The turmoil in the energy market continues anew once again. The market rallied today on the rumor of a planned cut in production floated by the Russian oil minister. Crude oil rallied briskly to the $33 level, a welcome relief to the energy bulls. The article below will update my thoughts on how sustainable the current rally is.
The market has put in a bottom in the $28 range. The energy market has bounced nicely over the $30 level with help from talk of a production cut. While a production cut would certainly aid in bringing the market into balance, my question is "Why now?". The OPEC cartel, most notably Saudi Arabia could have reduced output at any time, yet they have decided to keep production running at full tilt to maintain and expand market share. The strain is being acutely felt the world over by commodity producing countries of which Saudi Arabia is one of the largest. There is no doubt at some point production levels will be reduced to bring the market into balance. The problem with doing so right now is the wave of expected bankruptcies has not played out.
US production has expanded tremendously over the past few years in large part by smaller, less well-capitalized companies that formed to exploit the vast oil resources trapped in shale formations across the US. The fuel needed to fund such endeavors was provided by the banking system, made possible through very low-interest rates that have persisted post the great recession of 2008. The smaller shale frackers were taking market share away from OPEC and most notably Saudi Arabia. The OPEC cartel desperately needs a stable oil price to fund the social programs at home. The constant new stream of supply would not only reduce market share, it would inevitably lead to a price lower than the preferred level.
To gain better control of the marketplace, in my view the decision was made to drop the price of oil and drive the smaller less well-capitalized companies out of the industry. The plan has been in place for over 15 months, we are rapidly entering the "maximum pain phase" yet the marketplace has not seen a wave of bankruptcies yet. For OPEC to cut production now would send a lifeline to the shale producers, at which point one has to ask what was accomplished besides depleting one's foreign reserves.
Core Labs commentary
I use the results from Core Labs (NYSE:CLB) and Schlumberger (NYSE:SLB) as a "tell" as to the anticipated path of future production. The following commentary from CLB's recent transcript is quite interesting:
The Company continues to anticipate a "V-shaped" worldwide activity recovery in 2016 with upticks starting in the third quarter. Global demand for hydrocarbon-based energy continues to improve, while worldwide crude oil supply peaked in the second half of 2015, beginning a decline that Core believes will continue through all of 2016. The Company currently believes that U.S. land production peaked in March 2015 and has fallen since then by over 600,000 barrels of oil per day ("bopd"), some of which was offset by new additions to production in the Gulf of Mexico ("GOM") as a result of recent field developments coming on-line in 2015. Given the current, depressed commodity prices, Core believes further new additions to production in the GOM will not be sustainable. Based on currently available worldwide crude oil production data, coupled with internal Core Lab data, Core has increased its estimate of the net worldwide annual crude oil production decline curve rate to 3.1% from 2.5%. This additional 60 basis points decline is predicated on sharper decline curve rates for tight-oil reservoirs and the significant decline in maintenance capital expenditures for the existing crude oil production base.
At current U.S. activity levels, Core predicts 2016 crude oil production to be lower year-over-year; perhaps falling by over 900,000 bopd in 2016. This, coupled with the continuing decline in international production and the continuing increase in global energy consumption, should create a tight crude oil supply market for the second half of 2016, which should lead to increased crude prices and industry activity levels worldwide.
Link courtesy of the Sentieo platform
In fairness, CLB management team expected a "V" shaped recovery to commence in late 2015. I find their recent commentary to be quite illuminating and in-line with my own thoughts. SLB CEO was very cautious in calling for a bottom, although he did mention he expects a recovery in 2017.
The impact on the Integrated Oil Majors
The greatest challenge facing the integrated oil majors (IOC), is the severe shortfall in upstream (exploration and production) revenue. Using ExxonMobil (NYSE:XOM) as an example, the slide below clearly illustrates the challenge facing the company. Downstream (refinery) profits can partially offset the profit shortfall. Keep in mind, the figures below are for the third quarter, XOM has yet to report 4th quarter numbers. Crude oil average price was higher in the third quarter than the fourth; I expect XOM numbers will feel the impact yet again of the low price of crude oil.
The Path Forward
I suspect the bounce in oil here is not sustainable outside of a production cut. The industry will again feel the pain in the current quarter as we are 1/3 of the way through, and the price of crude is substantial below the fourth quarter numbers. I suspect the proclamation from CLB will be proven accurate yet not before we have a solid retest of the lows coupled with a swath of bankruptcies in the industry. At this point, the field will be cleared for the larger players to reassert their dominance once again. With concern to XOM, they have a golden opportunity to use their balance sheet to acquire assets at prices that will be proven to be a depressed level. While there are scant guarantees of success (see the XTO energy purchase) some well-timed investments will set the company up nicely for the next upswing in energy.
While the recent price action is positive, the jump higher in the past two days off of the rumor of a production cut will more than likely not be sustained. The energy market will remain under pressure until additional companies are forced into bankruptcy. We can see the fear clearly in the underperformance of the banking industry. I remain intrigued here; a very profitable long-term opportunity will present itself, yet we are just not quite there yet. I thank you for reading and look forward to your comments.
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Disclosure: I am/we are long SLB.
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