Despite Huge Losses Oil Companies Reluctant To Shut In Production

As energy investors look for reasons to be optimistic, many are keeping close tabs on supply figures.

There are some signs that supply is taking a hit from disparate parts of the globe. According to Bloomberg, China might see its output dip by 3 to 5 percent in 2016, down from a record high of 4.3 million barrels per day (mb/d) last year. If that occurs, it would be the largest drop since at least the early 1990s and the first decline in seven years.

China's oil production does not get nearly as much press as its consumption figures do, but China is actually the fifth largest oil producer in the world. However, China's onshore oil fields - where the country gets 80 percent of its production - are mature. Without ongoing investment, production tends to decline. Any sources of new production will come from more expensive offshore or tight oil.

"We expect significant cuts in upstream production as the companies cut output at loss-making fields," Neil Beveridge, an analyst at Sanford C. Bernstein & Co, told Bloomberg in an interview. "Chinese explorers need to take more radical action to cut operating costs and increase efficiency." China's Cnooc, one of its main oil producers, probably has a breakeven price near $41 per barrel. The company says that it will spend less and produce less in 2016. Related: Despite Bold Predictions, T. Boone Pickens Sells All Oil Holdings

In the U.S., there are signs of adjustment as well, although very slowly. Continental Resources gutted its spending program for 2016, reducing capex by 66 percent. That will translate in a dip in production. Output will fall steadily over the course of the year, and the company expects to close out the fourth quarter with production of 180,000 to 190,000 barrels of oil equivalent per day, which could be 10 to 15 percent below its 2015 average. Continental Resources might be illustrative of the ravages of low oil prices, since it had much less of its output hedged at higher prices over the past year after liquidating a lot of its hedged positions in 2014. As such, many more companies could begin suffering the same misfortune of lower production as their hedges roll off.

Overall, the EIA expects U.S. production to fall by 700,000 barrels per day by the end of 2016 to 8.5 mb/d, or more than 1 mb/d below the 2015 peak.

However, the oil markets are still suffering terribly because of the ongoing glut. Much of that can be pinned on the fact that oil producers are reluctant to shut in production, even if they are losing money on every barrel sold. A new report from Wood Mackenzie finds that 3.4 mb/d of oil production is "cash negative" at today's prices, equivalent to about 3.5 percent of global production. But shutting down has its own costs, and could make restarting more difficult and expensive. For some oil fields, shutting down could cause permanent damage to reservoirs. Related: Obama Proposes $10 Tax On Each Barrel Of Oil

That means many companies have every incentive to keep as much production online as possible, even if it ends up being a net-loss. "Given the cost of restarting production, many producers will continue to take the loss in the hope of a rebound in prices," Robert Plummer, VP of investment research at Wood Mackenzie said, according to Reuters. "Curtailed budgets have slowed investment which will reduce future volumes, but there is little evidence of production shut-ins for economic reasons."

Wood Mackenzie came up with a pretty shocking figure that will make the hearts of every oil bull sink: only 100,000 barrels per day of global production - out of total global output of 96.1 mb/d - has actually been shut in so far (output declining because of natural depletion is a separate thing. This refers to production intentionally shut down because of economic reasons).

It is an unbelievable statistic, given today's prices, and it demonstrates the difficulty that the oil markets will have in finding some sort of equilibrium. Related: U.S. Rig Count In Free Fall: Plunges By 48 In One Week

Still, there are significant volumes underwater. Wood Mackenzie says that the 2.2 mb/d of expensive oil sands in Canada are in the red. Venezuela is also sitting on 230,000 barrels per day of heavy oil is being produced at a loss. Offshore in the North Sea is another high-cost area, and there is about 220,000 barrels per day of "cash negative" production there. Nevertheless, instead of shutting down, most companies producing at a loss - even at a loss! - will continue to produce, and divert their production into storage rather than suffer the costs of shutting down.

That, of course, will mean that it will take much longer than expected for oil prices to rebound, which will only occur when demand rises and soaks up the excess supply and/or natural depletion saps global production. Maintenance or mechanical problems could knock some output offline as well. But the whole process will take still more time.

In a dramatic move, Morgan Stanley cut its estimated oil price for 2016. The bank now expects oil prices to continue falling through the year instead of rebounding in the second half. The investment bank expects Brent to average $29 per barrel in the fourth quarter, rather than its previous estimate of $59 per barrel issued just last month.

Then again, what if OPEC and Russia meet in February to coordinate production cuts? It still seems unlikely, but unless that happens, oil prices may not stage a rally this year.

By Nick Cunningham of Oilprice.com

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