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Midweek Sector Update: Will Shale Producers Give Into Temptation?

Midweek Sector Update: Will Shale Producers Give Into Temptation?

With oil prices wobbling above and below $60 per barrel, US shale drillers now face a quandary. Many in Texas and North Dakota could profitably drill somewhere around this range, and indeed, some oil executives have hinted that they may deploy a handful of rigs back into the field. Moreover, as drillers have squeezed out more efficiency in their operations, breakeven prices may have fallen by $10 to $15 per barrel, according to Wood Mackenzie.

Yet, obviously, there is a game theory problem facing the oil industry at present. It may make sense for individual firms to drill a few more wells to improve cash flow, but if hundreds of companies do the same thing at the same time, the collective increase in oil production would send prices back down, hurting all involved. Related: Could Middle East Switch From Oil To Renewable Superpower?

With that said, there is no sign that oil drillers are returning to the oil patch en masse, at least not yet. Oil rigs continue to dip, albeit at a much slower rate. Last week saw 10 oil and gas rigs disappear from the operations.

Whether or not a huge uptick in drilling actually takes place, a lot of oil drillers are being kept alive by generous financing from Wall Street. Eagerly searching for yield in a low-interest rate environment, major financial institutions, including a growing presence of private equity, are continuing to extend credit to oil firms, even those in distressed financial positions.

The big question is whether or not exploration companies will take advantage of the easy money to shore up their balances sheets, or, conversely, they will continue to spend lavishly as if the oil price crash had not taken place. Some are ignoring the warning signs and are using the credit to pay for drilling operations that will only extend their leverage further. On this, though, financiers are as responsible as the drillers. Many lenders are eyeing a massive opportunity in undervalued energy companies, which they believe will bounce back in a big way when oil prices rebound. That may be a prudent approach. But the only problem with that scenario is the possibility that the glut persists longer than they hope.

While the question of where oil prices are going is no clearer this week than it was in the last, the OPEC meeting is set to kick off on June 5, which should provide a sliver of direction. All signs point to a stay-the-course mentality heading into Vienna as Saudi Arabia continues its campaign to capture market share from higher cost producers.

No doubt the oil kingdom has been disappointed with the results in the intervening six months since they decided to leave the cartel’s output quota unchanged. US shale companies have held on a lot longer than expected, and US oil production, while having slowed considerably, has not appreciably declined. That does not exactly offer any reason to change tactics, however. OPEC – via the will of Saudi Arabia – will, in all likelihood, leave the group’s output levels unchanged, to the dismay of several members. Related: EU May Take Desperate Measures To Ensure Energy Security

That decision is likely already factored into the price of oil though, which should not significantly move on the news emerging from Vienna. November 2014 was a surprise, but this time around everyone knows what to expect. The only surprise will be if OPEC does, in fact, alter its production level. In that unlikely scenario, prices would soar.

The rally since March in oil prices is over, but the contango situation has become a bit more interesting. A major contango opened up when oil prices crashed – a situation in which near-future prices sell at a big discount to futures prices. That resulted from a short-term glut and the shrinking storage room for surplus oil. Nobody wanted to take delivery of crude.

But the contango has begun to ebb. The discount for WTI for near-term oil vs longer-term oil narrowed to its lowest level in five months. That suggests a more bullish attitude is beginning to take hold in the oil markets. Storage levels are starting to decline as production has leveled off and consumers are beginning to burn through excess crude. If the gap disappears and the market flips into backwardation, the bull rush is on.

Still, the contango is alive and well for Brent, an international crude oil benchmark. Part of the reason for that is the worse glut for oil in the Atlantic basin. Oil producers are struggling to find willing buyers in the Atlantic, forcing some oil into floating storage. That has hit Nigeria particularly hard, as reported by the Wall Street Journal.

The reason is entirely connected to what is going on in Texas, North Dakota, and other US shale regions. Nigeria produces a light and sweet form of oil, prized due to its ease of refining. However, the US is now producing much more light sweet oil, displacing imported crude from Nigeria. With many refineries around the world equipped to handle heavier types, Nigeria is having trouble finding a destination for its oil exports. Revenues collected from oil exports will drop from $88 billion last year down to just $52 billion this year, a big hit for the new Nigerian government. The problem also highlights the fact that while the US market could be tightening, the global supply of oil still exceeds demand.

We are now in the month of June, which means the negotiations over Iran’s nuclear program are coming down to the wire. It will be a busy month for US and Iranian negotiators, and US Secretary of State John Kerry will be recovering from a broken leg he suffered from a biking accident. The two sides will have a lot to overcome, but Iran, as we have reported before, continues to plan for a future without sanctions. Related: Can Cigarettes Beat Tesla At The Energy Storage Game?

Iran is rumored to be planning much sweeter terms for international oil companies that are interested in returning to the region once sanctions are lifted. Unlike in past contracts in the 1990s and 2000s, Iran is considering the possibility of allowing private companies a share of production, a much more attractive feature than before. That shows a level of seriousness on Iran’s part about partnering with international oil companies to develop its oil and gas resources, and it also shows that Iran is confident a deal can be reached with the West. That bodes well for the outcome of the negotiations.


In an odd bit of news, Brazil’s Petrobras sold $2.5 billion in new debt. While that in of itself is not odd, the terms of the new bonds were: the bonds will mature in the 22nd century. That’s right. Petrobras issued 100-year bonds. That type of length is usually left to more estimable and credit-worthy borrowers – Petrobras’ debt is rated as “junk.” Moreover, who is to say what the state of the oil markets will be in 100 years – or if the world will be using oil at all?

By Evan Kelly Of Oilprice.com

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  • randy on June 02 2015 said:
    I think a number of these shale plays are literally trying to drill their way out of a fiscal hole that they are in... regardless of what happens in Vienna this FRI, they ultimately need the cash flow and simply because of that, they are forced to drill. I do think OPEC will stay the course (to no surprise) and we will start to see WTI heading down after the 4th of July wknd... I sense we will see WTI continually head lower into the late summer/early fall just like it did last year. I see $45 WTI by years end.

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