AS I WRITE this column, oil futures are hovering at about $41.86/bbl (WTI). Brent crude is nearly $3 higher at $44.61. This is not the direction the industry wants commodity prices to go. More importantly, it is not the direction the industry expected it to go - not now, in late July, during the peak summer driving season in the US when fuel consumption is supposed to increase and retail prices rise accordingly.
A month ago, crude futures were flirting with the $50 mark. Oil and gas companies were making plans to ramp up again. Industry executives were preparing for a recovery. From all appearances, it seems that recovery may be delayed.
So, what now? We have moved into the third quarter of a new year, and companies are starting to report second-quarter earnings. It still looks pretty dismal. Even energy giants like ExxonMobil are concentrating on reducing costs rather than expansion. Exxon, which purchased shale producer XTO Energy in 2009 for $41 billion, a deal that drove the oil major's net debt to $35 billion from a previous cash surplus. Faced with declining revenues and net income, in April of this year the Irving, Texas company lost its coveted AAA credit rating.
With low fuel prices at the pump, even the refinery sector is suffering. Margins have fallen due to excess inventory and reduced driver demand. So the refining business hasn't bailed out the integrated majors this year as it has in the past.
If prices collapse again while hedge funds and short-sellers take their profits, energy companies will be in worse trouble than ever. Although they have taken an axe to spending and laid off tens of thousands of employees, many of them are in no position to survive another wave of low prices. They are still leveraged to the hilt financially and desperately need cash flow to meet their obligations. However, many E&P companies are using revenues to finance drilling operations rather than pay down debt. Their hope is they can do both, but low prices often mean uneconomic wells and insufficient cash flow. A well that might be marginally economic with $50 oil doesn't perform as well at $40, and is a disaster at $30.
At the risk of stating the obvious, we have a supply-and-demand problem. US oil and product inventories have hit an all-time high of approximately 1.4 billion barrels. This is far greater than would be expected during the summer when people are driving more and taking vacations. Blame the Permian Basin producers if you like. Unlike the other major US shale basins (Bakken, Eagle Ford, etc.), where we have seen production declines, operators in the Permian believe they can still drill profitable wells. Maybe they can with $50 oil, but how about $40? How about $30? And how much does that production help to keep US inventories high and prices low?
The Saudis are the obvious villains in the eyes of many US producers. They have refused to cut production to make a place in the market for the roughly 50% increase in North American oil since 2009. Imagine that! Why wouldn't they gladly hand over market share to the Americans? We'd do the same for them, right?
But not only have the Saudis not cut production, they have increased it. The Saudis seem convinced that the fossil fuel industry is dying, and they have ramped up production to sell their crude while they believe there is still a market for it. Saudi Arabia's 20-year strategy is based on the assumption that renewable energy is the wave of the future. They don't see any point in conserving what there may not be a market for in the years to come.
It doesn't matter if we disagree with that point of view; it is clear that is the Saudi strategy. And Russia seems to be operating on the same premise. Don't expect either nation to cut or freeze production levels despite occasional rumors they will do so. More than likely, the rumors are a marketing ploy.
In short, with this significant imbalance between supply and consumer demand, it is reasonable to expect prices to remain low until the situation changes.
Rusty Braziel, president and principal consultant for RBN Energy in Houston, addressed this issue in an interview in the June issue of OGFJ. "We are witnessing the impact of creative destruction," said Braziel. "The survivors will be those companies that learn how to adapt to today's market realities."
Boom and bust cycles will continue to come and go, said Braziel. "The obvious lesson is that nothing lasts forever. This [downturn], too, will pass. But the more important lesson is that the winners are those that position themselves in the bust cycle to ride the next boom up. The natural tendency in a busy cycle is to hunker down, and to some extent, all must do that. But if a company can align its opportunities with what the next market is likely to bring, it can be hugely successful, regardless of when the next cycle happens."
I would add to that - get your finances in order. A heavy debt load among US oil companies has ballooned seven-fold in a decade, according to a Houston Chronicle analysis. That debt is far too high and will delay the eventual recovery.