Oil Majors Are Ready To Rake In Profits

Friday April 28, 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. Bakken is rebounding

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- North Dakota was hit hard by the oil price downturn, with companies scrapping rigs and laying off workers. Oil production in the Bakken fell from a peak of 1.2 mb/d in late 2015 to below 1 mb/d a year later.

- The Bakken was hit again when oil companies realized that the Permian was much more competitive. Shale companies began withdrawing from the Bakken and redeploying assets into the Permian.

- The lack of pipeline infrastructure pushed down the prices that Bakken producers could obtain, forcing them to offer discounts to get their crude onto pipelines. Otherwise they had to move crude by rail.

- But the rise of oil prices to $50 has some companies drilling again in the Bakken. The rig count is up and production is finally starting to rise again, putting output back above 1 mb/d.

- In fact, Reuters reports that the first shipment of Bakken crude was recently exported abroad. The completion of the Dakota Access Pipeline will boost the competitiveness of the Bakken, allowing more oil from North Dakota to make its way to the Gulf Coast.

2. Jobs in renewables surging

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- Wind and solar still make up a relatively small fraction of the U.S. electricity system, but they employ a lot of people. The solar industry - which generates just 1 percent of total U.S. electricity - employs 370,000 people.

- That is a remarkable contrast to the 160,000 people working for the coal industry, even though coal accounts for about a third of U.S. electricity generation.

- Coal employment has long been in decline because of technology and automation. The decline of coal-fired power plants and coal production has accelerated the job losses.

- Wind and solar together employ roughly 475,000 people, or about three times as many as coal.

- But because wind and solar jobs are dispersed across the U.S., whereas coal jobs are concentrated in Appalachia, coal still maintains disproportionate political power.

- Nevertheless, with wind and solar cost competitive with coal in many parts of the country, coal is on its way out.

3. OPEC cuts depend on Russia

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- With OPEC's monitoring committee officially recommending a six-month extension of the production cuts, a deal seems likely in late May. But an extension will depend on continued cooperation from Russia.

- Most analysts see Russia agreeing to an extension, but one problematic issue for Moscow is the fact that Russian oil production ebbs and flows seasonally. Icy winters tend to push down production a bit. That made Russia's initial acceptance of production cuts not all that painful. Output would have likely fallen by 40,000 to 50,000 bpd in early 2017 even if Russia did not sign on to OPEC's agreement.

- Russian oil production is expected to rise in the summer, so agreeing to an extension will require more sacrifice than the original agreement. "It was not a surprise and not a big deal to have production going down in the first half of the year," James Henderson, a Russian oil expert at the Oxford Institute of Energy Studies, told Bloomberg. "When you go into the second half it's a different story. All thoughts of production growth this year go out of the window."

- On top of this, Rosneft has an oil field in East Siberia slated to start production in the near future. Lukoil has new wells coming online in the Caspian Sea.

- Russia's situation could complicate its calculations when negotiating with OPEC.

4. Breakeven prices fall for shale plays

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- Shale production is rising in all the major basins in the U.S., aided by a rebound in oil prices since late last year. But the biggest reason for the rebound is the sharp fall in the cost of production.

- The five largest shale plays account for 80 percent of U.S. shale production, and the breakeven prices have falling dramatically in all of them.

- In the Permian Midland, for example, the breakeven cost has plunged to $39 per barrel, a 60 percent decline since 2013. The Permian Delaware breakeven has fallen to just $33 per barrel, also a 60 percent decline.

- Some of the cost savings could be eroded, however, with oilfield services companies demanding higher prices for rigs and equipment.

- But as long as oil prices stay above $50 per barrel, there is plenty of room to run for U.S. shale.

5. Oil traders less interested in oil futures for delivery several years out

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- The oil futures market is larger than ever, with an estimated 2 billion barrels of contracts traded on the New York Mercantile Exchange.

- However, the volume of contracts traded several years out has plunged, with traders focusing much more on short-term trades.

- According to the FT, since 2012 the open interest in oil futures for delivery three to four years from now has declined by 75 percent.

- This is the result of the shale industry, which is having a growing influence over oil prices, particularly for WTI. With shale drillers able to complete wells in a few weeks and sell the crude in less than six months from the initial drill date, there is much less of a need for long-term hedging and most companies have hedges that expire within a year.

- That makes the back end of the futures curve much more uncertain. "Liquidity breeds more liquidity, but illiquidity breeds more illiquidity. It's a vicious circle on the way down," John Saucer of Mobius Risk Group, an energy risk advisory company, told the FT.

6. Confidence in EV revolution rising

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- French oil giant Total SA (NYSE: TOT) is the latest to warn about the pending revolution in electric vehicles, which could pose an existential threat to the oil industry.

- Total's chief energy economist, Joel Couse, told Bloomberg New Energy Finance that EVs will account for 15 to 30 percent of the vehicle market by 2030, causing crude oil demand to "flatten out" and "maybe even decline." EVs only capture 1 percent of the market today.

- BNEF has warned about the rise of EVs, but Total's prediction is one of the most aggressive.

- Batteries are the costliest part of an EV, but battery costs are declining by about 20 percent per year.

- New EV models set to be unveiled in the next few years will accelerate sales. "By 2020 there will be over 120 different models of EV across the spectrum," Michael Liebreich, founder of BNEF said. "These are great cars. They will make the internal combustion equivalent look old fashioned."

7. Big oil profits

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- Higher oil prices and lower production costs are expected to result in a dramatic improvement in the bottom lines for the oil majors.

- Earnings season is getting underway, and the first quarter of 2017 could see profits for the oil majors double. Bloomberg estimates that cash flow could for the five oil majors could be 67 percent higher than a year earlier.

- Analysts expect Royal Dutch Shell (NYSE: RDS.A) to see earnings the highest in nearly 2 years.

- ExxonMobil (NYSE: XOM) announced a 2 cent per share increase to its dividend earlier this week, marking the 35th consecutive year of a dividend increase.

- With lots of speculation about rising debt and unsustainable dividend payouts, the improvement in the financials for the oil majors means their fortunes are rebounding, likely ensuring their dividends survive for the time being.

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