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How Far Will Oil Sink Before Christmas?

From the key figures from the oil and gas industry this week, we see U.S. crude imports surge, whereas U.S. domestic production sees a slight decline. U.S. average gasoline prices see a minor decline and U.S. crude stocks see a minor draw.

(Click to enlarge)

Related: How Electricity Markets Could be Upended by this Supreme Court Decision

Last week’s OPEC decision has set off another round of crude losses, which persisted through the week. WTI is now decidedly in mid-$30s territory, with Brent breaking through the $40 per barrel threshold. The losses were once hard to imagine. The bearish voices out there (Goldman Sachs, for example) had raised eyebrows over the course of this year when they predicted oil would drop below $40 per barrel, even provoking some mockery at times. But they were right – here we are.

The short run doesn’t look great, either. “When we look at 2016, I don't see many reasons why we can see upward pressure on the prices…Demand is weaker and we may well see Iran come back (to the market) and there will be a lot of oil,” IEA’s executive director Fatih Birol said in Paris this week. “So 2016 may well be another year with lower prices and this will have implications of course for investments in the oil sector.”

The collapse of crude prices has once again put pressure on emerging market currencies. Canada’s dollar hit an 11-year low against the U.S. dollar this week. Colombia’s peso hit an all-time low. Russia’s ruble is once again under fire, nearing record lows. Other currencies under pressure – the Saudi riyal, the Nigerian naira, the South African rand, Brazil’s real, and Mexico’s peso. With a rate hike just around the corner from the Federal Reserve, the dollar could appreciate further – or put another way, emerging market currencies could continue to fall. This threatens to destabilize fragile economies with rising inflation and depleting foreign exchange reserves.

OPEC piled on the bad news. After last week’s removal of a production target, this week the oil cartel released figures that showed the group collectively produced the most oil in three years in November, ramping up output to 31.7 million barrels per day (mb/d). Iraq accounted for most of the monthly gains, achieving more than 247,000 barrels per day in increases from October. Related: Strippers Suffering From Low Oil Prices

The bearish news suggests more pain in the offing for U.S. shale. The EIA put out an estimate, expecting U.S. shale to lose 116,000 barrels per day in production in January, with the largest losses once again coming from the Eagle Ford shale (down 77,000 barrels per day).

Production could continue to decline for quite a while. Chevron (NYSE: CVX) and ConocoPhillips (NYSE: COP) each announced spending cuts for 2016 of an eye-watering 25 percent. The oil majors are struggling to cover organic cash flow with revenues at today’s prices. More spending cuts from a lot more companies should be expected.

An estimated $250 billion has been slashed in 2015 compared to spending levels in 2014, according to Rystad Energy. The same consultancy sees another $70 billion trimmed from spending next year.

The fall in oil prices and the corresponding deep cuts in spending are what we are dealing with today, but some in the industry think that the world is planting the seeds for a major shortage of supply in the years ahead. The CEO of Italian oil giant Eni (NYSE: ENI) Claudio Descalzi told Bloomberg that a price spike might occur in the medium-term because of the shortfall in investment today. “What is worrying me is not the price of today; it is what is happening in the industry,” Descalzi said from the COP21 climate change conference in Paris. “We cut about $200 billion and I think next year we are going to do the same and that can create in the mid-term an imbalance between supply and demand.” Low investment today means a shortage of new supply three, four, or five years from now. Related: Venezuelan Government Losing Grip As Low Oil Prices Take Their Toll

Mining companies are also getting walloped in today’s market. Mining giant Anglo-American (LON:AAL) announced that it would be laying off 85,000 workers in a major restructuring. Its share price dropped by 20 percent this week, hitting a record low. The company’s dividend will be suspended for at least a year. With metals and coal prices down to multiyear lows, the mining company is seeing revenues dry up.

Low oil prices have another detrimental effect on oil companies: it reduces their assets, officially. Producing oil at these low prices, in many cases, is not profitable. That means that oil companies have to officially lower their reserve figures when reporting to financial regulators. Chesapeake Energy (NYSE: CHK), for example, has seen 1.1 billion barrels of oil vanish from its books because of low prices, reserves that are no longer technically recoverable. Although this is an accounting quirk (the oil in the ground has not gone anywhere), it can have a material impact on the share prices for companies, and thus the returns to investors. In the coming months, as a result, we could see the collective figure for U.S. recoverable oil reserves fall significantly.

Mexico is preparing for another oil auction on December 15, this time for onshore tracts. The Mexican government has held two auctions in recent months for shallow water tracts in the southern Gulf of Mexico. The first, over the summer, was a disappointment, but tweaks in bidding terms attracted a bit more interest in September. The upcoming auction has attracted even more interest, with a record 79 companies qualified to bid, up from just 20 in September. Mexican regulators have not set a minimum bid requirement for the tracts, and says that royalties will range from 1 to 10 percent. Bloomberg raised the question of security – over 3,600 illegal taps on oil pipelines in Mexico siphoned off over $792 million worth of stolen fuel in 2014. So far, oil companies – 50 of the qualifying bidders are Mexico-based – are not showing signs of being deterred by oil theft.

By Evan Kelly of Oilprice.com

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