FT: “Plunging share prices for US oil and gas companies in recent days have highlighted a potentially decisive factor in the looming crude price war: investor confidence.”
“On Monday, shares in Goodrich Petroleum, a small oil and gas producer, fell 30 per cent, making it the day’s most spectacular casualty, but much larger companies were hit too. Continental Resources was off 5.1 per cent, Hess off 5.8 per cent and EOG Resources off 6.8 per cent. Most of them recovered a little on Tuesday morning, and Goodrich was up more than 7 per cent, but all were below the levels at which they had started the week.
After three years of what was described by Christof Rühl, former chief economist of BP, as an “eerie calm” in the oil market, volatility is back.
Saudi Arabia’s apparent willingness to let crude prices fall to damage its competitors will test the capital markets’ support for US producers. It is shaping up to be the North American industry’s toughest examination since the shale revolution started to revive US oil production in 2009.
….Wood Mackenzie, the consultancy, estimates the majority of US shale production will break even at $75. The International Energy Agency said on Tuesday steeper drops in the price of oil are needed for US shale and other unconventional energy production to take a meaningful hit.
….The steep decline in production from shale wells – it can drop 60 per cent or more in the first year – means that companies have to keep drilling merely to maintain their output, let alone increase it.
If the funds for drilling dry up, then production will fall quickly and the US oil boom will go bust.
As recently as August, analysts were forecasting that next year the leading US shale oil and gas producers would, as a group, be covering their capital spending from operating cash flows. Now that prospect is receding.
Many producers use derivatives to shield them from the risk of falling prices. Pioneer Natural Resources, for example, reported in August that it had bought options to sell in 2016 54,000 barrels of oil a day – about 65 per cent of its oil production in 2014 – with an average floor price of $85.83 per barrel.
Philip Verleger, an energy economist, argues the use of futures and swaps made the US shale boom possible, because the smaller companies that led the revolution were able to secure financing only because they had hedged themselves against commodity price risk.
If oil had stayed at $100 per barrel, all of the main shale producers would have been able to cover capital spending from cash flow within two or three years, according to Phani Gadde, analyst at Wood Mackenzie. Below $90, between 30 per cent and 60 per cent of these producers will still be outspending their cash flows.
….However, Paul Sankey, an analyst at Wolfe Research, cautions that it is hard to calibrate the effect of these price moves precisely. If too much production is knocked out and demand continues to grow, the oil market could tighten again quickly, he says.
“The risk for the Saudis is that they overdo it, and end up with $150 oil on the other side.”
Future Today
