Oil prices will remain lower for longer as the global oil supply demand imbalance remains and concerns over Chinese growth, the resilience of U.S. oil production, and other factors keep a bearish hold on the market, according to an analyst with Rigzone.
The decline in global oil prices has been underway since late last year, when prices started declining on supply, and the Organization of Petroleum Exporting Countries (OPEC) decided to maintain its production and not follow prices. However, August in particular has been a bad month as fundamentals remain weak,
On Aug. 11, oil hit a new six-year low when China, the second largest global consumer of oil, devalued their currency, indicating that their economy is in worse shape than markets have presumed. It didn’t help that, on the same day, OPEC reported they had hit a new record production level in July, said Delia Morris, senior market analyst for Rigzone’s data services team, during a presentation Thursday in Houston.
On Monday, West Texas Intermediate (WTI) crude hit a new six-and-a-half year low of $41.87/barrel when China devalued its currency again, trying to pump liquidity into its market to spur growth. WTI then dropped below $41/bbl yesterday, hitting another new six-year low.
The bearish outlook this month has prompted hedge fund and money managers to reduce their net long positions for WTI to levels not seen since September 2010, when the world was just coming out of the global financial crisis. Other bearish factors weighing down prices include the global oversupply of oil – which the International Energy Agency (IEA) reported in July to be around 2.5 million barrels per day. Estimates of the global supply demand imbalance range from 500,000 barrels per day to 3 million barrels per day, with the consensus falling somewhere between 2 and 2.5 million barrels per day.
The resilience of U.S. oil production also means that production is not rolling off as expected. Drilling efficiencies and cost deflations of as much as 40 percent have jammed the signal, and U.S. production is not rolling off. Morris said that the market would have to wait until October for U.S. Energy Information Administration (EIA) data to get an accurate picture of U.S. oil production.
The U.S. Energy Information Administration’s (EIA) U.S. crude inventory report for the week of Aug. 14 showed a higher than expected level for the summer driving season, when demand is typically higher. A new low for Brent crude of $47/bbl, and the approach of U.S. refinery maintenance season and lower crude demand, added to the bearish sentiment this month.
Given the ongoing weakness in fundamentals, oil prices are expected to remain lower for longer, with the market not convinced that a floor will be reached anytime soon, said Morris. The consensus is that the needed market rebalancing also will not occur this year or even in 2016, Morris said. “The market is now being driven by pure sentiment, with a bearish outlook taking hold.”
The global supply demand imbalance that began in July 2014, jitters over Chinese economic growth, and resilience of U.S. tight oil production, which will not roll over in the second half of 2015 despite the dramatic decline in the U.S. rig count, mean that oil prices will remain lower for longer. A strong U.S. dollar versus other global currencies, the possibility of Iranian oil returning to the global market, and strong Iraqi oil production, despite control by ISIS of Iraqi oil fields. However, many experts don’t think production at these levels can be sustained, given lower investment levels.
Though the current downturn doesn’t exactly resemble previous downturns, the same general principles apply. Moving forward, easy oil will be produced first, Morris said. The need to replace reserves through the drillbit also will continue, given the annual average decline rate for global oil production is 4.5 percent and the world’s dependence on hydrocarbons for the foreseeable future.
Activity also will continue if oil and gas producers keep making money, which Morris believes will be for quite some time. “In theory, if we believe that shale is new swing producer, the oil price should have a floor at around marginal cost of production, which for some major shale producers is around $40 to $50/bbl,” Morris commented.
Both operators and drillers are working under the assumption of lower for longer prices, with no oil price uptick expected to occur in the next 18 months as existing market fundamentals remain. Historically, oil companies have been quick to pare back spending budgets, with cuts of as much as 50 to 60 percent on average seen from 2014 levels. Morris noted that around $200 billion in exploration projects have been deferred. However, some opportunities may exist for projects where operators can achieve cost reductions. One example is Royal Dutch Shell’s Appomattox project in the U.S. Gulf of Mexico.
“There seems to be a competition going on of cost cutting among operators,” said Morris. Another example of cost-cutting is Total, who squeezed suppliers in its global operations – even asking vessels supplying offshore rigs to go slower and burn less fuel. Maersk Oil said in its last earnings call that it was revising previous drilling production targets and would pare back exploration opportunities to focus on acquisitions instead. The company expects its cost-cutting goals of 10 percent by year-end 2015 and 20 percent in 2016 to help it achieve a breakeven operational price of $55 to $60/bbl. Majors oil and gas producers with significant offshore operations also could abandon previous production targets with the aim of maintaining balance sheets and shareholder value.
Smaller exploration and production companies, especially shale players, are in survival mode now, with asset sales and bankruptcies expected. Little of this activity is expected to impact U.S. production, though, as the absence of smaller producers won’t be felt, and assets exchanging hands won’t disrupt production volumes, Morris said.
The implications of these fundamentals for the offshore rig market are great, Morris said. For a typical project, rig costs represent 40 percent of the total, but anecdotal evidence indicates that operators have been able to sanction projects for less by squeezing the supply chain, even in high cost environments such as Norway.