Ever the pessimists, our friends at Standard & Poor's have updated their price assumptions for West Texas Intermediate, crude oil, Brent crude oil, and Henry Hub natural gas. The revised prices are down for the rest of 2014 and through 2015.
"The downward revisions to our oil price assumptions reflect dramatic recent movements in future prices for both Brent and WTI," says S&P credit analyst Ben Tsocanos. "We attribute the declines to continued supply increases in North America and recent data indicating softening demand from European and Asian economies.
Tsocanos added, "The downward revision to our natural gas price assumptions for the remainder of 2014 and 2015 reflects strong North American supply and moderate demand growth."
In its October 20 US Research report, Raymond James, which is usually only slightly less pessimistic than S&P, says it believes the recent weakness in crude prices is "likely more trading related than fundamental related." Nevertheless, RayJay notes that several fundamental oil drivers have deteriorated over the past couple of months. This includes increased production from Libya and to a lesser degree Nigeria, lower global oil demand assumptions, and Saudi Arabia's willingness to allow oil prices to fall below $90 per barrel.
Market observers know that price assumptions often turn on a dime and move in the opposite direction just as quickly as the 180 they did in the past 12 months. Commodities markets are similar to the stock markets in this regard. Trends can hinge on market perceptions, and in the case of crude oil, prices can spike if one major oil-producing country or region has a terrorist incident or shows signs of political or economic upheaval. Perception is reality for oil and gas analysts.
Despite what they are saying publicly, the Saudis are playing a giant game of chicken with the United States with regard to oil production. The kingdom of Saudi Arabia could easily curtail production, as it has many times in the past, without harming its economy. This reduction in supply would bolster oil prices.
Unhappy with the ramp up in oil production in the United States, the Saudis have increased their own oil output substantially. This has had the effect of reducing global oil prices from in the range of $100 a barrel to about $80/bbl as of late October - a 20% drop. Officials in Riyadh apparently think they will make the US blink first since finding and drilling costs presumably are higher for US shale producers than for conventional production in Saudi Arabia.
But this isn't just about Saudi Arabia and the United States. Consumers seem to be happy that their costs have declined, and this may boost spending and improve economies in Europe and Asia that may be lagging, thus increasing demand. In addition, the governments of Iran, Venezuela, and several other OPEC nations have expressed consternation at the Saudis for not reducing their output because lower prices mean less revenue for them. Other OPEC members such as Kuwait and the United Arab Emirates generally support the Saudi position. If Saudi Arabia doesn't relent, it could bring about a schism within the cartel, which is the last thing the Saudis want.
From Saudi Arabia's perspective, the US should be the one to reduce production to balance the market. Publicly, they say they welcome US oil production because it will help prevent price spikes up to $150/bbl as we have had in the past. However, prices have dropped to nearly half that, so one would think the Saudis would have begun curtailing production well before prices decreased to their current level. Instead, they are waiting for the US to do so.
Robert McNally, president of the Rapidan Group and a former energy adviser to President George W. Bush, recently told Platts that he thinks Saudi Arabia's breakeven price is $87/bbl, citing the International Monetary Fund (IMF) as his source.
However, McNally said, "I think Saudi Arabia could withstand a drop into the $70s or $60s for a short period of time much better than some of their rivals…Also, Saudi Arabia has a war chest, about $750 billion earned in recent years, that they can use to tide things over while they sweat some production out of the US and other competitors."
He estimates that if oil stays between $50 and $80 for an extended period, the US would start to see a drop in drilling in some shale plays. Combined with the steeper decline rates of shale wells, that would lower production, he added.
At the annual Texas Energy Update in Dallas on Oct. 24, several researchers and senior oil and gas executives expressed their view that the domestic energy industry is not suffering excessively in the current lower price environment. For some shale operators in parts of the Eagle Ford shale play, for example, the breakeven price point is as low as $40/bbl, they said. For other operators in different parts of the play, it could be $70 or $80, they added. In other words, the economics can vary significantly from company to company, from shale play to shale play, and even from one well to another within the same play.
Overall, the Texans exuded confidence. In other words, it's not a given that the US will be the first to blink.