Oil prices have cratered in recent weeks, dipping to their lowest levels in more than seven months and any sense of optimism has almost entirely disappeared. All signs point to a period of “lower for longer” for oil prices, a refrain that is all too familiar to those in the industry.
WTI Crude oil dipped below $44 per barrel on Tuesday, and the bearish indicators are starting to pile up.
Libya’s production just topped 900,000 bpd, a new multi-year high that is up sharply even from just a few weeks ago. Libyan officials are hoping that they will hit many more milestones in the coming months. Next stop is 1 million barrels per day (mb/d), which Libya hopes to breach by the end of July.
U.S. shale is arguably the biggest reason why prices are floundering again. The rig count has increased for 22 consecutive weeks, rising to 747 as of mid-June, up more than 100 percent from a year ago. Production continues to rise, with output expected to jump by 780,000 bpd this year, according to the IEA. Ultimately, the shale rebound appears to have killed off yet another oil price rally, the latest in a series of still-born price rebounds since the initial meltdown in 2014.
Hedge funds and other money managers slashed their bullish bets on crude oil futures in the latest data release. Sentiment is profoundly pessimistic at this point, and because the IEA, OPEC and EIA recently published very downbeat assessments about the pace of rebalancing, a grim mood will be sticking around for a little while. The next reports from those energy watchers won’t come out for almost another month.
In the meantime, the weekly EIA data on production and inventories will have outsized importance, mainly because it is one of the few concrete indicators that comes out on a routine basis. Analysts are now worried that a string of bearish data could push oil prices down even further. “We cannot afford to have another build in crude or gasoline,” Bob Yawger, director of futures at Mizuho Securities USA Inc., told Bloomberg before the latest data release. “The market’s just dying for a reason to buy this thing, but you can’t really do that before” the EIA publishes its next batch of weekly data on Wednesday. Gasoline demand also looks weak, just as the summer driving season in the U.S. gets underway, a period of time that typically sees demand rise.
The market got a bit of a reprieve on Wednesday when the EIA reported some decent figures – a drawdown in crude oil inventories by 2.5 million barrels. Also, imports were flat and gasoline stocks fell slightly.
Still, the figures aren’t enough to put the market at ease.
Amid all this doom and gloom, Saudi Arabia’s energy minister Khalid al-Falih tried to put on a brave face, arguing on Monday that the market will “rebalance in the fourth quarter of this year taking into account an increase in shale oil production.” He waved away the recent price drop, dismissing the importance of such short-term movements in the market.
But with WTI dropping below $45 per barrel, most sober oil market analysts are not nearly as sanguine. OPEC’s objective of bringing global crude oil inventories back into five-year average levels is looking increasingly difficult to achieve, at least in the timeframe laid out by the cartel. “There seems to be very low conviction in the market that there really will be any inventory drawdown in the second half of the year,” said Bjarne Schieldrop, chief commodities analyst at SEB AB.
“This is like a falling knife right now, I genuinely haven’t seen sentiment this bad ever,” Amrita Sen, the co-founder and chief oil analyst at Energy Aspects, told CNBC on Wednesday. “We have had clients emailing saying they have been trading this for 20 or 30 years and they have never seen something like this.”
One pivotal factor that could really cause prices to plunge is if compliance with the agreed upon cuts starts to fray. There are several reasons why some participants might start to abandon their pledges. Russia, for example, tends to produce more oil in summer months, a fact that might tempt them to boost output. Iraq is also eyeing higher production capacity this year. In addition, weak prices could start to undermine the group’s resolve. “Lack of major upside price response to the OPEC output cuts upping the odds of reduced compliance to the agreement in our opinion,” Jim Ritterbusch, president of energy advisory firm Ritterbusch & Associates, wrote in a research note.
Moreover, simmering conflict in the Middle East could continue to grow, threatening to derail cooperation between OPEC members. The conflict between Saudi Arabia and its Gulf allies on the one hand, and Qatar and Iran on the other, could deteriorate. Although that could spark some price gains for crude oil if supplies are affected, it could also undermine the OPEC deal.
