March 15, 2016
Author: Per Magnus Nysveen, Senior Partner & Head of Analysis
Publisher: Oil & Gas Financial Journal
The oil and gas business offers investors exposure to the most volatile of commodities. The roller coaster adventure for this industry has been fueled by OPEC’s gradual loss of market share to US shale over the last decade. Saudi Arabia, the cartel’s strategic leader with a long-term view, has been the only country willing to somewhat comply with the collective quota. This is because the more defecting members’ oil differs less and less from non-OPEC supplies in terms of reserves replacement and extraction costs. All this limits the potential for the cartel to promptly add new supplies to the market in case of shocks to the oil supply-demand balance. Therefore, the rebound could be violent for prices, activity, costs and stocks.
The business cycles within oil and gas exploration and production are longer than what we see in any other industry: For offshore about five years and for US shale 12-18 months. This corresponds to the typical time from price swings to supply response. Several factors contribute to these long lags: geologic de-risking (1-2 years), official and commercial decision processes (1-2 years), field development (2-5 years), and infrastructure and operational de-risking (0-2 years). Empiric analyses of the relationship between price and supply response is not straight forward as the back-end of the future curve reacts to swings in investments and activity, long before response is observable in production data.
The North American shale revolution constitutes a new short-cycled supply source with the potential to bring 10-15 MMbbl/d of oil and NGL to the market. We are today only halfway into this production build-up, and less than 5% has been recovered in the US of the ultimate shale resources at 100 USD/bbl. This massive and unexpected potential effectively punctuated OPEC’s price volume strategy. The future of the oil market is perfectly determined by fundamentals observed in cost of supply and profitability through the value chain.
During the upcycle in the global economy from 2009, we saw massive overcapacity coming on stream in the oil industry. Supported by eager investors, megaprojects in Saudi Arabia, Iraq, Canada, and Brazil brought twice as much reserve additions as needed to balance production. The service industry benefited as costs increased and E&P companies suffered from over investments and debt increased. Fundamental analysts like Rystad Energy warned the markets early 2014 of a coming rout, but too few listened to the alarm bells before the OPEC Meeting November 10th.
E&P stocks traded flat in almost 5 years as companies saw increased breakeven prices. Oil service stocks traded upwards in the same period, as value was pushed down the chain. Junk spreads doubled from 4% early in the rout, then recently tripled to 12%, as more companies look distressed in a prolonged bear market.
Leading shale companies attracted global investors in 2013, but closely followed the oil price drop, despite reduced costs to drill for the barrels. Majors traded more slowly up to a peak in 2014 at the same level as the peak in 2008. Shale unit costs have halved from 40 USD/boe to 20 USD/boe (per barrel of ultimate reserves) while offshore rig rates for new contracts has increased by 50% over the same period.
The massive shortfall of investments over a period of two years is unprecedented in the oil industry. 2016 non-OPEC capex is expected down by as much as 30%, on top of an equal shortfall in 2015. Surprisingly to some analysts, the rout was extended into 2016 as US drillers managed to keep protection flat down to 40 USD/bbl, contrary to common belief that 50-60 USD/bbl would trigger strong decline. We warned about the rout, as we warned about the recent extension of the rout. Now we find the market is more than halfway through the balancing that started mid 2104 with the flattening of US shale production. At 30-40 USD/bbl, even US shale will decline. Reduced short-cycled offshore investments in producing fields will further add to the balancing.
Finally, we see neither Saudi Arabia, Iran, Iraq, US shale nor the downsized service industry is able to respond as fast as needed in the rebound. This even if economic growth now slows down as the market expects for early 2016. We find oil is heading for the strongest cycle in decades, hopefully with some lessons learned to control costs and financial leverage, at least in the short-term.
For link to article, click here
About Rystad Energy
Rystad Energy is an independent oil and gas consulting services and business intelligence data firm offering global databases, strategy consulting and research products.
Rystad Energy’s headquarters are located in Oslo, Norway, with additional research teams in India. Further presence has been established in Norway (Stavanger), the UK (London), USA (New York & Houston), Russia (Moscow), Brazil (Rio de Janeiro), Africa as well as South East Asia.