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The Pain Game – How Low Can Oil Prices Go?

The critical figures and data in the energy markets this week reveal a further decline in North American oil rigs as natural gas rigs increase slightly.
Oil prices took a dive this week after last week's OPEC meeting. How much pain can North-American producers handle and how much pain is yet to come?

(Click to enlarge)

Chart of the Week

• We have followed the EIA crude oil inventories closely, as they represent a rough proxy for oil supply/demand balance. Rising inventories indicate production outstripping demand.
• The chart shows that inventory levels in 2014 began to detach from the five-year average, rising at an accelerated rate at the beginning of the year as U.S. oil production continued to climb. The jump above the five-year average corresponds with the beginning of the decline of oil prices from the June 2014 peak.
• About 55 percent of the U.S.’ oil storage capacity is located along the Gulf Coast. Cushing looms large because of its basis for the WTI benchmark. But it holds just 13 percent of the country’s storage capacity.
• The EIA says that the crude oil storage utilization at Cushing and the Gulf Coast is at 70.2 percent, a touch below the record utilization rate of 71.2 percent set in April 2015. Near record-high inventory levels continue to weigh on oil prices. Related: This Is Why $20 Oil Is A Possibility

Market Movers

Devon Energy (NYSE: DVN) announced on December 7 its decision to buy 80,000 acres in the Anadarko Basin STACK play from the private company Felix Energy. The $1.9 billion deal will be funded with new equity plus cash (some of which will come from debt). Separately, Devon also spent $600 million to purchase 253,000 acres in the Powder River Basin. The purchases were not looked upon favorably by credit ratings agencies. Moody’s and S&P both put Devon under review for a possible downgrade. Some analysts believe Devon paid too much for the acreage.
Kinder Morgan (NYSE: KMI) moved to reassure the markets about the integrity of its dividend and cash flow after its share price took a dive last week. The pipeline operator says that it expects to grow its dividend by 6 to 10 percent from higher cash flows in 2016. The company’s statements came after its share price fell 30 percent following a Moody’s report raised red flags about KMI’s debt. And as Bloomberg digs deeper on KMI’s balance sheet, it finds that despite assurances from KMI, the company could be facing increasing pressure to slash its dividend.
Royal Dutch Shell (NYSE: RDS.A) obtained approval from Australian regulators for its $70 billion takeover of BG Group (NYSE: BG). The decision had been delayed multiple times. Australia was a particularly important country because of BG’s heavy presence there. China is the last country in which Shell need to wins approval.

Tuesday December 8, 2015

Crude oil prices plunged to new lows on December 7, following on the heels of OPEC’s decision to scrap its production target last week. The markets are reaching new depths of pessimism, with WTI and Brent breaking fresh seven-year lows, dipping below the nadir from earlier this year.

The decision to scrap its production target stems from the increasing competition between Saudi Arabia and Iran. As Iran has the intention of bringing 500,000 to 1 million barrels of oil per day back online within the next year, Saudi Arabia decided to abandon all pretense of a production ceiling. As we reported in last week’s newsletter, the practical effect of removing the ceiling will likely be minimal – OPEC members were ignoring it anyways.

But by erasing the production target from its official policy, Saudi Arabia and Iran could engage in increasing pricing competition and fights for market share. All OPEC members, except for Saudi Arabia, are producing flat out. Iran will soon be doing the same. Saudi Arabia, on the other hand, could decide to produce more or discount its crude further in order to capture more market share in Europe and/or Asia, for example. Either way, the repercussions are not good news for oil prices as supplies will remain abundant and could even increase. The markets reflected the grim news on Monday with oil prices plunging by more than 5 percent. Related: Is OPEC Losing Influence?

The steep drop in crude prices sent share prices of companies across the energy sector tumbling as well. Heavily indebted oil and gas companies saw their stocks fall much deeper, as the integrated large oil companies have a degree of insulation from their refining units. Linn Energy (NASDAQ: LINE) fell by nearly 17 percent; Consol Energy (NYSE: CNX) was off 15 percent; and Rice Energy (NYSE: RICE) was down by more than 14 percent. The larger companies fared a little better – Marathon Oil (NYSE: MRO) dropped 8.31 percent; Pioneer Natural Resources (NYSE: PXD) was off by nearly 6 percent; and EOG Resources (NYSE: EOG) fell by 5 percent.