One unknown factor that could prevent oil prices from falling further is the possibility that prices floundering in the mid-$40s actually puts a lid on shale production. If U.S. shale underperforms over the next year, the OPEC deal could succeed in balancing the market. But if U.S. shale continues to rise, and OPEC fails to extend its deal beyond the first quarter of 2018, oil prices could fall to $30 per barrel, according to Fereidun Fesharaki, chairman of consultants FGE. – Nick Cunningham
Many U.S. shale drillers have said that they have full-proofed their operations for $40 oil, having lowered breakeven prices substantially over the last few years. They may soon have to prove it. Oil prices dropped to fresh seven-month lows on Tuesday, officially entering bear market territory, down more than 20 percent year-to-date. The declines have raised questions about the possibility of WTI hitting $40 soon.
A rising U.S. rig count, multi-year record production levels from Libya, and a general mood of pessimism more than outweighed the positive news that OPEC and non-OPEC producers increased their compliance rate in May. There is now a growing consensus that the OPEC deal won’t be sufficient to bring down inventories at a fast enough pace to balance the market this year.
Can U.S. shale survive in a world of $40 oil prices?
There are very different answers out there depending on who you ask. Most of the oil majors and some top shale companies such as EOG Resources, are said to have break-even prices below $40 per barrel. That would suggest that their drilling campaigns would not stop even after taking into account the latest slide in oil prices.
But those are just the top companies, not everyone across the industry. Some smaller companies in more marginal parts of U.S. shale basins will face much more pressure in today’s market.
A long list of shale drillers have dramatically reduced their breakeven thresholds, lowering costs so that they could make money, by and large, with oil prices in the $50s. That is why the rig count surged over the past year.
But $40 oil is much different than $50-$55 oil. “We had $52 on average in Q1 and everyone said we are going to start growing again. Everyone said our balance sheets are fine,” Paul Sankey, a senior analyst at Wolfe Research, said on CNBC. “The market is now testing who can really stand up and run. At $52 the answer was too many people. Now at $43 we are going to really find out as we go into Q2 earnings who can really get this done at $43. And I can tell you, there’s not many companies that we like…Most of the sector has got an awful problem down here for sure.”
UBS says that oil prices at $45 per barrel “slows most U.S. shale plays.” The Bakken, the Eagle Ford and the Niobrara struggle below $45. But if oil prices drop to $40, companies will be forced to “hit the brakes,” even in the highly-sought after Permian Basin.
So even as shale executives talk up their cost reductions, they will be put to the test in the near future. “We are nearing the point where it’s going to be a challenge for them as well, if you break $40 per barrel,” John Kilduff of Again Capital told CNBC.
“With oil prices at $45, there will be very little movement in capital globally, and fewer projects will get sanctioned,” David Pursell, an analyst at the investment bank Tudor, Pickering, Holt & Co., told the Houston Chronicle.
Because there is a lag between oil price movements and rig counts, the effect of the recent slide in oil prices might take some time to become apparent. Moreover, with rigs already out in the field drilling, production might continue to rise even if oil prices fall.
But if oil prices fail to rebound, the gains in the rig count could start to slow. Companies would have to start thinking about paring back their drilling campaigns the longer that oil prices stay in the low or mid-$40s. “[T]he rate of growth in drilling we’ve seen over the past year might not be sustainable through the year and certainly not into 2018,” said Jesse Thompson, a business economist at the Houston branch of the Federal Reserve Bank of Dallas, according to the Houston Chronicle. “At a certain price point, you’ve eventually saturated the drilling you can afford to do.”
The equation, however, would really change if oil prices continue to fall even more. “I think we most definitely go to $40. We’re probably looking at the upper-$30s at this point now,” John Kilduff told CNBC. – Nick Cunningham
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