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How long does the world have to wait before all the surplus oil sloshing around gets mopped up and prices find an equilibrium point that represents balanced supply and demand? Would you believe it if someone said that might be just a quarter and a bit away?
On the supply side, all bets are on shale to bail: there is no hope of output cuts from OPEC, let alone a coordinated action with other major producers such as Russia, amid a stubborn quest for market share.
If anything, most OPEC members are pumping full tilt and some such as Kuwait and Iraq are eying a production boost this year. A sanctions-free Iran is preparing to offload an additional 0.5-1.0 million b/d on an already oversupplied market, though the pace of that return is highly uncertain.
The question then arises, how long before more US producers buckle under and how sharp might the drop in output be?
Standard & Poors Ratings earlier this month downgraded big names in shale including Chevron, Apache, EOG Resources, Devon, Hess, Marathon and Murphy. Of the 20 “investment-grade” companies the agency reviewed, three were placed on Creditwatch with negative implications, and the outlook on another three revised to negative.
Until now, such actions had mostly affected the speculative-grade companies, S&P noted.
Following on from a sharp downward revision in its benchmark crude and natural gas price assumptions in January, S&P also lowered the ratings on 25 speculative-grade companies after reviewing 45.
S&P on January 12 slashed its Brent and WTI crude price assumptions to $40/barrel each (from $55 and $50 respectively) and Henry Hub natural gas price assumption to $2.50/MMBtu (from $3).
S&P flagged the “liquidity risks” faced by the smaller E&P companies, “particularly with respect to the April 2016 revolving credit facility bank borrowing base redeterminations.”
A borrowing base is the maximum amount of money a bank will lend to an energy company based on the value of its reserves at current market prices.
S&P expects the companies’ borrowing bases will have shrunk by 20-30% at the next re-determination in April, as the cutback in drilling activity in 2015 has hobbled their reserves replacement.
Also, more hedges will roll off this year, and the values on the futures curve are below many bank borrowing base prices, S&P credit analysts noted.
As they hunker down, S&P expects many of the companies to continue lowering capital spending and focus on efficiencies and drilling core properties. However, the analysts say, “these actions, for the most part, are insufficient to stem the meaningful deterioration expected in credit measures over the next few years.”
The US Energy Information Administration in its short-term market outlook released Feb 9 said it expects US production to fall to an average 8.69 million b/d this year from an average of 9.43 million b/d in 2015. And slip further to 8.46 million b/d in 2017.
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But like any forecast, this year’s figure could be revised down further. Exactly a year ago, in its February 2015 report, the EIA had estimated 2016 US production at 9.52 million b/d. The agency has progressively whittled down the figure since October last year.
Meanwhile, a total of 67 US oil and gas companies filed for bankruptcy in 2015, according to consultants Gavin/Solmonese, a whopping 379% spike on 2014, CNN reported last week.
Might the other big shadow looming on the markets — Iran — turn out to be a teddy bear?
Iranian businesses continued to be hobbled by the sanctions fallout. Some US clearing banks have warned banks in Europe, Asia and the Middle East that their US-based dollar accounts will face close scrutiny if they do business with Iran.
This has prevented banking transactions with Iran starting up again despite the removal of sanctions, the Financial Times said in this report Feb 14.
Not surprisingly, expectations on the pace of Iran’s incremental barrels flowing into the market are taking a more conservative turn. As Platts reporter Robert Perkins highlights in this analysis published Feb 8, a 500,000 b/d immediate rise and 1 million b/d within six months is seen as “wildly optimistic.”
Platts calculations based on current market consensus point to a far sober 200,000 b/d rise in the first quarter, growing to 450,000 b/d by year-end.
Excluding Iranian supply, global oil balances are now seen returning to equilibrium by the third quarter of 2016, according to implied market outlooks from the International Energy Agency, the EIA and OPEC.
That brings us to the “dread discount” on oil because of the wider global financial markets panic since the start of the year, triggered in large part by fears over Chinese economic growth.
While impossible to quantify, could the discount evaporate if the global economy performs much better than the doomsday scenarios currently preying on nerves?
To paraphrase Mark Twain, it ain’t what the oil markets don’t know that will get them into trouble. It’s what they know for sure that just ain’t so.
Research Scholar, McGraw Hill Financial Global Institute