Mayer Brown: How to survive low oil prices

With West Texas Intermediate trading at US$60.13/bbl and NYME natural gas set at $2.94/MMBtu, hydrocarbon producers are looking for ways and means to survive the low price environment. Some of those that are best weathering the storm are those that made specific choices before the fall, according to Dr. Michelle Michot Foss, chief energy economist at the University of Texas at Austin. Foss was the keynote speaker at Mayer Brown’s 10th Annual Global Energy Conference.

“The cheapest producers are also the ‘gassiest’ producers that, for the most part, did not move out of gas and into liquids because of cost and capital constraints,” she says. “Also, production companies thrive on economies of scale. Shale oil and gas is not cheap to produce, and companies need those economies of scale to spread the costs across large production areas to survive.”

However, high-cost producers can also prevail by reducing costs, improving their acreage and by drilling less expensive wells, says Foss. Gas producers should minimize ethane production and optimize natural gas liquids production to maximize value.

Lynn Cook, deputy Texas bureau chief and deputy energy editor for the Wall Street Journal, says, “We’ve plunged from $100/bbl to $40/bbl, and have since clawed our way back up to $60/bbl.” But operators should not get too confident just yet, she says. “The rally might have gotten ahead of itself. We could still drop right back to $40.”

During another panel discussion, a group of economists and industry leaders were asked to answer the burning question of the day: When will oil prices recover? Despite the fact that the learned executives had left their crystal balls at home, they each gave it their best shot.

John Gerdes, managing director and head of research for investment and merchant banking firm, KLR, predicts that prices could “re-evolve to US$80/bbl” sometime next year.

James West, senior managing director and fundamental research analyst for Evercore Group, says, “We are decidedly bullish on oil prices. We see capex coming down by 20%. Production could be down by 500,000 bpd by the end of this year, and maybe down by as much as 1 million bpd in 2016. I think we will see $75- to $80-oil by the end of this year.” Also, West believes that deepwater costs could come down during the next few years. “We don’t think deepwater is dead, even though many people do. We think it is just on pause.”

Regarding the financial market’s appetite for oil and gas investment, Pearce Hammond, managing director and co-head of E&P research for Simmons & Co. International, says, “So much private equity is chasing distressed debt that there is no more distressed debt. The oil price has fallen, and the cost to drill has fallen, and productivity has improved.”

In fact, at $65/bbl, many producers are earning the same return in some plays as they earned a few years ago at $90/bbl, he says. Operating companies’ cash flows are down about 40%, but he believes the oil price has an upward bias to it. “Oil service companies have cut costs so much that some producers are talking about going back to work at $65/bbl,” he says. “That could be the cause of new increased production — which we don’t need.” Hammond notes that offshore deepwater, Arctic, and Canadian oilsands producers have been harder hit than onshore shale producers because “shale players are quicker to react.”

Could US crude exports bolster oil prices? No so much, says Gerdes. “With the price of Light Louisiana Sweet crude and Brent near parity, there is not a lot of incentive to export crude in terms of practical economics.”

According to Pearce, the export ban is not likely to be lifted during the Obama administration, but West expects the ban to be lifted during the next US presidential administration. Meanwhile, condensate that has been processed through splitters or separators is considered to be a product, not crude, and is being exported.

What about the Iranian and US “ducks” overhang? Not significantly relevant, say the panelist. “Iran is not going to bring on more than 500,000 bpd,” says West. “The Iranian minister says he can bring on as much as 3 million bpd, but we don’t think that is true.” As for the “ducks,” a term that refers to drilled but uncompleted (DUC) wells that many industry professionals believe could be quickly completed and thus crash the oil price, Gerdes says, “That overhang inventory cannot enter the market quickly. About 70% of the cost of each well is the completion, and it’ll take a long time just to find service capacity,” which is vulnerable to personnel attrition as redundancies continue.

So where is the oil price headed? Not anywhere soon, says Charles Ebinger, senior fellow of energy security and climate initiative for Brookings Institution. “Global oil demand has been declining during the past 11 years. This slowdown can be attributed, in part, to the lack of demand, especially falling demand in China and India.” European oil demand is forecasted to be flat for the next decade, he adds. Other low-demand contributing factors include the global aging of country populations, and heavy national debt loads. Also, coal usage is still the fastest growing fossil fuel in the world. And in the mid-term, truck and vessel fleets can turn to natural gas for fuel.

Yet, all forecasts can be immediately erroneous at any instant. “The old rule of forecasts was to make as many predictions as possible, and publicize the ones you got right,” says Ebinger. “The new rule is to forecast so far into the future that no one will remember anyway.”

The good news? “I see no oil or gas shortage in the near term,” says Ebinger.


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