With oil prices hitting their lowest levels since March, a renewed sense of gloom has washed over oil markets, and with it, fears over deeper trouble for U.S. shale companies are spreading.
After hitting $43 per barrel in March, oil prices jumped to $60 per barrel by May and then stayed around that level for almost two months, raising confidence that a rebound was underway, albeit at a slow pace. A few companies, including EOG Resources, Pioneer Resources, Occidental Petroleum, and Diamondback Energy, suggested that they were considering stepping up rig counts and drilling activity this year on the heels of stronger oil prices. Having weathered the worst, drillers had cut costs and planned on bouncing back with gusto.
But the optimism is a thing of the past. WTI dipped below $48 per barrel on July 27, not far from the March lows. The low oil prices will likely force a fresh round of layoffs across the shale patch. Halliburton and Baker Hughes have eliminated 27,000 jobs combined, twice as much as they originally announced in February, according to the Wall Street Journal. Months ago job cuts were centered on rig workers and other blue-collar jobs at drilling sites, but now the layoffs are moving up the food chain, hitting engineers and scientists. Usually that is something companies try hard to avoid, for fear of losing irreplaceable talent.
The renewed downturn is also sparking pessimism among oil traders. In recent weeks speculators have taken the most bearish position on oil in years. Net-long positions on oil – betting that crude prices will rise – dropped by 28 percent for the week ending on July 21. The ratio of long to short positions for hedge funds dropped to 1.7 to 1, down from 4 to 1 over the past three months. In fact, net-long positions are at their lowest levels since 2010. In other words, speculators are the most pessimistic about oil prices than they have been at any point in the last five years.
With hedging positions expiring, more companies will lose their protection and suffer from low prices. And unlike earlier this year when banks and equity markets were eager to provide cash injections into battered shale companies, betting on a rebound, financial lifelines are not as generous or as accessible as they were just a few months ago. New loans are coming with onerous interest rates. For some of the weakest companies, access to credit could soon be cut off entirely.
If traders are right and oil prices do not rebound soon, more oil companies could be in trouble. On July 15, Milagro Oil & Gas, a small oil company based in Houston, announced that it has filed for Chapter 11 bankruptcy protection. On the same day, fellow Houston driller Sabine Oil & Gas also filed for bankruptcy.
Even the oil majors are making big-time cutbacks. From the largest oil companies alone, more than $200 billion in spending on new oil projects have been cancelled or suspended, according to a new Wood Mackenzie report. Those 46 projects account for 20 billion barrels of oil reserves. Many of the projects are large-scale offshore projects located in the Gulf of Mexico and off the coast of West Africa, but also high-cost onshore fields, such as Canada’s oil sands. These projects require large upfront costs, require complex engineering, and take years to develop.
Royal Dutch Shell is expected to announce fresh spending cuts this week, slashing several billion dollars off of its $33 billion spending plan released in April.
Deferring projects today makes sense as oil companies try to plug deep holes in their balance sheets. But it also raises the question over available supplies over the long-term. Cancelling projects now will “create a substantial hole in the industry’s investment pipeline,” the Wood Mackenzie report concludes.
But that is too far off for companies to think about. For now, many are just trying to survive the latest downturn in prices.
By Nick Cunningham of Oilprice.com
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