Yves here. There have been two view of how the sudden plunge in oil prices would affect US oil production. The first was the classic supply and demand view, that at a lower price, fewer players will want to provide energy. The second was that of John Dizard of the Financial Times, which we picked up here, that US producers, particularly of shale gas, would not cut back until their money sources forced them to. This OilPrice article suggests that Dizard’s counterintuitive reading was not all wet.
Yet it is instructive to see how different reporters are reading the same data sources. The Financial Times in a story tonight that also looked at oil production levels, pointed to a decline in rig count and in filing new drilling permits:
Last Friday Baker Hughes, the energy services group due to be bought by rival Halliburton, published data which showed the number of rigs drilling for oil in the Eagle Ford shale of south Texas had fallen by 16 since October to 190. The number of rigs in the Bakken shale and related North Dakota formations had meanwhile dropped by 10 to 188.
Also last week Drillinginfo, a consultancy, published figures showing that the number of applications for permits to drill new wells had fallen by about 30 per cent in both the Bakken and the Eagle Ford areas last month compared with October. That may overstate the likely drop in activity, because companies will have a backlog of permits they can use, but it is clear the industry is responding to a steep drop in the oil price.
The Financial Times also points out that areas that will be hardest hit are the marginal ones, and contends that good assets in the hands of overlevered drillers will move to stronger owners. It ends on an upbeat note:
. But some analysts expect the overall impact on US oil production to be relatively modest.
“The rate of increase in production is going to slow down,” says Philip Verleger, an energy economist. “Even at $50 oil, though, US production probably plateaus, but it doesn’t start going down.”
However, keep in mind that these comparatively sunny views are based on the assumption that oil prices next year average $70. If they are sustained below that level, the picture starts to change. Note this contrasting view from Bank of America, via Ambrose Evans-Pritchard:
The Opec oil cartel no longer exists in any meaningful sense and crude prices will slump to $50 a barrel over coming months as market forces shake out the weakest producers, Bank of America has warned.
Revolutionary changes sweeping the world’s energy industry will drive down the price of liquefied natural gas (LNG), creating a “multi-year” glut and a mucher cheaper source of gas for Europe…
The bank said in its year-end report that at least 15pc of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55. The high-cost producers in the Permian basin will be the first to “feel the pain” and may soon have to cut back on production…
It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year,” said Sabine Schels, the bank’s energy expert.
Yves here. But in Soros’ classic reflexivity, wouldn’t the belief that everyone else will be rational lead many producers to not cut back, particularly since a rebound to $80 or $90 would lead to an average price somewhere in the $60 range, with much better prospects going forward? The confidence that the supply problem will sort itself out (save for the most marginal producers, who presumably will fold early) could lead to the reset taking longer than in the Bank of America scenario. As Warren Buffet said, “Only when the tide goes out do you discover who’s been swimming naked.” With the supply situation so dynamic, at this point, the tide has only begun to recede.
By Andy Tully, an editor at OilPrice. Originally published at OilPrice
The drop in oil prices caused by a supply glut hasn’t daunted US drillers.
Oil companies are still drilling in the United States at the highest rate in more than 30 years even as demand in China and Europe sags. In fact, the Houston-based oilfield-services giant Baker Hughes is reporting that the number of active US rigs saw a net increase of three to 1,575 the week ending Dec. 5.
This defies predictions that drilling, much less exploration, would decline because of OPEC’s decision on Nov. 27 not to reduce its production limit of 30 million barrels of oil per day. The move was orchestrated by Saudi Arabia and other extremely wealthy Persian Gulf oil producers despite the pleas of poorer members such as Venezuela and Libya.
The wealthier OPEC members are defending their market share and apparently challenging American shale oil producers, whose methods, including hydraulic fracturing and horizontal drilling, are more expensive than conventional extraction methods and unsustainable if prices drop too low.
It’s too early to say whether this modest increase is a signal that US producers are fighting back against OPEC. Although the American rig count reached a record 1,609 in mid-October, the number has receded in five of the past eight weeks, according to the Baker Hughes report, issued on Dec. 5. Still the count is more than 200 rigs higher than in December 2013 when 1,397 rigs were drilling.
