Oil Expectations Go Low – 1/11/16

Morgan Stanley, Goldman Sachs, and Citigroup recently put out expectations for the price of oil to soon reach the $20 range as China growth slows, the dollar appreciates, and drillers continue pumping through the glut. It appears that market sentiment has well and truly turned against the possibility of a quick rebound. So now the question on everyone’s mind is, when will the losses finally collapse enough producers to put supply in line with slumping demand? Better prepared companies are locked into prices above $50 a barrel this year thanks to hedges. Managers at those companies have every incentive to keep the oil flowing as their most efficient wells are still making decent returns while investors are still willing to put their faith in the energy companies that seem ready to ride out the brewing storm of bankruptcies. All of this happening after the companies took on large debt burdens to take advantage of the time when triple digit prices seemed to go on forever and oil expectations were high.

Even if a large portion of US shale companies go bankrupt when capital markets turtle up and options run out, the assets will just be sold cheap and free of debt to private-equity firms. And once the slate is wiped clean, the rigs will be ready to start up again with the new owners not worrying about debt loads weighing down profits. After the bloodbath, after the bondholders and other stakeholders accept their fates, its hard to say if the hit to production will have a significant, lasting effect since so many are ready to buy up assets and see the benefits when prices rebound.

Cuts in investment made by more traditional producers may be a more permanent feature as the technology that makes high-cost production like shale-oil fracking possible is going to get cheaper and better long before it goes away. The US export ban is gone. As result, the US is ready to be a net exporter of gas as horizontal drilling and fracking made it possible to access previously untapped energy reserves.

Saudi Arabia has made it clear that it will not reign in production even as US producers show significant resilience and a war in Yemen threatens to eat into a government budget counting on 70% of government revenue coming from energy exports. Massive reserves and minimal debt will keep the country from complete collapse but it will still need face oil prices projected to reach $20 a barrel. If oil prices remain low for a protracted period during Saudi attempts to exert influence in Yemen, the government might find itself burning through cash and debt at an unsustainable rate even as it cuts expenditures and attempts to tap international debt markets.

Still, the country is in better shape than Russia and Venezuela. Both countries would need to see a return to $100 barrels to balance budgets. Depending on how long the price collapse lasts, the two countries, and many others, will face short falls and internal unrest that would have been unthinkable a year ago.

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