OPEC Throws Shale a Lifeline

Friday, September 30 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Fighting for China

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- The battle for market share in China is hotter than ever, both because of the expected rise in Chinese oil demand and also because reduced U.S. imports leave exporters searching for markets.
- Saudi Arabia, long one of China's top suppliers, has seen a rash of new competition for the Chinese market.
- Part of the reason is the rise of China's private refiners, known as "teapots," which have made up most of the 13.5 percent gain in Chinese oil imports this year. Saudi Arabia has dealt with Chinese state-owned companies, but other suppliers are taking advantage of demand from private teapot refiners.
- Angola has seen exports to China climb by about 15 percent because it offers a lower-sulfur variety of crude, The Wall Street Journal reports.
- Russia has also offered more flexible terms than Saudi Arabia, such as allowing Chinese teapots to make payments within four months of delivery. Saudi Arabia has not been as generous, and as a result, it is seeing competitors make inroads into China.

2. Production costs falling everywhere

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- The costs of production continue to decline around the world, across all sorts of oilfields.
- Part of the reason is equipment standardization, according to Bloomberg. Some of the industry's largest players have met to begin the process of standardizing equipment and parts in order to reduce costs. Parts, valves, pipes, and even small things like light bulbs have long been unique and different from project to project. That is changing as the industry faces financial pressure.
- Standardization can allow pre-stocking, reducing the time needed to sign contracts and get to work. Bringing production online faster reduces overall costs.
- For example, standardizing subsea forgings alone resulted in a 30 percent reduction in project lead times, Bloomberg says.
- This effort is benefitting deepwater the most, which is rapidly becoming competitive with U.S. shale.
- Falling production costs could ensure steady output in the face of low oil prices - which, in turn, could keep oil prices lower for longer.

3. U.S. shale could ramp up

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- U.S. shale has demonstrated its resilience in the face of low oil prices, although U.S. oil production is down more than 1 million barrels per day from its April 2015 peak.
- Goldman Sachs predicts that output could ramp back up, with production rising by 600,000 to 700,000 barrels per day from today's levels.
- There have been more than 100 bankruptcies in the North American energy industry, but the strongest shale drillers could soon begin drilling again. More than 100 rigs are back in the field.
- U.S. shale is often depicted as the highest cost source of output, but it has breakeven prices that range between $40 and $65 per barrel, depending on the shale play. "The U.S. isn't the marginal barrel but the most flexible," said R.T. Dukes, an analyst at Wood Mackenzie, to The Wall Street Journal.

4. Prices spike on OPEC deal

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- OPEC shocked the world with a deal to cut production, the first cut in seven years. Oil prices surged more than 6 percent on the news.
- Goldman Sachs says the deal, if finalized, could add $10 to the price of a barrel of oil. Still, there are questions about whether or not OPEC can actually implement the cuts, especially since the specifics about who will cut and by how much, have been punted until the November meeting in Vienna.
- Goldman says that it will keep its 2017 forecast intact until OPEC actually delivers on the deal.
- The investment bank noted that past cuts have been possible because of falling demand. This time around will be different, since demand is growing. That will test whether or not OPEC is serious about cutting output.
- Other investment banks were equally skeptical. Citi says the announcement only amounted to "kicking the can down the road."

5. OPEC to solve global surplus?

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- OPEC's promise to trim output by a combined 200,000 to 700,000 barrels per day could go a long way to resolving the global oil supply surplus.
- But the details will matter. If OPEC follows through on cuts of 200,000 barrels per day, the supply overhang will persist until the middle of 2017.
- However, if the group cuts 700,000 barrels per day, the supply/demand balance will tip into deficit as soon as the first quarter of next year.
- Huge pitfalls remain. Iraq has disputed the data on its production levels, with its oil minister saying the country is producing more than it was getting credit for. Arguments like these could derail the effort.
- Moreover, output is coming back in Iran, Nigeria and Libya. While it is impossible to know how much oil will return to the market, those three countries are aiming to bring a combined 1.5 mb/d of capacity back online. If that were to occur, it would more than overwhelm any production cuts from the cartel.

6. Saudi Arabia wanted a deal badly

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- Saudi Arabia has been comfortable letting the market sort out the supply glut over the past two years, knowing it had a large war chest of foreign exchange to fall back on.
- But the oil bust lasted much longer than anticipated, putting increasing financial pressure on Riyadh.
- Saudi Arabia has used more than $182 billion in cash reserves over the past two years, with its total reserves falling to just $564 billion, according to Reuters.
- That is more than enough to maintain its currency peg and keep its economy humming along at today's oil prices for a while, but the Saudi government has become concerned about its cash burn rate and was desperate for a deal with OPEC to lift oil prices.
- It went as far as allowing its regional rival Iran to be exempt from the cartel's production cut.

7. Shale breathes sigh of relief

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- The day of the OPEC announcement, crude prices surged by more than 6 percent. OPEC producers, especially financially-strapped countries like Venezuela, were likely relieved with the price response.
- But U.S. shale has just received a new lease on life. Bloomberg Gadfly notes that on September 28 the top 10 performers in the SPDR S&P Oil and Gas Exploration and Production ETF were embattled shale drillers.
- Their share prices received a more powerful jolt than much stronger oil and gas companies. Murphy Oil (NYSE: MUR) has the highest credit rating of the bunch - S&P gives it just BBB-. Higher oil prices increase the likelihood that these companies will survive the downturn.
- OPEC has succeeded in forcing out some high-cost shale producers, but the adjustment was not finished. OPEC, under financial pressure itself, blinked and threw U.S. shale a lifeline.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.