Sunday, January 31, 2016

Oil industry - this time is no different!

Commodities markets are prone to the classic boom and bust cycle - economy booms/demand increases, prices rise, capacity expands, production soars, excess supply/economy weakens, prices fall, capacity expansion halts, and so on. The US shale market is the latest to fall victim. Shale oil production in the US soared on the back of rising global oil demand (China effect), rapid technological developments (hydraulic fracturing and horizontal drilling), and cheap capital. The FT writes,
Companies have achieved remarkable gains in productivity by optimising production techniques and drilling only in the “sweet spots” that generate the most. They have also been driving down the prices they pay their suppliers and contractors. Jim Burkhard of IHS, the research group, says the cost of drilling and completing a typical shale well fell 35-40 per cent last year...

US crude production rose from 5.1m barrels a day at the start of 2009 to 9.7m b/d in April last year, a surge that has few parallels in the industry’s history... The small and medium-sized companies that led the shale revolution raised $113bn from selling shares and $241bn from selling bonds during 2007-15, according to Dealogic... Low rates drove investment in marginal US shale projects “that are uncompetitive at lower prices and now need to be unwound”...

The boom years left the US oil industry deep in debt. The 60 leading US independent oil and gas companies have total net debt of $206bn, from about $100bn at the end of 2006. As of September, about a dozen had debts that were more than 20 times their earnings before interest, tax, depreciation and amortisation... Almost a third of the 155 US oil and gas companies covered by Standard & Poor’s are rated B-minus or below, meaning they are at high risk of default...

Private capital funds raised $57bn last year to invest in energy, according to Preqin, an alternative assets research service, and most of that money is still looking for a home... Bankruptcies, a cash squeeze and poor returns on investment mean companies will continue to cut their capital spending. The number of rigs drilling oil wells in the US has dropped 68 per cent from the peak in October 2014 to 510 this week, and it is likely to fall further... The US oil and gas industry has lost 86,000 jobs over the past year, about 16 per cent of its workforce, and many of those people will never return. When the industry does want to expand again, it will need to offer attractive wages and training, which will raise costs.
This is all predictable history, exactly the same storyboard as earlier episodes. There is nothing which warrants a belief that this time will be different with the rebound. The most compelling arguments in favor of a long period of low oil prices are secular stagnation in developed economies, the continuing decline of Chinese demand, and the full return of Iran and Iraq. All first is only a marginal contributor to the decline in demand, the second vastly over-played, and the third marginal and one-off. So the question is not whether oil prices will stay long for a long period or not, but when, over the next 1-3 years, will it start its rebound. 

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