Tuesday, June 20, 2017

Three Years On, Oil Industry Comes To Terms With Cheap Crude

Companies drive down costs, scale back projects and tackle spendthrift culture; ‘lower for longer’ is the new mantra.


By Georgi Kantchev, Sarah Kent and Erin Ailworth
The Wall Street Journal
June 20, 2017

Three years after the price of crude began its rapid descent, the oil industry and investors are finally resigned to the idea of lower prices for longer, potentially ending a period of crisis for the sector.

The price of Brent crude, the international benchmark, is down 59% since it hit a closing high of $115.06 a barrel three years ago on Monday. West Texas Intermediate, the U.S. gauge, also is 59% lower than the $107.26 high it hit a day later.

The steep fall sparked a slump in oil company profits, recessions from Russia to Venezuela, and huge job cuts across the world’s oil fields.

But now, petrostates, investors and major oil companies are adapting to a world in which they see a range of $50 to $60 a barrel as the new equilibrium. The industry has had little choice but to accept the new reality after the Organization of the Petroleum Exporting Countries and other big producers failed to lift oil prices by capping their production, most recently at a meeting in late May.

Producers have cut costs, focused on more-profitable assets and no longer throw money at costly projects in places like the Arctic. Their ability to profit at lower oil prices has helped steady investors’ nerves, and they are starting to fund new projects again, though a debate is still raging over the prospect of a supply crunch down the line.

“Lower for longer has become the new mantra in the industry,” said Daniel Yergin, vice chairman of IHS Markit and a longtime oil-market watcher. “People are re-gearing themselves to a new price level and $50 to $60 seems acceptable to most.”

To be sure, this new range is far from comfortable for some countries and companies, particularly in the services sector, which continue to struggle. Venezuela and its oil-fueled economy have collapsed, and others, like Iraq, are still facing economic challenges.

On Monday, oil prices edged lower, with Brent down 1%, to $46.91 a barrel, and U.S. crude off 1.2%, to $44.20.

But for others the new level is a relief after a combination of booming U.S. shale output and Saudi Arabia’s continued pumping sank crude to decade-low levels of under $30 early last year.

Those U.S. drillers have led the way in adapting to the lower price. Before the bust, producers often needed oil at $80 to $85 a barrel to break even.

Shale producers operating in a number of fields can break even at $50 to $60 oil today, according to oil-and-gas data firm Rystad Energy. There are a handful of companies that have learned to make money on wells at $40 oil.

When the oil price began to fall, Bryan Sheffield, chief executive of Parsley Energy Inc. doubted his Austin, Texas-based company would pull through.

“In year one, I wasn’t sure we were going to survive. We went from $17 to $11 in like three days,” he said of a decline in share price at one point in 2014.

Since the start of 2015, in the U.S., 105 producers and 120 oil-field-service companies have filed for bankruptcy, according to Haynes & Boone LLP. In a calmer environment, there might be one or two bankruptcies of note among oil and gas producers a year and a few more among smaller services companies.

U.S. shale drillers persevered by focusing on their best acreage and making technological improvements, such as drilling supersize wells with more sand to gain savings via economies of scale.

Parsley repeatedly sold shares to raise cash, bolstering its balance sheet and allowing it to make acquisitions in the Permian Basin, a drilling field in West Texas that has become one of the most economic places in the U.S. to operate, where producers can make money on wells even at low oil prices.

Now, Mr. Sheffield said Parsley can continue to expand even if oil drops down to $40 a barrel.

Big oil, too, is settling in for an extended period of cheap crude.

Chevron Corp. , Royal Dutch Shell PLC, Exxon Mobil Corp. and BP PLC have all indicated they will be able to generate enough cash at $60 a barrel to cover spending and shareholder payouts this year, a major focus for investors worried about the safety of dividends. At $50 a barrel, the picture is more mixed. But the companies say they are focused on living within their means at even this price.

In the first quarter of 2017, many big oil companies posted their highest profit in over a year, and investments are picking up again as cost-cutting efforts begin to pay off.

BP spent most of this decade retrenching in the wake of its fatal blowout in the Gulf of Mexico in 2010 and as the oil price skidded lower, but despite weaker crude prices the U.K.-based company is now preparing for a period of strong growth. It is planning to add 800,000 barrels a day of new production by 2020. Last week, BP said it plans to spend $6 billion with partner Reliance Industries Ltd. to develop gas projects offshore India.

“Across the business we are firing on all cylinders,” BP Chief Executive Bob Dudley told investors at the company’s annual meeting last month.

Others are also stepping up activity. On Friday, Exxon and its partners announced a $4.4 billion project to develop one of the largest oil finds in the last decade off the coast of Guyana.

Shares in Shell and Exxon are trading at or just below the levels of much of 2011 to 2014, when oil prices were consistently over $100 a barrel, showing that investors, too, believe big oil companies can handle the lower prices. Companies have driven down costs by squeezing suppliers and contractors, trimmed less profitable projects and tackled a once spendthrift culture.

This is all a big change from just three years ago.

In 2013, Saudi Arabia’s then oil minister, Ali al-Naimi, declared $100 a barrel a “reasonable price” for consumers and producers. Now, many people in the oil industry don’t even want to see that price again, some analysts say. That is because high oil prices triggered a big investment boom that fueled a global supply glut and crashed the market.

In Iraq, the once-booming oil town of Basra is now dotted with half-finished construction projects and motorways that go nowhere, stalled as the oil price plummeted. In Peace River, Alberta, Canada, the promise of a $2 billion new Shell oil facility was expected to double the population of the town. The project never happened.

Cheap oil also helps the economies of major consumers such as the U.S. and Europe. U.S. motorists had logged a record number of miles in the year till March, according to the Federal Reserve Bank of St. Louis.

“For oil, $50 to $60 is a sweet spot both for consumers and for producers,” said Rob Thummel, who manages energy assets for Tortoise Capital Advisors.

While prices are trading below that level—in part because of drillers’ success in adapting—it is a range that has persisted for much of this year and that analysts expect to last.

Over the past year, analysts have steadily downgraded their expectations for oil prices. In The Wall Street Journal’s May survey, analysts predicted Brent would average $59 a barrel next year, down from $68 in the survey a year earlier. For 2019, the analysts now see Brent at $60 a barrel, down from a prediction of $76 last May.

The adaptability of shale producers is key. As the price heads higher, they can open up the taps, sending oil back down and ensuring a range-bound price.

The oil industry may also be wrong and prices may still fall. A slowdown in China, the world’s second-biggest oil consumer, could hit demand. On the supply side, OPEC and other producers could abandon their agreement to cap output.

But the oil industry is feeling better about itself. At this year’s big gathering, Houston’s CERAWeek conference, the mood was palpably lighter, said BP’s Mr. Dudley. “I don’t think I heard anyone laugh last year at anything,” he said.

“It feels like we’re heading into a balance point here,” he said.


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