The bear market for oil continues. The historic deal with Iran has sparked a lot of speculation about how much Iranian oil will come back to the market, and how quickly. The estimates run the gamut, as we explained in Tuesday’s Newsletter, but suffice it to say Iran could bring somewhere near 1 million barrels of crude per day back online within a year. December 2015 is the earliest date that sanctions will come off. In the meantime, Iran has around 40 million barrels of oil sitting in storage that could be sold off much more quickly.
As the markets try to digest Iran’s potential, oil prices have sunk. WTI dropped on July 16, falling dangerously close to the psychologically important threshold of $50 per barrel, flirting with the possibility of sub-$50 oil for the first time in several months.
The ongoing slump in oil prices continues to hit the largest oil companies. ConocoPhillips (NYSE: COP) announced its decision to further slash capital expenditures on deep-water drilling and instead divert more of its resources to boost its dividend by one cent to 74 cents per share. The company decided to cancel its contract with the Ensco DS-9 drillship, which ConocoPhillips had planned on using to drill a deep-water well in the Gulf of Mexico later this year. Cancelling a contract is not cheap however. ConocoPhillips must pay the owner of the ship, Ensco plc (NYSE: ESV), termination fees equal to about two years’ worth of daily renting of the rig. That could come out to around $550,000 per day, for two years, plus other fees that Ensco might incur from the contract cancellation. Still, ConocoPhillips hopes that the move will help it improve cash flow from 2017 onwards. Related: These Factors Will Send Oil Prices Down Even Further
The problem for the oil majors is still the cost of production. Much has been made about the efficiency gains that oil companies are making, locking in lower costs for services and equipment, which lowers the breakeven cost for oil projects. But the larger savings are occurring in the shale patch, where most of the oil majors have relatively little exposure. For the largest companies, it is still a lot more expensive to produce oil than it was in years past. Boston Consulting Group finds that discovering and developing new oil projects is now three times more expensive than it was a decade ago.
And the oil majors are increasingly relying upon natural gas for their profitability, which masks the high cost of production for oil. The all-in cost for developing new oil projects was near $105 per barrel in 2014, the consulting group concludes. So the cost savings that oil companies have been achieving in recent months come nowhere near what is needed now, with oil trading at half the level that it was a year ago. Much larger cost savings have to come in the form of standardization, overhauling operations, coordination between companies, and more, the Wall Street Journal reported on July 15. But it is not clear that such a massive rethink is underway yet. Related: OPEC, Get Ready For The Second U.S. Oil Boom
It isn’t just the oil majors that are hurting – the weaker shale companies are too. Sabine Oil & Gas became the sixth U.S. oil producer to file for Chapter 11 bankruptcy protection. It is also the largest company yet to do so, surpassing Quicksilver Resources, which went bankrupt earlier this year. Sabine had hoped to right the ship by cutting spending and selling assets, but low oil prices depressed the value of those assets, so selling them wouldn’t have been enough. The renewed slump in oil prices likely means Sabine will not be the last company to be overwhelmed by its debt. With credit redeterminations just a few months away, more and more companies could see their credit lines cut, ultimately pulling out the rug beneath them.
The EIA reported that it expects U.S. oil production to continue to sink, predicting a decline of 91,000 barrels per day in August from the country’s main shale regions. The losses will continue to be led by the Eagle Ford with a loss of 55,000 barrels per day, followed by the Bakken (expected to drop by 22,000 barrels per day) and the Niobrara (down 20,000 barrels per day). Meanwhile, the EIA also reported ongoing drawdowns in crude oil inventories, with another 4.4 million barrels pulled from storage over the past week. The trend towards adjustment is slow, but at least it appears to be steady. On the other hand, Baker Hughes has reported three weeks of rig count gains, suggesting the rig count has bottomed out for now. Related: Dispute Between Baghdad and Kurdistan Holds Back Iraqi Oil Potential
Mexico reported the results of its first oil auction this week, a milestone for the country. After passing a major energy liberalization package, Mexico loosened the grip of its state-owned oil company, Pemex, on the country’s oil and gas industry. The “Round One” auction was the first in a series of auctions in which Mexico would sell off the rights to tracts of oil and gas reserves. Round One offered shallow water blocks in the Southern Gulf of Mexico near the states of Veracruz and Tabasco. Despite the anticipation, Round One fell short of expectations, with only two of the 14 blocks successfully awarded. The winner of the two blocks was a venture between Sierra Oil & Gas (Mexico’s first independent explorer), Talos Energy LLC, and Premier Oil Plc (LON: PMO). The poor showing is a symptom of low oil prices and perhaps unattractive profit-sharing terms from the Mexican government. However, Mexican officials expressed optimism for future rounds.
U.S. President Barack Obama is expected to meet with the Saudi Foreign Minister on Friday at the White House in an effort to calm Saudi fears of the Iran deal. Saudi Arabia and Iran are bitter enemies and the Saudis are deeply mistrustful of any accord with their regional rival. Obama offered security guarantees to the Saudis earlier this year that he now wants to reaffirm following the Iran deal.
By Evan Kelly Of Oilprice.com
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