Profits Possible at Low Oil Prices But Tough Changes Required
Low oil prices look like something the industry needs to get used to. “This will be with us for a while,” said Rex Tillerson, chairman and chief executive officer (CEO) of ExxonMobil. While prices will swing up at times, he predicted a “difficult price environment for the next couple of years.”
The message was repeated over and over by the speakers at the annual IHS CERAWeek conference in Houston, which attracts executives from around the globe.
“You have to prepare for USD 60 and less,” said Stephen Chazen, president and CEO of Occidental Petroleum. To adapt to the new environment, “we cut costs by a third. Some projects are going away.”
Companies will need to concentrate on reducing their breakeven costs permanently or “you will have tough times,” said Patrick Pouyanné, CEO and president of the executive committee for Total. For many, tough times are already here, with announced layoffs from the global oil and gas industry surpassing 100,000 by April, according to The Wall Street Journal.
The number of drilling rigs working in North America is less than half of what it was at the peak last year, but that does not necessarily mean oil production will decline. Continued low prices led natural gas producers to sharply increase their productivity, allowing them to produce far more with a fraction of the rigs once needed.
“A significant decline in rig activity did not diminish the growth in capacity” in natural gas, Tillerson said. “Will we see the same phenomenon in tight oil? I do not know, but that is why I believe this is a very resilient industry. I think people will be surprised.”
So far, the measures of drilling efficiency and well productivity in the US oil plays have improved at a rate that followed the path previously traveled by gas producers, he said.
Occidental’s plans for its key holdings in the Permian Basin in west Texas suggests as much. Chazen said that despite the more than 80 years of exploration and production in the enormous basin, “we are on the edge of a revolution in productivity” in the Permian. “We will find better ways to produce them,” he said. Progress over the next decade could add “another 10–20 billion barrels we do not see today” in that basin.
Following the lead of Saudi Arabia, the Organization of the Petroleum Exporting Countries (OPEC) has abandoned its role as the swing producer in the oil markets. Rather than cutting production to limit price moves, it chose to raise production to defend its market share.
“OPEC is not dead. It will continue to matter, but it is not what it used to be,” said Jim Burkhard, chief researcher, global oil markets and energy scenarios, for IHS. It is no longer balancing the oil market, adjusting the supply as market conditions change.
That led to a discussion of whether the US is now the new swing producer in the global oil market. If so, it is likely to disappoint anyone hoping it will use its influence to stabilize the market and push prices back up. US companies have slashed drilling by 50%, but producers, who pushed production from 4 million B/D to 9 million B/D in 4 years, are not talking about cutting output.
Prices now are too low to expect growth. That led to numerous calls at IHS CERAWeek to lift the US oil export ban. This could relieve the current oversupply of light US crude, which is more than the domestic refineries’ need, and eliminate the large price gap between the value of US crude and the international standard, Brent crude.
The price will not need to rise far to bring back growth. Scott Sheffield, chairman and CEO of Pioneer Natural Resources, said, “At USD 70 we can grow. At USD 80 we can grow more.”
The breakeven price is falling for many companies. “We have seen 20% to 25% reduction in costs in four and a half months,” said Harold Hamm, chairman and CEO of Continental Resources. The company is also producing significantly more of the oil in the ground. “We are now seeing 16% to 20% recovery in the Bakken. It used to be 2%” of the hydrocarbons in the ground.
Another way to reduce costs is to target drilling in the most productive spots. This could significantly improve efficiency because “a relatively small number of wells does the heavy lifting,” said Raoul LeBlanc, managing director of IHS.
A recent IHS study sees early signs that oil producers are getting more selective. In US states with unconventional production, it divided oil-producing counties into three groups based on average production. LeBlanc said the study found that drilling declined more in low-productivity counties. Breakeven price levels for oil producers could be significantly lowered by targeting the best reservoir rock, reducing service company costs, and improving methods for identifying drilling targets and completing wells.
Drilling fewer wells at carefully selected spots has been a major reason for the big productivity gains of natural gas producers, said Steve Mueller, chairman and CEO of Southwestern Energy, adding, “It is really about the rock.”
Southwestern focuses on finding the best drilling sites and the most productive intervals, targeting layers as narrow as 20 ft in formations hundreds of feet thick, said Bill Way, president and chief operating officer of Southwestern, in a recent investors meeting.
To Mueller’s mind, USD 100/bbl oil was too high. While low gas prices forced tough decisions, higher oil prices allowed operators to drill in marginal areas. As for whether oil can follow the path of gas, Mueller said that is hard to say if the same production gains can be achieved in this ultra-tight rock because “oil molecules are different.”
As the cost of producing oil falls, even a modest rise in prices could quickly increase production by North American producers holding thousands of wells that have been drilled but not completed, LeBlanc said. “The companies that drive the US production system are into growth, growth, growth. The key constraint [on that] is the amount of cash in their pockets,” he said.
While massive layoffs by US companies have been the clearest indication of the pain inflicted by lower prices, oil-producing countries can expect demands by international oil companies seeking better terms because they cannot afford high royalties and fees when oil prices are down, and operators will be expanding the use of cost-cutting methods used in unconventional formations.
“We will apply the lean culture we learned onshore to our offshore business,” said John Hess, CEO of Hess Corp. “Low oil prices will impose more cost discipline.”
A factor making this downturn different is that investors are more willing to finance US oil companies, buying billions of dollars of stock and bonds in recent months, Burkhard said. This will help keep companies in business as they work to cut costs and adjust to this lower-price environment.
In the 1980s, there was a mass failure of energy lending banks, and in 2008 the price crash was triggered by the global financial meltdown, sharply limiting financial support. The main source of funding now is from financial firms rather than bankers.
Growing US influence in oil prices is also expected to mean greater volatility. When Saudi Arabia was committed to stabilizing the market, traders betting on falling oil prices could lose big if Saudi Arabia moved to prop up prices. Now those traders are the ones providing price discipline, and discipline “is not what we think of when we think of financial markets,” said Roger Diwan, vice president of financial services at IHS.
The lower-price case is also supported by weak demand from China, which had been the world’s swing consumer, absorbing rising oil production in recent years. Growth has slowed in China. It has reported its gross domestic product (GDP) is growing 7% a year, which is down from what it was during booming years and at the minimum that is required to create the jobs needed by its growing workforce. But even that number may overstate the real growth rate.
“China will be lucky to get to 6%,” said Nariman Behravesh, chief economist at IHS. While China recently moved to stimulate bank lending, its options are limited because it has doubled its debt as a percentage of GDP in recent years to an unsustainable level.
“It will take a long time to unwind this debt situation,” he said, adding, “This is a nasty scenario. They can delay it but I do not see how they can avoid it.”
That scenario anticipates a long slowdown for China. But predictions of the future are no more reliable today than they were a year ago when the consensus was for oil to remain at USD 100/bbl.
Burkhard’s job is to consider a range of possibilities. One such scenario, which IHS calls “vertigo,” assumes that a large developing country, such as China, opts for a massive economic stimulation program that causes a short-term spike in oil prices.
A price spike still is possible, because while oil supplies are now high with a lot of oil stored in tanks and tankers, the margin between demand and production is relatively slim, at less than 2 million B/D. But based on recent experience, with a continued moderate global GDP growth rate of 2.5% to 3% and reduced oil production costs, Burkhard said “we could stay at USD 50 or so for a long time.”
Profits Possible at Low Oil Prices But Tough Changes Required
Stephen Rassenfoss, JPT Emerging Technology Senior Editor
01 June 2015
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