CLEANING THE U.S. OIL MARKET - 2
Saudi Arabia and its OPEC allies' firm stand against cutting crude output to slow the plunge in oil prices has set the energy world on a painful course that will leave the weakest behind, from governments to U.S. wildcatters.
A grand experiment has begun, one in which the cartel of producing nations -- sometimes called the central bank of oil -- is leaving the market to decide who is strongest and how to cut as much as 2 million barrels a day of surplus supply.
Oil patch executives including billionaire Harold Hamm have vowed to drill on, asserting they can profit well below $70 a barrel, with output unlikely to fall for at least a year. Marginal producers in less profitable U.S. shale areas, as well as countries from Iran to Russia and operations from Canada to Norway will see the knife sooner, according to analyses by Wells Fargo & Co., IHS Inc. and ITG Investment Research.
"We're in a very nerve-wracking environment right now and will be for probably the next couple of years," Jamie Webster, senior director for global crude markets at IHS, said yesterday in a phone interview. "This is a different game. This isn't just about additional barrels, this is about barrels that are going to keep coming and keep coming."
Investors punished oil producers, as Hamm's Continental Resources Inc. (CLR) fell 20 percent, the most in six years, amid a swift plunge in crude to below $70 for the first time since 2010. Exxon Mobil Corp. declined 4.2 percent to close at $90.54 in New York. Talisman Energy Inc., based in Calgary, was down 2.7 percent yesterday in Toronto after dropping 14 percent the day before.
A production cut by the 12-member Organization of Petroleum Exporting Countries would have been the quickest way to tighten the world's oil supplies and boost prices. In the U.S., output is expected either to remain flat or rise by almost 1 million barrels a day next year, according to the Paris-based International Energy Agency and ITG.
That's because only about 4 percent of shale production needs $80 or more to be profitable. Most drilling in the Bakken formation, one of the main drivers of shale oil output, returns cash at or below $42 a barrel, the IEA estimates.
ITG estimates it will take six months before lower prices slow production growth from U.S. shale, which is responsible for propelling the country's production to the highest in more than three decades.
Elsewhere, oil markets already have begun to pressure governments that rely on higher prices to finance their budgets, fuel subsidies to citizens and expand drilling. Venezuela's oil income has fallen by 35 percent, President Nicolas Maduro said on state television Nov. 19.
Nigeria increased interest rates for the first time in three years on Nov. 26 and devalued its currency. The government is planning to cut spending by 6 percent next year, Finance Minister Ngozi Okonjo-Iweala said Nov. 16. Both Nigeria and Venezuela are part of OPEC.
Several countries within OPEC such as Iran, Iraq, Nigeria and Venezuela, as well as non-OPEC states such as Russia and Norway, will probably have to cut production with lower oil prices in 2015 and beyond, Roger Read, an analyst at Wells Fargo, said yesterday in a note to investors.
The probability of a recession in Russia in the next 12 months rose to 75 percent, according to a survey of economists compiled by Bloomberg -- the highest since the first poll two years ago. Russia receives about half of its budget revenue from oil and gas taxes.
In Canada, the massive investment needed to exploit oil sands has generated momentum that will take time to stop. Output will rise from money already spent and projects that are too expensive to halt, said Jennifer Stevenson, who helps oversee C$5.5 billion ($4.8 billion) at Dynamic Funds in Calgary.
Shale producers have a closer hand on the throttle, she said. Because output from new wells declines rapidly, a cutback in drilling by cash-strapped companies can slow production in months, not years. Cash flow for EOG Resources Inc. (EOG) would fall 24 percent next year to $28.96 per equivalent barrel of oil with U.S. crude at $65 a barrel, versus $85, according Peters & Co estimates.
"Any of these high growth companies are going to have less cash flow and less growth so I think you'll see the overall growth rate of North American production slow down," Stevenson said. "What I don't think you'll see is the overall production actually decrease."
With a sustained price drop to $60 a barrel, North American shale drilling would be especially challenged in emerging fields such as some in Ohio and Louisiana, where costs are at the highest early in development, according to Citigroup and ITG.
"It's going to be very producer-specific," said Judith Dwarkin, chief energy economist at ITG in Calgary. "Companies have to revise their budgets, then you see the laying down of rigs, then you see the fewer wells being drilled, then you see the natural decline rates starting to have more of an effect."
Drilling in Western Canada may drop by 15 percent in 2015, according to a report yesterday by Patricia Mohr, an economist at Bank of Nova Scotia in Toronto.
Among the worst hit shale producers will be smaller operators that rely heavily on debt and are focused on newer, higher-cost areas.
Goodrich Petroleum Corp. is one example. With a market capitalization of just $269 million, the upstart producer is developing a prospect in Louisiana and Mississippi that one rival called possibly one of the last great opportunities in North America. But drillers in the Tuscaloosa Marine Shale need oil prices at about $79.52 a barrel, according to Bloomberg New Energy Finance. Goodrich fell 34 percent yesterday to $6.05, its biggest drop ever.
Wells drilled by Hess Corp. in Ohio's Utica formation require almost $80 a barrel for profitability, according to Citigroup.
A prolonged period of lower prices risks will erode profits for even the cheapest suppliers of crude from U.S. shale, and threatens the viability of others around the world.
"It's going to be ugly," said John Stephenson, who manages C$50 million at Toronto-based Stephenson & Co. as chief executive officer. "We're in for lower oil prices for the foreseeable future."
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