The Oil Story : To 2020 and Beyond

Lucky me. Instead of reading through volumes of oil reports, I got an invitation to a presentation by the experts from Norway, who talked me through the entire story complete with numbers and a mini dissertation on the Saudi royal family.

These opportunities don’t come regularly for me and so the brain got some exercise along with the fingers, taking down a nice set of notes that I shall share with readers over a few posts, I expect.

The oil story does not end with the 78 dollar a barrel oil today, from 107 in June. It has just begun and we shall be seeing repercussions all the way till end 2016 from this price rout, repercussions that will extend into the entire supply chain and unrelated industries, I expect.

How did oil rally up to 107 when it was going to crash ?

The Bare Facts :

  • US shale production was completely underestimated and the US now produces close to 9 mio barrels a day with shale accounting for 3.3 mio
  • Iraq fears overblown as ISIS failed to capture the southern fields
  • Venezuela and Libya had supply outages which quickly resumed production
  • IEA production forecasts has been too low especially for the US
  • Global demand growth is slowing and is now at 1.1% from a previous 1.7% historical average

Warnings Signs in June :

  • Curve contango which meant future prices were higher indicating less current demand and parties were buying to stockpile and sell at a future date
  • Refining margins in Asia were pressured lower as African Bonny crude came cheaper
  • Supply exceeded daily demand by about 1.3 mio barrels
Brent Crude Forward Prices

Brent Crude Forward Prices

 

Only 4 countries/regions really suffer on lower oil prices :

  • Opec countries
  • Russia
  • Norway
  • Mexico

The rest of the world spends an average of 5% of their GDP on crude imports. And  a 25% drop in prices would add, on average 0.5-1% to GDP.

The key player identified is Saudi Arabia, pumping about 8.3 mio barrels a day (less than the US). Saudi would need to cut down 1.3 mio barrels or so, to keep demand and supply in equilibrium.

But there are benefits to Saudi from lower prices besides the usual spite reasons.

  • more demand at lower prices
  • slow down the US shale boom
  • Iran will be significantly hurt by the lower prices
  • the industry will invest less in offshore drilling
  • alternative energy sources will suffer

The Next Steps ?

It looks like shale will not be hurt too much till oil is between 70-80 bucks. Most of the costs involved is in sinking the new wells and there is a constant need for that to ensure their continuity as the old wells run out. Monthly oil well additions was running at record pace at the start of 2014 and does not look like it will slow down.

Yet shale producers are highly leveraged players and thus, their survival depends on their ability to access funding.

Most of the big oil producers are hedged for prices till 2015 and early 2016. Thus the current low prices will only hit their cashflows and bottom line from 2015 onwards.

Oil demand will have to catch up in the case where Saudi does not cut supply and shale producers go on full steam without going bust.

COST OF OIL PRODUCTION

Supply and Cost of Production. Chart from DNB.

To visualise the risks to the various producers at current prices.
acronyms : CIS = Canadian Industry Standards; GTL = gas to liquids; CTL = coal to liquids

Why 2020 ?

  • pace of current fields running out
  • demand increase because of lower prices
  • considering the decline in demand growth

The truth is that we have overestimated a lot of demand and underestimated the supply shock.

It does look like the stalemate is here to stay unless something gives eg. supply outage, Saudi cuts, shale bust.

In the meantime, we have to recognise that industry CAPEX will be reduced, along with exploration work.

Industry consolidation will occur and credits will be affected.

To be continued …..