The definition of “unsustainable,” according to the Oxford Dictionary, is a situation which can’t be maintained at its current rate or level. Unsustainable is also the best way to characterize the oil price when it is near US$30 per barrel -a situation that is not tenable on many dimensions.
Why low oil prices may suddenly be considered a problem for that global economy
Usually low crude prices are good for the world economy, but an increasing share from the world’s consumers and investors have been in the places getting hammered by the rout in commodities. Read on
Many companies are taking a loss at US$30 per barrel. Here in Canada, where our local prices are even less once transportation costs and quality differences are factored in, oilsands producers are pumping out red ink with every barrel of bitumen they extract.
Compared with oilsands, Canadian conventional and tight oil producers have lower operating costs along with a higher valued product. However, despite these advantages, a lot of companies cannot keep your lights on at these prices. Even for the group that may generate some money flow, the amount is a trickle compared to the last few years.
The pain is not isolated to Canada. In the usa, tight oil producers are also showing indications of distress. Reacting to low prices and compressed corporate cash flows, recently Continental Resources, Anadarko, Hess Corporation, and Noble Energy all slashed their 2016 spending plans within the range of Half compared with last year.
Further, Hess and Continental will also be now predicting production declines with this year, demonstrating that even stubborn tight oil isn’t safe from US$30 per barrel oil.
Supermajors are also under pressure. Chevron just released their first financial loss since 2002. In Brazil, Petrobras announced another round of cuts last week with the CEO describing the situation as “-a scenario of total distress.”
And, some Russian production continues to be generating positive income, the nation has marginal wells that are losing money at this time.
Oil and gas companies cannot lose money forever. We all know the issue here is brewing when the rate of cash leaving corporate bank accounts is greater than the dollars coming in. Making matters worse, not many oil companies have savings to draw from. Let’s assume that price remains low for the following couple of months, the first quarter results will provide hard evidence from the level of financial pain inflicted by US$30 per barrel oil.
Today’s low price situation is also completely unsustainable for a lot of governments in oil producing regions. Like a domestic example, Canadian producing provinces C mainly B.C., Alberta, Saskatchewan, and Newfoundland received $16.5 billion of royalty income in 2014, but this past year, we estimate the number was slashed to $7 billion. If prices hover around US$30 per barrel for most of 2016, this income is going to be squeezed to only $2 billion or about 10% of the 2014 level.
This painful situation is not unique to Canada, it’s challenging for all governments that rely on oil revenues to balance their budgets. It is no wonder why Nigeria and Azerbaijan are actually searching for emergency financial help, or why Russia has recently be interested in opening up a discussion around the chance of an oil production cut.
Finally, today’s prices are equally questionable when you consider the oil market fundamentals. When you adjust for inflation a US$30 per barrel oil prices are close to the prices during the 1986 oil crash. Yet today’s oil market fundamentals tend to be stronger than 30 years ago, a fact that isn’t reflected in the present oil price. In 1986, spare capacity was equal to 12 million barrels each day, or 20 per cent of worldwide demand. With such a large glut of oil, lower for extended made a lot of sense back then-but not today.
Today, spare capacity plus the amount of oil the world is overproducing means under four million bpd or 4 percent of global demand. Even when Iran increases its production as anticipated, it is extremely possible that declining production elsewhere combined with still-strong demand growth could balance the marketplace within a year.
As the old saying goes, the best remedy for low price is low cost. Everything the same, cheap oil will accelerate demand, cause more megaproject cancellations than there’d have been otherwise, speed up the decline rates for neglected legacy oil fields, and inflict even deeper wounds in the oil field service sector. While it may not happen immediately, the pain sensation of today’s unsustainably low prices will only strengthen the forces which will result in tighter markets along with a price recovery.
Jackie Forrest is V . p . of Energy Research at ARC Financial Corp., Canada’s leading energy-focused private equity manager.
