If the round of second-quarter upstream conference calls showed anything, it was that operators have been humdingers in recent months: incredibly competitive, ruggedly hard-working and totally determined to match their operating costs to slipping oil prices, with a bit left over for profit. And they have succeeded beyond their most extravagant forecasts. The cost of producing the once-perceived “high-priced” unconventional oil patch has now fallen, in some cases, to per-barrel breakeven prices pretty much on par with an extra-large delivered pizza with all the works, including tip. According to the North Dakota Oil and Gas Division, some parts of the Bakken Shale in that state have breakeven prices as low as /b. And a recent analysis by Moody’s showed that North American independent producers, most of whom have shale operations, can survive at about /b — about what oil is right now. Imagine that.
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If the round of second-quarter upstream conference calls showed anything, it was that operators have been humdingers in recent months: incredibly competitive, ruggedly hard-working and totally determined to match their operating costs to slipping oil prices, with a bit left over for profit.
And they have succeeded beyond their most extravagant forecasts. The cost of producing the once-perceived “high-priced” unconventional oil patch has now fallen, in some cases, to per-barrel breakeven prices pretty much on par with an extra-large delivered pizza with all the works, including tip.
According to the North Dakota Oil and Gas Division, some parts of the Bakken Shale in that state have breakeven prices as low as $24/b. And a recent analysis by Moody’s showed that North American independent producers, most of whom have shale operations, can survive at about $42/b — about what oil is right now.
Imagine that. All the labor, ingenuity, science and pricey sophisticated hardware that goes into identifying prospects, exploring, drilling, completing wells, and hauling up a barrel of oil originally sited at 8,000 or 10,000 feet below the surface of the earth, is valued at about the same as a much yummier but less vital product made by a guy who throws a little dough on a table, spoons some cheese and tomato sauce and tosses a couple of toppings on it, and bakes it all up at 700 degrees Fahrenheit for a few minutes.
The last month has also proven something else: that oil companies, which after the first quarter were getting ready to shrug off the down-cycle doldrums and look ahead to what was thought would be a return to reasonably higher crude prices, have now reckoned with a long spell of dismal price levels. Producers appear resigned to sub-$50 oil for the duration and are now thinking about how to manage a company in 2016 at 2004 crude price levels, and possibly for the next couple of years.
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The admirable part is that they’ve proved they can produce prodigious amounts of oil, and also that they’ve crash-dieted their costs to very bony levels in a hurry. More puzzling was that even with signs earlier in the year that some order of lower oil prices would be around for awhile, most upstream E&Ps were in no rush to scale back production even though they knew that was what US shale producers needed to do to ease prices.
As Iberia Capital Partners analyst David Amoss put it: E&P companies that are producing more oil at less cost “will probably also tell you they expect US production to decline in second-half 2015 — just not their production.”
In a report summing up the second quarter’s results, analysts at boutique investment bank Global Hunter Securities wrote: “Every US producer seems to claim an inventory of project IRRs [internal return rates] that work at $50 oil, plus possesses a general paranoia of letting production go on decline.”
Even as oil prices plummeted below $45/b in recent weeks, some operators raised production targets for this year because of outstanding well performances. Not every company, but many did. Investment bank UBS noted that of its coverage universe, at least 18 companies moved up their 2015 production estimates recently.
In an era like the present, pride goeth before a fall — of oil prices that is: a 60%-plus drop in value since mid-2014 and more than 30% in the last two months. It must be difficult for oil company executives who have boasted of growing oil volumes 20% or 30% year over year to have to brake to just a few percent growth in output for next year. How do you learn to saunter when you’ve been running a marathon for several years?
So old habits die hard. The hope is that US second-half oil production growth will be more sedate, and even inch down a bit to balance off the 9.5 million b/d average that the US Energy Information Agency estimates producers turned out in the first half of 2015. EIA estimates full-year US production for 2015 at 9.36 million b/d.
Industry-watchers observe that one reason for continued high production rates, despite a general recognition that more oil equals lower price in these times, is staying attractive to shareholders. When operators can point to raised output, lower costs and beating guidance, it delivers a lot of nice warm fuzzies.
For most of 2015, industry has been confident that slashed E&P capital budgets this year would naturally lead to less production, and has eagerly watched for signs of it. But significant output declines failed to materialize in the first eight months of the year as official estimates wobbled up and down.
So what’s next? Already companies, prodded on by Wall Street, have begun to telegraph their thinking about 2016 capital budgets and production targets. And while the information so far is scanty — after all, they still have four months of 2015 ahead and this year has been enough of a challenge for any executive — early signals about next year are mixed.
Everything, of course, depends on oil prices. Most producers say they can be flexible with their budgets. Some will lower capex next year, but even more important than a figure is that most intend to be cash flow-neutral — that is, holding their spending to income levels. And most of the larger producers will show some oil growth but nowhere near the double-digit levels year on year that many touted at the start of 2015. A few producers have been forced to suspend drilling or keep it to skeletal levels to fulfill obligations — to hold onto acreage, for example.
In short, “Lower for longer is here,” said Global Hunter Securities in a recent note, summing up a recurrent phrase of Q2 upstream corporate earnings calls. But “we don’t see an easy fix that balances [the market] anytime soon.”