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March 2016

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Editorial comment

US$40 is the new US$70 – at least that’s the phrase that has been making the headlines recently. It wasn’t too long ago that US$70 was seen as a rough minimum required for US shale producers to make money. As the downturn wore on, that figure soon fell to US$60, then US$50 and now – if John Hart, CFO of Continental Resources is to be believed – US$40 could be the turning point.

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According to Reuters, Hart stated that Continental would be prepared to increase Capex if US crude prices reach “the low- to mid-US$40s range”, effectively boosting 2017 production by at least 10%.1 Whiting Petroleum Corp, the biggest producer in the Bakken is currently on track to stop fracking of all new wells by the end of March, but CEO Jim Volker was quoted as saying that the company would “consider completing some of these wells” if oil made a return to the US$40 - 45 range.2

This sounds like good news for shale producers, but is such a rally likely in the short term? As I write this, Brent crude has spent more than a week sitting comfortably above US$35. Whilst that’s nothing spectacular, it’s certainly an improvement on the lows of US$27 that were reached just a few weeks earlier. The driving force behind this particular upswing appears to have been the recent announcements by several major oil and gas producers, Russia and Saudi Arabia included, that they would aim to negotiate a production freeze and cap output at levels seen in January. The news of this potential agreement brought a surge of optimism to the market and lifted oil prices. After all, a production freeze could be seen as the first step along the way to production cuts, a reduction of the supply glut, and a return to higher prices. Alexander Novak, Russia’s Energy Minister said the aim of the production freeze was to “stabilise the price of oil around US$50 - 60/bbl”.3

It’s not all sunshine and rainbows, however. As tempting as it may be to buy into the possibility of a sudden upswing, Matthew Smith, Head of Commodity Research at ClipperData summed up the situation neatly, “Fundamentally, things are still extremely weak. It’s being driven more by hope.”4 All the factors that caused prices to fall in the first place are still in play. A freeze in production might seem like an admirable first step – an attempt to work towards cuts – but agreeing to freeze production at levels that outmatch demand seems of little practical use. The other spanner in the works is Iran; having finally emerged from sanctions earlier this year, the Iranian government is – I think understandably – more than reluctant to agree to the freeze and effectively start sanctioning itself.5

Despite these issues, oil prices will eventually recover – that much is certain. For one thing, the supply glut is unsustainable in the long term – major suppliers, such as Saudi Arabia, are burning through their cash reserves to make up the shortfalls in their budgets. In the meantime though, it’s encouraging to see the continued ingenuity and tenacity of the US shale industry, despite the hardship felt by many. The same drive that brought about the shale boom in the first place, and made the industry profitable at US$100/bbl, has led to the development of technologies and processes that allow companies to operate at less than half the price. It’s that kind of approach that will see the upstream industry make it through the downturn.

References

  1. ‘U.S. shale’s message for OPEC: above $40, we are coming back’ – http://www.businessinsider.com/r-us-shales-message-for-opec-above-40-we-are-coming-back-2016-2?IR=T
  2. Ibid.
  3. ‘Critical Mass’ of Oil-Producing Countries Agree to Freeze Production’ – http://www.wsj.com/articles/critical-mass-of-oil-producing-countries-agree-to-freeze-production-1456865007
  4. ‘Is the oil crash over? Prices soar 32% in 12 days’ – http://money.cnn.com/2016/02/29/investing/oil-prices-surge-opec/index.html
  5. ‘Iran pushing forward with plans to ramp up oil output’ – http://money.cnn.com/2016/02/28/news/economy/iran-oil-production-deputy-minister-interview/

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