. In the extreme, the original deal could at the end even be renegotiated, presumably then in good faith.
Ultimately, these factors point to one conclusion: Somebody has to lead for the situation to improve.
In February 2015, Eikland Energy Perspectives projected that US shale oil production would decline to about 4.7±0.2 mill. Bbls/day by the end of 2015. The latest monthly EIA drilling productivity report now indicates 4.8 mill. Bbls/day. Industry cost reductions have been 20-30% greater than anticipated, offsetting some of the oil price fall. The volume equilibrium is not yet in sight, even with the help of the recent WTI price boost after the prohibition to export US crude oil was lifted.
The latest oil price weakness amplifies the expected decline in activity and output, since it now also impacts highly productive drilling prospects previously thought protected. The ND Department of Environment has an excellent exhibit of marginal economics in the Bakken.
In addition, the lower activity level hurts unit costs because remaining contracts are firm and “well factory” operations have less optimization scope. We now consider that the new drop in oil (and US natural gas) prices can lead to an unprecedented further decline in the active rig count, to less than 300 active oil-directed rigs at 35 USD/Bbl (Brent). This will be facilitated by the earliest possible, yet normal expiry of 3-5 year service contracts entered into in the 2011-13 period.
Surprisingly, while US shale oil has been OPEC’s main target, it does not seem that the organization has yet fully understood how deeply its market share strategy is impacting the US industry.
In fact, at a persistent price of around 40 USD/Bbl, US shale oil production is expected to see an accelerating fall to ultimately 2.7 mill. Bbls/day by end of 2017. The stark reality is that US shale oil is mortally wounded and many companies are “bleeding out”. Production is elastic and could fall to less than 2 mill. barrels should crude prices stay around 35 USD/Bbl.
For more than a year, strategic positions have been fixed in stalemate draws awaiting the supply response of US shale oil. However, elsewhere there is a chain of new large oil fields coming on stream along with exports from Iran, more than offsetting any output decline from maturing fields globally. Demand remains stale and there is a significant crude and product storage volume overhang that is also important to market psychology.
As I wrote in the 23 January 2015 note “Crude oil prices 2015 at 35 USD/Bbl – An avoidable worst-case scenario”, it is now time for the market to change tack. Many think that WW1 escalated for the lack of belligerents to meet and talk, and it became a war of attrition in entrenched positions. The situation in the global oil market is amazingly parallel. To avoid devastation and deep cyclicality the oil industry may need to dare talk about volume management.
The discussions and resolutions in the months leading up to the next regular bi-annual OPEC meeting in June 2016 will determine if oil prices will remain low or if they could stabilize between 50 and 60 USD/Bbl. Such discussions certainly include the joint interest and participation of leading exporters outside of OPEC.
Meanwhile neither oil companies nor exporters should in their revised budgets not assume crude oil prices any higher than 40 USD/Bbl.
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Contact Eikland Energy Perspectives (+47 995-17-555, firstname.lastname@example.org) for further details. Supporting data comes from our global databases and energy models.