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Oil Markets Coming To Grips With Prices Remaining “Lower for Longer”

Oil Markets Coming To Grips With Prices Remaining “Lower for Longer”

“Lower for longer” is on everyone’s lips in the oil industry.

A survey by the Wall Street Journal of investment banks found a growing consensus that oil prices not only won’t rebound soon, but could remain at today’s low levels through much of next year. The average of the 10 oil price forecasts surveyed by WSJ predicted that oil prices would not rise above $70 per barrel until late next year, with WTI averaging just $63.40 for 2016.

U.S. shale is definitely adjusting downwards, with production losses continuing to mount. It’s just that the cut backs aren’t happening quickly or deeply enough to ease the glut.

In a worrying concern for shale drillers hoping for a rebound in prices, the rig count across North America has started to tick upwards over the past few weeks. Since hitting a low point in June at 628, the industry has added 44 oil rigs through August 14, according to Baker Hughes. Although that increase is small compared to nearly one thousand rigs lost since last year, the trend is significant for the mere fact that companies have stopped making cuts to the number of rigs deployed even though oil prices remain depressed. Related: Could This Be The Next Great Renewable Energy Source?

Of course, there is a lag effect with the production data. Removing a thousand rigs surely has to lead to a pretty significant decrease in U.S. oil production, but it could take a few more months before the decline in output clearly shows up in the data. And since oil markets are hyper-sensitive to every new data release, a few rigs being added back to the oil patch – while data showing big declines in output has failed to show up – leads to pessimism about any rebound in the oil price.

In fact, Citigroup has produced a wildly pessimistic scenario for oil prices. Although the bank has a range of forecasts, its “bear case” calls for oil prices dipping into the low $30s per barrel this year and staying there through much of 2016. Citi only assigns a 30 percent probability to such an outcome, but that is higher than the 15 percent probability it gives its “bull case,” which only consists of oil rising to $70 per barrel next year. The assessment highlights the growing concern about the “lower for longer” scenario.

Abroad, oil producers are keeping up the pressure. OPEC continues to produce well in excess of its stated target of 30 million barrels per day, driven by production levels from Saudi Arabia, and increasing gains in output from other OPEC members such as Iraq and Iran. Iraq’s oil production hit 4.18 million barrels per day in July, a record high. Related: PV Solar Could Have Some Serious Competition

The coming months don’t exactly bode well for the oil price either. U.S. motorists travelled the most miles on record so far this year, taking advantage of low oil prices, but it hasn’t been enough to soak up the excess oil floating around. Moreover, peak summer driving season is soon coming to an end as we enter into autumn months, which could cause demand to level off.

An even bigger threat to oil prices looms in the background. Refineries have been operating full tilt, pushing facilities to the limits of their capabilities. Running refineries at such an intense level will likely require deeper and more extended maintenance. An outage at BP’s Whiting facility in Indiana due to leaks has taken a massive refinery offline for perhaps a few months and highlights the risk. Several other refineries have suffered damage, and more could need maintenance in the months ahead as summer driving season ends. More refineries offline could divert excess crude into storage and depress oil prices further.

Hedge funds are reducing their net-long positions on oil prices to their lowest level in five years. Such a metric can be interpreted as a proxy for market sentiment, meaning large investors have become the most pessimistic about oil prices since the aftermath of the financial crises. Related: Germany Struggles With Too Much Renewable Energy

The depressed oil price will claim an increasing number of casualties in the oil industry. Samson Resources, a Tulsa-based shale driller, just announced that it plans on skipping an interest payment due on August 17 and would instead file for Chapter 11 bankruptcy protection. Hercules Offshore, a supplier of shallow-water offshore rigs, recently admitted that it is seeking bankruptcy protection as well. The Houston-based company has suffered from a dramatic downturn in business following the collapse of oil prices as well as stiffer competition for more modern rigs. A handful of other drillers have come before Samson and Hercules, and they probably won’t be the last to go bankrupt.

Fitch Ratings warned that more offshore drillers, particularly smaller companies, would face financial distress in the coming months as work dries up. “Backlog protections for offshore drillers are falling away at a fast clip – a significant portion will roll off within the next year – which will likely begin to pressure cash flows,” Fitch analysts wrote in an August 14 statement following the Hercules announcement.

By Nick Cunningham of Oilprice.com

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