Glut May Push Oil Prices Down Further
For those of you waiting for the inevitable rebound in oil prices, you might be waiting a while longer.
Global energy markets are still holding out for a much bigger contraction in oil supplies before the oil price rallies, but the ongoing low-oil-price environment will likely put further pressure on this process. With the price of West Texas Intermediate (WTI) testing six-year lows, the rate at which energy companies are rushing to cut spending and cancel drilling projects will increase, eventually bringing about the much-needed market correction.
Translation: oil falling below $40.00 per barrel was a good start, but we’ll need it to drop to $30.00 before extreme pressure on companies can translate to a much-anticipated rebound.
Oil Price Crash: It’s Going to Get Worse Before It Gets Better
If you thought the upstream exploration and production sector was going through a tough time, you haven’t seen anything yet. With the last remaining vestiges of favorable hedging about to dry up, oil drillers are about to be exposed to the reality of $35.00-per-barrel oil.
While a great many oil and gas companies were able to stave off financial ruin by cutting back on expenses, lowering service costs, and making their operations as efficient as possible, January will prove a critical period for many. As previously locked futures expire, the financial stress of exposure to the ongoing oil price collapse will cause widespread havoc on companies’ balance sheets. (Source: “With oil hedges rolling off, U.S. shale producers face stiff test,” Reuters, December 14, 2015.)
Of the 30 biggest oil companies surveyed by Reuters, just five were able to expand their hedging strategies in the third quarter of 2015. The remaining 25 were unsuccessful and saw their hedging positions recede as futures contracts expired. Most alarmingly, eight of the companies surveyed held no hedging positions at all for 2016.
Fewer than expected seem to have taken advantage of oil’s slight rebound back in late spring 2015, when WTI briefly surged to around $60.00 per barrel. Rather than learning their lesson from the missed opportunity to lock in at least a portion of their production, most oil majors again overlooked the opportunity to do so when oil rose to $50.00 in September to October.
Whether it was greed or false optimism, what’s done is done. The chance to lock in prices and guaranteeing some semblance of survival in 2016 has passed. The resulting exposure in January will be nothing short of savage, as oil prices now threaten to hit their lowest level in more than a decade.
The long-term effects of not pursuing a hedging strategy cannot be overstated, because a lower bottom line translates to lower investment expenditures, which means lower production at a future date. Companies have no incentive to drill when they face the prospect of losing money on each barrel of oil pumped, which in turn causes them to become more and more conservative in pursuing new projects.
When Efficiency Is Not Enough
Turning a profit when oil hovers below $36.00 per barrel is no easy feat and even the most efficient upstream producers will find themselves unable to keep up with the ongoing downturn.
Despite producers showing a fair amount of resourcefulness when it came to adapting to the oil price crisis and employing strategies, such as concentrating on “sweet spots,” getting creative with lateral drilling and putting pressure on suppliers, this may not be enough to survive. Analysts estimate that perhaps a third of all oilfield service companies will not make it through 2016. (Source: “Crude falls as fears of glut intensify,” Houston Chronicle, December 11, 2015.)
Shale oil plays will be hit worst of all, it seems. This is not to say that extreme efforts were not made to try and prevent it. The breakeven cost of producing a barrel of North American shale was once about $65.00 per barrel, but some very clever workarounds led to efficiency gains that pushed it down to $50.00. Cutting costs and streamlining operations can’t go on forever, though, and it appears that this is about as efficient as shale oil can get.
The oil sector will be responding to the ongoing crisis and cutting expenses by a forecasted $115 billion in 2016. (Source: “$30 Oil Will Accelerate Much Needed Rebound,” NASDAQ, December 15, 2015.) The decline in active U.S. oil rigs continues, after North American shale showed an impressive resilience, and what some might have called stubbornness, in the face of growing global oversupply. Overall American rigs fell by 28 last week, the largest drop in three months. (Source: Baker Hughes, last accessed December 15, 2015.)
Oil Price Forecast 2016
As oil continues to test record-lows, there is ample reason to expect this rig reduction rate to grow. The combination of lower expenditures and falling rig counts will result in lowered medium- to long-term production levels. Ongoing projects will eventually dry up and be abandoned and there won’t be the same replacement rate of new projects to take their place. It’s only then that we will see a rebound in oil prices.