Since June 2014, the oil price has been on a downward spiral. The price of West Texas Intermediate (WTI), a key global oil price benchmark, has more than halved and fell below US$50/barrel for the first time in 5.5 years yesterday (5 January).
How will this impact oil producers and service firms?
According to ratings agency Moody’s, the picture is not going to grow rosier any time soon. It says the global oil and gas industry is entering a challenging 2015, with stubbornly low oil prices.
While integrated oil majors will be best positioned to react to lower prices, offshore contract drillers are likely to have their toughest year since 2009, Moody’s says, as a “tidal wave” of new rig deliveries hits the market this year.
The low prices will also hit exploration and production (E&P) first, followed by oilfield services (OFS) and midstream energy operators, who will feel the knock-on effects of reduced capital spending.
"If oil prices remain at around $55 a barrel through 2015, most of the lost revenue will hit the E&P companies' bottom line, which will reduce cash flow available for re-investment," says Managing Director -- Corporate Finance, Steven Wood. "As spending in the E&P sector diminishes, oilfield services companies and midstream operators will begin to feel the stress."
Some companies have already announced spending reductions for 2015, including Royal Dutch Shell and Total, and cuts look likely at others, including BP.
Meanwhile, Westhouse Securities is watching US production to see how it will impact the market and thinks that prices could return to $70-$80/bbl in coming months. The problem is that oil supply is expected to continue to grow, despite weakening demand fundamentals.
It says the continued sell-off in oil prices reflects the market’s concern that the major oil producers are now engaged in a battle for market share, even in an environment of weakening demand growth. “The major Gulf producers (Saudi Arabia, Kuwait, UAE) have consistently argued that the market should determine prices, and as the lowest cost producers, they are best equipped to manage in a protracted low oil price environment,” says Mark Henderson. “This position is significantly influenced by the experience of the mid-1980s when Saudi Arabia saw production fall from 10 MMbbl/d to 2.5 MMbb/d as it attempted to defend prices. US shale has added 4 MMbbl/d of production in the past five years, with much of this growth funded by debt, and the Gulf producers are essentially betting that the high-cost nature of this new supply, combined with the aggressive decline rates (wells decline by up to 80% in the first year) will lead to a rapid correction in production.”
There had been expectations OPEC (Organization of the Petroleum Exportig Countries), which includes the world's second biggest oil producer Saudi Arabia (behind Russia), would reduce its production in order to bolster prices back up, but, the organisation has said the market should be left to rebalance itseld, as OPEC defends its own market share.
Westhouse says there is evidence of slowing drilling activity in the US, with rig counts down and many oil companies making dramatic cuts to 2015 capex budgets. But, it is likely that it will be a few months before there is any meaningful tangible evidence that the Gulf producers’ strategy is working.
“It is worth noting however that the “spare capacity” in oil markets is much lower than it was 5/6 years ago and so any meaningful disruption in supply, clear evidence of production slowing in the US or improved demand fundamentals could lead to a sharp reversal in the downward trend,” adds Henderson. “Oil companies have made dramatic cuts to exploration budgets and there are a lot of projects that will not deliver positive returns at $50/bbl, so we would expect to see oil prices recover to the $70-80/bbl range in coming months.”
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