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John Manfreda

John Manfreda

John majored in Pre-Law at Frosburg State Universtiy and received his MBA at Trinity University. He has co-authored The Petro Profit report and dividend stock…

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Support For OPEC Production Cut Is Increasing

Support For OPEC Production Cut Is Increasing

Recently, Bloomberg reported that Iran’s oil minister had spoken with Mexican officials with regard to stabilizing the oil market. Iran claims that, if OPEC decides to more actively manage the oil market, that Mexico, the third largest oil producer in the western hemisphere, will cooperate with them in an attempt to stabilize the oil price.

For the general public this may seem like a new idea, but the fact of the matter is, that this wouldn’t be the first time that Mexico has co-operated with OPEC in an attempt to stabilize the oil price. The first time this happened was in 1998, when Mexico, as well as OPEC members Venezuela and Saudi Arabia, organized a coordinated production cut with 17 other countries that included Norway and Russia.

While rehashing this plan may sound great on the surface, the reality looks to be much different than it was in the late 1990’s. Since 2003, oil production from Mexico has been on a significant decline. Related: With Shell’s Failure, U.S. Arctic Drilling Is Dead

For the first time in 40 years, Mexico has actually become a net importer of petroleum products in its trade with the U.S. Even though Mexico is still a net exporter of oil, it is starting to import its other petroleum-based products, such as natural gas and gasoline from the U.S. So while Mexico says it is willing to co-operate with OPEC, the reality of the situation is very different now.

This is why Mexico has stated that they can’t consider any production cuts at the moment. Some analysts are even estimating that Mexico might soon go from being a net exporter of oil to becoming a net importer of oil. Related: How Much Longer Can Venezuela Keep The Wolves At Bay?

Without Mexico’s co-operation, where can output cuts come from?

When it comes to production cuts other then Mexico, the first two entities that come to mind are Saudi Arabia and Russia. But Putin has already stated that he won’t be helping OPEC when it comes to production cuts, as he has just taken the title away from Saudi Arabia, to become China’s number one oil supplier. The Saudis, on the other hand, are unable to cut production as they are engaged in a battle for market share with producers from around the world, including the unconventional producers of North America, and as mentioned above, with Russia as well, among others. This is why the Saudi Arabia is unlikely to reduce its oil output anytime soon, despite the high cash burn rate its treasury is currently facing.

Now with Mexico, Russia, and Saudi Arabia out of the picture, the question remains: who is going to decrease their oil production? In my opinion, there is only one entity that comes to mind, and that entity is the U.S. shale producers. Related: Exxon CEO: Alaska Is Its Own Worst Enemy

Now the shale producers won’t willingly reduce output, as shale production is made up of many different companies, and not a national company like most global oil producers; but due to the economics of the current oil price environment, many shale oil producers will face bankruptcy next year, and as a result, will go out of business.

The reason being is that in 2016, most oil hedges will expire. These hedges have allowed shale oil companies to stay afloat and achieve cash flow neutrality, despite the decline in oil prices. These hedges have also helped shale oil companies gain access to credit, so they can raise the capital needed to put their wells into production. When these hedges expire, companies will not generate the cash flow needed to meet their covenants, which will in turn bankrupt them, and production from U.S. shale oil wells, will start declining rapidly. This will also dry up the credit markets and prevent any type of quick rebound in shale oil production.

This is why the IEA even estimates that U.S. oil output will start collapsing next year.

By John Manfreda for Oilprice.com

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  • Andrew on September 29 2015 said:
    Just because a company goes bankrupt doesn't mean their wells will stop producing. Those existing wells, and the fields they are in, will likely be acquired by a more stable company who will then maintain them.

    There's not a big red button that is pressed to control production (excluding an emergency kill switch)

    The accelerating or soon to be accelerating decline in production will be a result of stiff decline curves for shale wells and decreased investment in new E&P. Combined, these two factors will have a lasting effect that will continue well beyond a price rebound.

    WHEN the price turns, always when, never if (baring a miraculous break through science...GO PHYSICS), the U.S. industry won't and can't react immediately. In part because of what was mentioned above, but also because time will be a major issue.

    Assuming they had they capital to do so, companies will likely be stalled due to the availability of equipment and personnel. Rigs and service equipment will likely need to be serviced due to being idled and new personnel may need to be hired and trained as previous employees may have moved on to different careers. This will lead to increased competition for services likely meaning the cost for service will rise and those companies will work for whichever operator will pay them the most. This means the cost to drill a well will increase meaning a higher oil price will be required for profitability.

    However, if you want ignore all of that, and assume there will be no issues. Even if, I don't know, 500 rigs were added in one week (this is hypothetical mind you), those production increases would not result for likely 6-12 months as the process from spud date to in-service doesn't occur over night and has many "moving pieces"...both literally and metaphorically.
  • fred on September 29 2015 said:
    Actually, not quite the correct scenario. The shale wells owned by distressed companies will be purchased at rock bottom price, will continue to pump, and be very profitable at $40.
  • David Stephan on September 29 2015 said:
    If Shale producer are losing money on production and making money on hedges they should stop all production activity that are losing money and just collect on their hedges. But my guess is the Shale producers are not yet at the point where they are cash flow negative on production. They probably still have positive Ebitda. If they don't they can maximize value by stopping production.

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