For more than a year, every now and then, plunging oil prices have been impacting the market. In fact, the multi-year lows that crude witnessed frequently during this span dragged the major energy players especially the upstream firms to touch 52-week low marks. Following the events, many energy players are almost abandoning their respective upstream operations and are struggling to continue their dividend payments. Many firms are still paying dividend out of issuing debt, which is not sustainable.
Hence, oil price recovery is the only event that can salvage the energy players from their huge debt load. In such a scenario, the Organization of the Petroleum Exporting Countries (OPEC) came up with its October report forecasting a slowdown in U.S. production. Moreover, OPEC added that global demand is growing.
With oil demand improving and U.S. supply expected to go down, obviously a big push is likely in the near future that can lift the oil price if not to its prior lofty levels, then at least to a decent trading band.
Looking Back
It is common knowledge that the oversupply of crude led the commodity prices to enter into the bearish territory. Weak global demand was also a major concern.
Here’s a quick recap on the history of the crude oversupply. During 1990 and early 2000, the U.S. was more dependent on crude import as domestic demand was far above its conventional oil supply. But with the invention of new techniques like hydraulic fracturing and horizontal drilling, U.S. shale producers ramped up oil production relentlessly. Eventually, owing to its huge scale of crude output, U.S. started relying less on oil import.
The shale boom turned the U.S. into an oil surplus economy from a crude deficit region. Along with the U.S., the OPEC cartel also pumped up more crude. All these events led to a global oversupply of the commodity and pushed oil to its multi-year low marks. West Texas Intermediate (WTI) crude closed at $47.10 per barrel yesterday, less than half the price of the commodity during the mid-2014 level. Most importantly, WTI crude witnessed the largest one day percentage fall – almost 5.4% − yesterday since Sep 1, this year.
Ray of Hope
The gloomy business scenario has halted major energy projects. Many energy players have stopped hunting for new oil stores. The lower exploration activities eventually halved the dayrates of offshore oil drillers from the peak rates seen two to three years ago.
It is to be noted that as per media resources, exploratory budgets for big energy companies fell 50% from the peak levels two years back. In more details, this year, oil firms have reportedly reduced capital expenditure by $130 billion, almost 22.4% below the level seen last year. In fact, the International Energy Agency (IEA) added that this drop is the worst ever. Paris-based IEA is the energy-monitoring body of 28 industrialized countries.
Many analysts are forecasting further reduction in capital spending next year. Barclays PLC BCS is anticipating 2016 global upstream capital expenditure to drop up to 8%, while Citigroup Inc. C foresees oil and gas spending in the U.S. to reduce by 15% to 20%.
With significant reduction in capital spending on oil and gas upstream activities, near-term commodity supply will surely reduce. Moreover, since very few long-term upstream energy projects are now being sanctioned, a further reduction in oil supply is anticipated for the coming years. Both events are bankable for a crude recovery from the bearish territory as oversupply of oil has been the prime reason for the freefall in crude price.
In its latest October report, OPEC projected 13.5 million barrels per day decrease in the U.S. crude and natural gas liquid production for year 2016. Most importantly, this forecast is totally opposite to OPEC’s September projection of stepped-up U.S. output. Investors should note that this the first time in the last eight years that the cartel is anticipating a production drawback for the U.S. As per OPEC secretary-general Abdalla Salem el-Badri, lower future oil supply following a considerable spending cut might help the oil price to recover.
Royal Dutch Shell plc RDS.A, one of the largest integrated energy firms in the world, has also pointed out significant exploratory spending budget cut will be the key to an oil price pick up in the near term.
Who Will Benefit?
The debt laden U.S. energy players involved in oil upstream operations or in generating maximum cash flows from exploration and production activities will be the major gainers from an oil price recovery. This is because the companies generate revenues from selling the commodity to customers that include refiners.
Just to mention that big energy companies like Shell, BP plc BP, Exxon Mobil Corp. XOM and Chevron Corp. CVX have suffered tremendously due to low oil prices. This is evident from the fact that year to date, Shell, BP, Exxon and Chevron are down 17.4%, 7.2%, 14.2 and 21%, respectively, on NYSE.
Hence, once oil price starts rebounding, the key players should start generating cash flows that will help them to unburden their huge debts, invest in prominent plays for long-term production and provide for future energy needs.
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