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Evan Kelly

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Midweek Sector Update: This Key OPEC Member Could Soon See Production Cuts

The business climate is only getting worse in Iraq for the handful of international oil companies operating in the war-torn country. The Iraqi oil ministry sent a letter to private oil companies operating in its energy sector that spending will likely be reduced in 2016. In Iraq, companies maintain and produce from oil fields and are reimbursed by the government. However, the collapse of oil prices has sapped the government of resources, and Baghdad has struggled to pay the money owed to companies.

The Wall Street Journal reported that the Iraqi government sent a letter, dated September 6, that warned oil companies to expect low reimbursement levels, and that they needed to submit only modest funding requests. “Because of the drop in our oil-sales revenues, the Iraqi government has sharply reduced the funds available to the Ministry of Oil,” the official letter read. “This will…reduce the funds available for the reimbursement of petroleum costs to our contractors.” The deteriorating fiscal position for the Iraqi government will negatively impact companies like Eni (NYSE: ENI), Royal Dutch Shell (NYSE: RDS.A), BP (NYSE: BP), and Russia’s Lukoil (MCX: LKOH). The situation is similar in Iraq’s northern territory of Kurdistan, a semi-autonomous region that has its own deals with oil companies. Kurdistan has also had trouble paying oil companies like Genel Energy (LON: GENL). The Kurdistan Regional Government has promised that it will begin paying companies this month, after moving to export oil on its own without the permission of the Iraqi government.

So far this year, Iraq has succeeded in achieving impressive production gains, surpassing 4 million barrels per day (mb/d). However, the inability of private companies to securely operate in Iraq and count on consistent payments from the government could cut into the country’s long-term ability to increase oil output. Iraq once had very ambitious goals to double its oil output to 6 mb/d by 2020, a goal that is now in jeopardy. Related: Low Oil Prices Throw North Sea Oil Into A State Of Crisis

Meanwhile, OPEC stays the course. In August, the latest month for which data is available, the oil cartel continued to produce well in excess of its stated target of 30 mb/d. Collectively, the group produced 31.5 mb/d, a level that has been mostly unchanged for more than three months. The high levels of output continue to keep pressure on oil prices, with crude trading in the mid-$40s per barrel. Nevertheless, OPEC predicts that shrinking U.S. output, coupled with rising global demand, will eventually erase the supply overhang.

The EIA estimates that U.S. shale oil production could fall by 80,000 barrels per day in October, in further evidence that low prices are significantly cutting into output. The losses will be led by the Eagle Ford in South Texas (down 62,000 bpd) and the Bakken (down 21,000 bpd). As the losses from legacy wells overtake new production, the overall decline from the shale patch will continue.

In the same report, the EIA also expects natural gas production to decline. After years of blistering growth, even during times of weak pricing, the U.S. shale gas industry is finally stalling. Even in the prolific Marcellus Shale, natural gas production has peaked and could continue to decline. The inflection point is intriguing because natural gas prices have gone through periods of sub-$3 per million Btu (MMBtu) gas, just as it is now, but producers still managed to increase gas flows. Now that is changing. The difference is that so much natural gas was being produced in conjunction with oil, almost as a byproduct. That meant that even though natural gas prices were low, oil prices were high, so drillers kept drilling and the gas kept flowing. Now that the oil rigs have vanished, natural gas production is falling. Related: Panasonic Now Gunning For Tesla’s Energy Storage Crown?

The financial struggles for U.S. drillers may come to a head this month and next. The periodic credit redeterminations are set to take place, meaning that weaker drillers could see their credit lines slashed. That could mean an accelerated pace of asset sales, injections from private equity, and/or more debt defaults and bankruptcies as companies run out of cash. The Wall Street Journal predicts somewhere around $10 billion worth of credit could disappear in the coming weeks.

Legendary investor Carl Icahn is raising his stakes in Cheniere Energy Inc. (NYSE: LNG), the company slated to be the first big LNG exporter from the United States. Icahn now holds 22.7 million shares, or about 9.59 percent of the company. The move follows the disclosure in August that Icahn had taken an 8.18 percent position in the company, upon which he had said the company was undervalued. Cheniere Energy’s stock jumped 3 percent on September 14 following Icahn’s increased position. Cheniere is expected to ship out its first LNG cargo later this year, marking a new era for LNG exports in America.

Oil Search Ltd. (ASX: OSH), an Australian oil and gas company, rejected an $8.2 billion bid by Woodside Petroleum (ASX: WPL), arguing that the offer “significantly undervalued” the company. The bid amounted to a 14 percent premium for Oil Search’s shares, but Oil Search says that figure doesn’t adequately account for its LNG expansion plans in Papua New Guinea. The rejected offer would have represented the largest energy acquisition in Asia. Woodside could still make a higher bid for Oil Search, and other counter-bids could come from other companies. Related: EU’s Energy Market In For Some Drastic Changes

Finally, in a bit of political news, Australia’s Prime Minister Tony Abbott was thrown out of power by his own party this week. Abbott had championed the resource extraction sector in Australia, cutting taxes on coal and iron ore, the two main exports for his country. However, he had grown deeply unpopular in Australia, where his highly conservative views on social policy appeared increasingly out of touch. That being said, Australia’s poor economic performance, stemming from plummeting prices for all sorts of commodities, is what really did him in. He is replaced by Malcolm Turnbull, who will face the same economic headwinds that Abbott ran into as the economy is dependent on the export of natural resources, a liability now that global commodity markets are oversupplied.

By Evan Kelly of Oilprice.com

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