The slide in oil prices also sparked a sell off in currencies from commodity-exporting countries. The Canadian dollar dropped to its lowest level in over a decade relative to the U.S. dollar. Colombia’s peso also hit a record low.

So while media outlets continue to opine about the “death of OPEC,” it is important to remember that while the group may not be able to dictate prices in the way that it could in the past, it still has extraordinary influence over market movements, even if that influence comes from its inability to make collective decisions.

Oil prices will continue to remain low now that the prospect of OPEC cohesion is off the table. That will increase the pain for oil producers. That also means that dividend policies could come under increasing fire. Kinder Morgan’s dividend is the subject of speculation, as mentioned above. In another example, Marathon Oil slashed its dividend a few weeks ago. The debt loads could become too big to ignore for a growing number of companies, and with few other places to find cash flow, dividends could become the target.

Meanwhile, the supermajors are on surer footing, but the path to create shareholder value is uncertain. In late November, Oppenheimer issued a little-noticed but important assessment of ExxonMobil (NYSE: XOM). The supermajor already slashed its share buyback program so that repurchase levels remained flat for the fourth quarter. The company is cutting spending, but will still produce a cash flow deficit of somewhere between $7 and $7.9 billion in 2016. With ExxonMobil’s production growth expected to be “both anemic and unsustainable,” Oppenheimer says that it believes “Exxon needs another Mobil to create long-term shareholder value through synergy benefits from cost savings and efficiency gains.” Related: Renewable Energy Bankruptcy Threatens Spanish Banks

In other words, the most valuable oil company in the world will be unable to grow production and won’t be able to meet current spending needs while still providing such a hefty payout to investors. The only path forward for growth is through acquisition, not the drill bit. In this context, the conundrum for Big Oil is clear, and Shell’s purchase of BG Group makes more sense.

In other news, Azerbaijan reported that a fire at an oil platform in the Caspian Sea has killed at least two people and left more than 30 workers missing. The fire started on Friday December 4 after a natural gas pipeline ruptured during a storm. As of Monday December 7, the fire had still not been extinguished. The incident took place at the Guneshli oil field. The platform itself only produces 6,000 barrels per day, but it serves at a hub of other Caspian production. Ultimately, around 100,000 barrels per day of output could be shut in. BP (NYSE: BP) is developing a separate section of the Guneshli oil field but the company said that its operations have not been affected.

The speaker of Brazil’s lower house announced plans to open up impeachment proceedings against Brazilian President Dilma Rousseff over breaking federal accounting laws. The move by Speaker Eduardo Cunha is not as straightforward as it might seem, however. Cunha himself is suspected of involvement in the massive corruption scandal that has plagued state-owned oil company Petrobras. Prosecutors say he took millions in bribes as part of the larger Petrobras scandal. The impeachment ordeal amounts to a power struggle between rival factions of government, and will cast a dark cloud of uncertainty over Brazil’s already floundering economy. The impeachment process could take a few months.

The EU Commission says that it “is currently not investigating further behaviors in price benchmarks for the crude oil sector,” ending a probe that raised questions around oil companies like Royal Dutch Shell (NYSE: RDS.A), Statoil (NYSE: STO), and BP (NYSE: BP). The investigation was tied up in the Libor rigging scandal, and the three oil companies had their offices raided in 2013. But, by closing the books on the investigation, no fines will be levied.

By Evan Kelly of Oilprice.com

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Leave a comment
  • rj on December 08 2015 said:
    $80 Oil By Christmas – Do NOT Be Fooled By The Mainstream Media,

    which Christmas?? asking for a friend
  • David on December 08 2015 said:
    I think oil will bottom out at 26$ a barrel beginning of January. Great time to buy an option :)
  • sportsjohn on December 09 2015 said:
    It's not all about what goes in your tank. Don't forget the electronics, plastics and other oil dependent manufacturing processes.

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