In the week ending Dec. 5, the oilfields with the most new rigs were the Granite Wash in Texas and Oklahoma, according to the Baker Hughes report. At the same time, some rigs were removed from the Cana Woodford field in Oklahoma, Eagle Ford in Texas and Williston, spanning areas of North Dakota and Montana.
Meanwhile, Baker Hughes reports that the number of vertical gas-drilling rigs remained static at 344, down by 11 from the same week in 2013. The number of these rigs had peaked at 1,606 in 2008. And the net number of horizontal rigs for both shale oil and gas dropped by three to 1,368 after peaking at 1,372 in mid-November.
The question remains: How low can the price of shale oil drop before it becomes too expensive to extract? The conventional wisdom is that the threshold is $60 per barrel.
One consulting firm, Wood Mackenzie of Edinburgh, says American producers should be able to profit from exotic drilling techniques for the near term. It sets the threshold at $70 per barrel for West Texas Intermediate, the US benchmark, but adds that the low prices are “so far not a material threat to U.S. [shale] oil or the industries that surround it.”
And perhaps the United States and OPEC aren’t playing exactly the same game. That’s the view of one analyst, Kash Kamal, of Sucden Financial Ltd. in London. “U.S. producers are more focused on preserving profitability, while the Saudis and Iraq are interested in preserving market share,” he told Bloomberg News. “Until we see an increase in demand outlook, it will be hard to pin down prices.”
I have wondered if this some coordinated effort between the US and Saudi Arabia, to impose a major hurt on Putin for his activities in Ukraine.
Isn’t the Russian budget close to 60% oil revenu? It would seem this dramatic fall in oil prices is much more punishing to Putin than the modest sanctions imposed.
While Russia is on the target list for the Saudis, they look to be far from the top of the hit list. And the US and the Saudi relationship has been poor of late, so the notion that this is coordinated is doubtful. If you look at states where the number of jobs has risen, it has taken place entirely in energy-producing states. The Saudis are currently upset with the US over its refusal to take military action, which even the generally-reckless US recognizes is a bridge to far and is a self-destructive Saudi obsession (the Iranians are well prepared to survive a first-round Western attack and their retaliation include the Strait of Hormuz and torching Saudi refineries). The Saudis were similarly angry that we did not go into Syria last summer and that we are effectively cooperating with Iran against ISIS.
The fall in oil prices has not hurt the Russian budget much, if at all, because Russia funds in rubles, and the ruble has tanked with oil prices. A story in Bloomberg today describes that the economy with Russia seems generally fine, contrary to Western efforts to depict it as a basket case. And Russians are famous for their cultural willingness to suffer hardship in the name of survival, so mere economic punishment, particularly in the face of what Russians perceive to be an existential threat (moving NATO into Ukraine, which was the aim of Western meddling), would not be sufficient to dislodge Putin.
Now having said that, the fall of the ruble is making it very hard for Russian banks to obtain funding for their dollar liabilities, so the Russian banking system is at risk, and if Russian banks start to fail, there could be real dislocation. And the inability to get dollar funding, even at very high cost, is a direct result of the sanctions. So on that axis, they’ve been pretty effective.
Thanks for this info. Very interesting.
China. Chinese banks are awash in dollars looking for someplace to go.
“The question remains: How low can the price of shale oil drop before it becomes too expensive to extract? The conventional wisdom is that the threshold is $60 per barrel.
Then, which is the bigger cash burn, extracting at a loss at $59/bbl or abandoning ship and extracting nothing at $0/bbl? None of this will turn on a dime. The players that are bleeding at $85/bbl are obviously going to do some anguished soul searching at $59/bbl sooner than their more efficient $60/bbl brethren.
$80 or even $60/bbl oil is a fairly recent development. I heard it put by an ex BP/Ammaco’er that this is an industry used to make huge bags of money. It will survive making smaller bags for a while.
Apparently many producers are hedged into 2016 or 2017, with some exceptions. Some banks have derivatives on the alternate side with major oil consumers like airlines, shipping firms, etc that would buffer them against the losses from hedging the producers. However, I am not that familiar with the distribution of these hedges or whether other large foreign producers are utilizing the same tactics.
