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Midweek Sector Update: OPEC Regaining Market Share, But At What Price?

Midweek Sector Update: OPEC Regaining Market Share, But At What Price?

The global oil industry will spend an estimated $129 billion less this year as a result of low oil prices, a new analysis from the FT shows. And from 2014 to 2016, that total will reach $200 billion. The crash in oil prices has led to spending cut backs, layoffs, and significant delays at major projects. High-cost projects in particular have received the axe first. Canada’s oil sands, several major LNG export projects, and the Arctic are some of the most affected regions in the world. The spending reductions will allow oil companies to retrench, save cash, and wait for oil prices to rebound. But waiting will also allow upstream producers to force their suppliers to renegotiate contracts and offer better terms for drilling services. This will allow producers to reduce the cost of drilling.

Nevertheless, spending cut backs and delays will push back the ultimate date when all of this oil comes online. The FT says that around 500,000 barrels per day will come online in 2022 instead of 2020 as planned. This offers some concrete evidence that OPEC’s strategy of pursuing market share is working. OPEC could capture an additional 2 million barrels per day of market share over the next five years as a result of the dramatic scaling back from non-OPEC producers. Related: Oil Prices Will Fall: A Lesson In Gravity

Texas is doing its best to keep the oil industry healthy. The state passed a law that will prohibit towns from banning fracking. The move came in response to a surprise voter-driven ban on fracking in the city of Denton, Texas late last year. Not normally known for its green tendencies, the Denton vote shocked the Texas oil industry. Enough people voted to prohibit drilling within city limits, angered by truck traffic and all the unwelcome byproducts of having a large industry presence in town. But then there was a backlash to the backlash. The Texas state legislature, with the support of the industry, quickly responded. On May 18 Governor Greg Abbott signed into law a bill that will prohibit bans on fracking and removes some of the zoning power that Texas towns and cities have over the siting of drilling. That will allow oil companies a freer hand in drilling where they want.

That is good news for the development of the Eagle Ford Shale, which has bright days ahead of it. In fact, drilling for oil in the Eagle Ford will get cheaper over the course of the next 12 months. By the summer of 2016, producing a barrel of oil from the prolific South Texas shale field will cost $10 to $15 less than it once did, according to a new analysis from Wood Mackenzie. As mentioned above, oil field service companies are cutting their rates that they charge exploration companies, driving down the cost of production. On top of those savings, drillers are also implementing other cost-saving methods and finding efficiencies amid the oil price downturn. That should keep drilling alive for years to come. “The death of the unconventional business has been greatly exaggerated,” a Wood Mackenzie analyst said. “Operators can still make money in the best portions of the best plays in the lower 48.” Related: Here Is Why Predictions For Lower Oil Prices Are Wrong

But lower drilling costs could mean that there is no meaningful correction on the supply side. In other words, if oil companies are not forced to cut back on production, oil prices may not rebound as strongly as many had hoped. Goldman Sachs says that the recent run up in prices is premature, and ultimately, self-defeating. Coupled with cheap capital, which allows shaky operators continued access to new funding and encourages drilling, US shale companies are set to force prices back down later this year, the investment bank says. WTI prices could fall back down to $45 per barrel by October.

The International Monetary Fund published a new study that found a staggering level of subsidies for fossil fuels. Along with traditional subsidies in their explicit form, mainly in developing countries, there is also a high level of indirect subsidies for oil, gas, and coal. Governments have to pick up the tab for damages to public health and the environment stemming from the use of fossil fuels. The burning of coal, in particular, contributes to one million premature deaths on an annual basis. These damages are “externalities” and amount to a massive subsidy for the energy industry. The IMF says that these direct and indirect subsidies total an eye-popping $5.3 trillion each year. The collapse in oil prices since the summer of 2014 has provided a unique opportunity for developing countries to trim their subsidies, which sap government resources. But removing all direct subsidies – let alone taxing for the unaccounted health and environmental damages – would lead to enormous increases in energy prices for consumers, the IMF conceded in its report.

The purchase of BG Group (LON: BG) by Royal Dutch Shell (NYSE: RDS.A) could lead to a huge natural gas multinational company, one that specializes increasingly in LNG. But before being approved, Shell must overcome antitrust scrutiny in several countries. Not only that, but Shell may have to shed some assets in order for the deal to go through. Some are due to antitrust concerns, but other asset sales – most notably in Kazakhstan – are due to specific terms in contracts with host governments. The Kazakh government reserves the right to buy back the Karachaganak natural gas field, a major gas-producing asset held by BG that has been called a “cash cow.” That option is triggered in the event that the project changes ownership. Last year BG was able to produce 85,000 barrels of oil equivalent per day. Related: This Tiny Nation Could Have Huge Oil And Gas Potential

Meanwhile, there was more bad news out of the Middle East this week. In Iraq, ISIS overran the city of Ramadi in Anbar province, an area that has some dark memories for the US military, which fought some bloody battles there in the past. The capture of Ramadi was a blow to the US and Iraqi effort to beat back the militant group. No major oil fields are in danger at this point, but Iraq is far from becoming a stable country. Furthermore, ISIS has also spread to Libya. The violence and power vacuum in Libya has opened up an opportunity for ISIS to expand beyond Iraq and Syria. ISIS has become popular among disparate militant groups across the world, but Libya marks the first major presence outside of its original stronghold. That obviously presents grave security concerns in North Africa, and points to a long bloody future for Libya. It also suggests that there is a high likelihood that Libya will be unable to finally get its oil industry fully back on track. The North African OPEC member may see its output run far below its potential for many years to come.

By Evan Kelly Of Oilprice.com

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