Tuesday, January 6, 2015

Drowning in Oil (excerpt)

The ongoing freefall in the price of crude oil is unsettling investors. It dropped to $53.04 per barrel of Brent crude yesterday, the lowest since May 2009. It is down 54% from last year’s peak of $115.15 on June 19. The next significant support may be the December 24, 2008 low of $32.27.

At the end of last year, Saudi Arabia’s oil minister Ali al-Naimi said in the Middle East Economic Survey that the current prices of oil will persist over the long term and that oil prices will never go back to $100. He also told the FT, “It is not in the interest of OPEC producers to cut production, whatever the price, whether it is $20, $40, $50 or $60, it does not make sense.” According to him, if Saudi Arabia lowers its production “prices will rise again but the Russians, Brazilians and US shale oil producers will take market share from us.”

For Ali al-Naimi, with production costs at $4-$5 per barrel, the Gulf countries can hold indefinitely with oil at current prices or even if it fell to as low as $20 per barrel. In contrast, the production of shale oil in the US costs in a range between $50-$80 per barrel. “They will be injured before we felt any pain,” he declared. Now consider the following:

(1) Hedges. Yesterday, Reuters posted an article titled, “Revamped U.S. oil hedges may test OPEC's patience.” The key point: “As a war of nerves between U.S. shale producers and Gulf powerhouses intensifies, OPEC's biggest members are counting down the months until their upstart rivals lose the one thing shielding them from crashing oil prices--hedges.

“They may need much more patience than they reckon, however, because those hedges are a moving target. Rather than wait for their price insurance to run out, many companies are racing to revamp their policies, cashing in well-placed hedges to increase the number of future barrels hedged, according to industry consultants, bankers and analysts familiar with the deals.”

(2) Stress test. On the other hand, Bloomberg yesterday ran an article titled, “Oil Below $60 Tests Economics of U.S. Shale Boom.” It notes that oil companies started slashing their capital budgets late last year, when oil was still above $60 a barrel. Bloomberg also reported that some of the largest U.S. shale drillers “have been spending money faster than they make it, borrowing to pay for their expansion, according financial statements filed with the U.S. Securities and Exchange Commission.”

The 12/15 FT reported: “Almost $1tn of spending on future oil projects is at risk after a brutal plunge in crude prices to nearly $60 a barrel, Goldman Sachs has warned. Any cancellation of these developments would deprive the world of 7.5m barrels a day of new output over the coming decade--or 8 per cent of current global oil demand. The findings suggest the supply glut that has sent prices tumbling could soon vanish as the oil majors delay big-ticket production projects--the lifeblood of future petrol supplies, heating fuels and chemicals.”

(3) Rig count. It’s too soon to tell, but my hunch is that US crude oil production peaked at the end of last year and could fall rapidly in coming months. The US oil rig count peaked at 1,609 during the week of October 10 and fell to 1,482 through the week ending January 2.

Today's Morning Briefing: Here We Go Again. (1) Déjà vu all over again. (2) Fear making a comeback? (3) Euro Mess is back with talk of “Grexit.” (4) Is QE the answer to “whatever it takes” for the Eurozone? (5) German bond yield just north of zero. (6) Drowning in oil. (7) Saudi oil minister gets the prize for lowest oil price target at $20. (8) Will hedges keep US frackers pumping longer than expected? (9) Oil industry is slashing budgets. (10) Plunging oil prices should trigger plunge in oil production. (11) Energy sector is weighing on S&P 500 forward earnings, which is at a record high excluding the sector. (12) Focus on market-weight-rated S&P 500 auto-related industries. (More for subscribers.)

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