FYI: started another link aggregation yesterday, which i’ve called focus on fracking: http://focusonfracking.blogspot.com/
right now i’ve just got the last two weeks up…but: for about two years now, i’ve sent out a weekly package of linked paragraphs to articles that have crossed my newsfeeds, preceded by a brief synopsis…this blog will serve as a repository of same, with older mailings to be added as time permits..
It’s actually quite simple. Shale companies that are so levered up have no greater need than immediate cash flow. The cash from oil, even though it is at a loss, is still cash. Losses (and more importantly the true nature of those losses) can be fig leafed (for a finite time) with accounting gimmicks. That is why stories are coming out that the “true” costs of production is supposedly much lower than it appears to analysts (“Are you going to believe me or your lying eyes?”). The shale market is in a state of panic trying to generate as much hard cash as possible to try to fool its bond holders. If they stopped production, the borrowing to pay debt obligations would be too naked to conceal; like paying off VISA with a new MasterCard. The clock is ticking on how long the top tier accouting plate spinners can maintain the illusion.
BTW, have you listened to Bloomberg radio lately? The commercial slots are crammed with ads asking “Would you like to own an oil well?” LOL Good luck with that one!
That makes sense and should have occurred to me. Dizard wasn’t willing to say something like that crisply in his piece, but that looks to be what he was seeing.
In addition to this, a substantial part of the cost of drilling is acquiring the rights. Once they are bought or leased, that’s a sunk cost and no longer figures into the the drilling decision. As a rule these companies are still making money by the actual drilling, but it won’t be enough to pay off debts incurred in getting the rights to drill. In many cases they only have a medium-term lease and they *have* to drill or lose the rights.
There’s a good chunk of junk drilling bonds out there seriously endangered by these changes. The companies will fail if that market collapses and they can’t get financing. If the shale oil bubble pops, it’s not going to be anywhere as bad as the housing bubble, but it will be a big hit on the banking system.
It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year
Too soon, IMO, but who knows. Right now, US production is growing at 0.5 MMb/d per year (??). so that has to wind down to equilibrium first, then stay at the reduced level while production goes down. Plus, what’s going to happen in 6 months? Maybe some low cost producers might want to turn the screws a little tighter? Or maybe Saudi A. is sending a “friendly message” and they’re going to end up cutting production in 3 months, once they see we got the message.
“The drop in oil prices caused by a supply glut hasn’t daunted US drillers”
Just a bit of sobering history on reaction time for major downward price change in price of oil to decisions on rig count: The peak was 1984.
I remember it well and the aftermath – BK from Tulsa to Houston –
Rig count for USA & Canada high was in December 1984 – 3,060 – this was the high point – a historic number never again reached.
By December 1985 – 2,342 or down by 23.5% – by December 1986 – 1,202 rigs operating – or down from the peak 60.7% !!!!!!!!!
it was mayhem – June 1986 oil at $9.62 Bbl. I put the company in Chapter 11 and was immediately ordered by Federal Judge into 7.
$60 million in Sales in 1985 – which was serious money in those days and 24% ownership – and the next year worth zip!
not a fun experience and today leverage is much, much greater
Simpler answer? Maybe there is a lot of oil under contract at prices well North of the scary numbers? Is it possible that some of these nice people have sold contracts on oil expected from wells being developed? Hmmm.
Slightly off topic here but Putin’s state of the Russian union speech: He actually said that Russia was more or less under attack by the “anglo-zionist empire.” So this has gotta be a financial empire based on oil and the control of oil. Because it is the only thing we will fight for these days. It makes sense that Russia has sold oil cheaper to the EU to gain market and we imperialists just put our foot down, using OPEC to do our dirty work. It’s almost a currency war. And Stanley Fischer just threatened to raise interest rates – no doubt he was talking to the Russians who have borrowed to get back on their feet. But Russial’s cutting into the EU market is just too much even for free-market-privateers. But back to the phrase “anglo-zionist empire.” That’s just way too protocols-of-zion for a level headed guy like Putin. I think that speech was pure theater. And I also think Fischer’s threat to raise interest rates is also theater. But what do I know. Not much. Anyway things are pretty interesting. And the only way for me to make sense of it is to speculate on what we intend to do with all this oil going forward. Will we use it to make one big globally mobilized effort to create a sustainable world? And since we gotta do it fast we are drilling like maniacs. I hope so.