Despite lower 2015 capex, could continued oil output gains delay price recovery?

Upstream operators that released 2015 preliminary capital budgets a few months before the year-end holidays have returned to the surgical table for more fiscal liposuction on already slender frames.  Despite this, they and other producers insist they can continue to grow oil production this year, and for some, growth will be in the double-digits.

Last week alone, small producers Halcon Resources, Sanchez Energy and Concho Resources all slashed projected 2015 capital spending by 48%, 29% and 33%, respectively.  In some cases this was the second revision from preliminary figures announced before oil prices began their steep descent to current levels below $50/b.

They are not alone.  Even the bigger players such as Continental Resources, a big Bakken Shale producer, said in late December its capex would be 41% lower than contemplated in early November when prices were still in the high $70s/b range, while ConocoPhillips will shave 20% off its budget compared to last year.

Of course, the budgetary chopping block is a response to oil prices that have plunged more than 50% in recent months, a drop particularly after OPEC opted in late November not to cut its production.  The price of oil is still below $50/b, down from a recent peak of $107/b in mid-2014.

But production will still continue to grow for all these operators:  Sanchez expects 40% higher output this year than last; for Concho, it’s 16-20% more; Halcon’s should come in at more modest 4% higher.  Continental expects 16-20% higher production in 2015, although its earlier budget had projected 23-29% output growth, and ConocoPhillips pegs its output growth at 3%.

These are impressive production yields, although the smaller companies are coming off a lesser output base.  For example, at ConocoPhillips’ estimated 1.53 million b/d of average oil equivalent production for 2014, 3% growth spells an extra 46,000 boe/d of hydrocarbons on the market.  (Important to note: companies’ production jumps are for oil, natural gas and gas liquids, although for most companies these days the bulk of output is liquids, largely oil.)

Still, amid the bare-bones budgets is one key issue:  will the continued gush of wells delay the price recovery?  If so, by how much?   After all, oversupply is being blamed for dragging the price of oil down a steep slope the last seven months.

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Analysts widely expect oil supplies to continue growing this year, even at lower prices.  While some are saying 2016 will be the turnaround year for a production response to low prices, others now think oil supply growth could continue into 2016.  For instance, Barclays analyst David Anderson on January 9 said his investment bank does not expect to see a supply response from reduced activity in 2015, but expects some in 2016, at least in North America.

So could the “pumping, pumping” of oil wells (to quote a nonchalant Gloria Swanson in the classic movie “Sunset Boulevard”), even if at lesser levels than originally contemplated, further push out the longed-for price relief?

The question evokes an interesting economic theory called Mandeville’s paradox — which posits that what is bad for the individual may be good for the group overall.  In oil patch terms, the reverse may be occurring:  namely, some phenomena (such as efficiency) that are usually deemed  good for industry — i.e., greater production yields — now have become “bad” because they resulted in too much oil that could not be absorbed.

Likewise, hedging — which producers and Wall Street generally view as “good” because it protects prices at higher-than-spot levels — might also allow companies to feel more secure in continued drilling, thus contributing to the “bad” glut.

RBN Energy analyst Sandy Fielden, in a Sunday blog, noted that in simple terms, exposed US upstream shale oil producers would see collective revenues from US shale production drop by nearly half this year, although hedging will protect many of them from price volatility for awhile.

While hedging impacts differ, “they typically only provide price protection for a year or two — at best delaying producer investment cutbacks rather than preventing them,” Fielden said.

The traditional oil industry model is that low prices lead to less drilling, causing production to drop, and the relative supply scarcity levers the price back up.  But anything can happen to throw forecasting off and cause oil prices to upright themselves sooner than later.

One such possibility:  OPEC could soften its stance in the coming months and become more amenable to production cuts.  The cartel’s refusal to cut output shocked the market at a time when oil was in the mid-$70s/b and led to acceleration of what until then was an otherwise gradual price fall.  In fact, a day after that decision, NYMEX crude futures plummeted $7.54/b, ending at $66.15/b.  Oil prices continued to veer south over the following month or so but have nested in the mid-to-high $40s/b since January 6.

In addition, geopolitical events could disrupt output of a producing country and prod oil prices up from perceived supply scarcity.  Or inefficient and overleveraged companies may be swallowed up in M&A activity, or just quit drilling.  At such times the entire industry becomes more compact and more capable — that is, more efficient.

So ironically, efficiency, which basically got the industry into an oversupply situation as prodigious oil volumes gushed out of such horns of plenty as the Bakken Shale in North Dakota, the Eagle Ford Shale in South Texas and the Permian Basin in West Texas/New Mexico faster and at climbing rates, could also help lead it out.  But that’s the nature of markets.

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