Petroleum resources, at present, constitute the dominant energy form used to propel the wheels of the global economy. When prices of crude oil or natural gas begin to tumble, economies are therefore affected, whether negatively or positively. For example, while some oil-producing countries reel from current price levels, consumer-countries such as the United States have seen low gasoline prices ― and just in time for the thanksgiving driving holidays ― as well as a spike in demand for SUVs.
Crude oil prices have fallen by as much as 40% since the beginning of the year due mainly to oversupply and decreasing demand. Crude oil benchmarks Brent and West Texas Intermediate closed at US$69.92/bbl and US$67.38/bbl respectively on Wednesday. Expectations that the meeting last week, of the Organization of the Petroleum Exporting Countries, OPEC, would resolve to cut the group’s oil production proved futile; and with good reason. First, OPEC had maintained official crude oil production rates in a narrow band about 30 million barrels per day (mbpd) for the past few years and has seen its market share fall to about 40%. Secondly, the preponderance of supply glut has come from a massive ramp-up of non-OPEC production (Figure 1), mainly from the United States (shale) and Canada (oil sands). Cutting production would have meant, in addition to revenue losses, ceding further market share to these higher-cost producers.
With none of the producer-groups willing to cut production in order to shore up prices, the stage is set then for a costly game of brinkmanship between OPEC and non-OPEC producers; and traditional as well as fiscal fundamentals will most probably define the outcome.
OPEC currently holds about three quarters of the world’s proved crude oil reserves and for the Middle East producers, that value is about two thirds. The latter, producing mainly from conventional fields boast an average production breakeven cost of about US$30/bbl according to Sanford C. Bernstein & Co; this gives them a competitive edge over the tight oil producers of the United States (US$65 – US$85/bbl) and Canada (US$65 – US$110/bbl). According to industry estimates, at crude oil prices of US$70/bbl, about 25% of U.S. shale production will become uneconomic, and at US$60/bbl, the value is about 90%. It is noteworthy that many of these producers have their operations well-funded through the next six months and any impact of the current price decline would only come after that.
That said, several tight oil producers are already feeling the effects of the oil price decline. In Canada for example, Connacher Oil and Gas Ltd, Southern Pacific Resources Corp. and Sunshine Oilsands Ltd, have been forced to review operations. According to Bloomberg, billionaire Harold Hamm, a founding father of the U.S. shale boom has seen his personal fortune fall by US$12 billion over the past three months due to falling oil prices. Hamm’s wealth is tied to Continental Resources, the major operator of North Dakota’s Bakken shale formation. In Australia, Santos, the oil and gas producer has axed a €500 million debt issue due to plunging oil prices. Schlumberger, a leading oil services company is already reducing its seismic survey fleet, for the same reason.
OPEC producers rely mostly on oil revenues to meet budgetary provisions and at current crude oil prices, only two of the OPEC producers are within fiscal breakeven levels. Saudi Arabia, Kuwait, Qatar and the United Arab Emirates however, have savings of about two and half trillion U.S. dollars, enough for some of them to meet capital expenditure for three years at current rates, possibly riding out the effects of low oil price regimes.
With fiscal breakeven values higher than the current oil prices, many of the other producers both OPEC and non-OPEC, such as Russia (US$100/bbl), Iran (US$131/bbl), Iraq (US$116/bbl), Algeria (US$132/bbl) and Venezuela (US$120/bbl), are beginning to feel the harsh effects of falling crude oil prices. Their positions are compounded by lean foreign exchange reserves. Hard-pressed Venezuela for example is putting up part of its PetroCaribe oil supply program among others for sale at a steep discount. The Russian economy, buffeted by United States and European Union sanctions and weighed down by falling oil prices is set to go into recession in 2015, according to the country’s central bank. The Nigerian government has already devalued her currency and set austerity measures in order to check slipping revenues.
All said, there are three note-worthy points:
First, a sustained regime of low oil prices will see the ousting of the higher-cost ― tight oil ― producers. However, with rising oil prices and subject to technical constraints, some production may rebound, making them the new determinants for oil price levels.
Secondly, the fiscally-challenged producers are really between a rock and a hard place; there are not many palatable options currently available to them and given their persistent unwillingness to diversify from an oil-dependent economy, will face these same conditions or even worse, sooner or later.
Finally, the Energy Information Administration projects that the U.S. shale oil production will peak by the year 2020 and then decline steadily thereafter. The implication then is that the capacity to sustain that game of brinkmanship may only endure for the mid-term at best.