Energy Industry Troubles Continue – 2/12/16

Recent pricing troubles have turned the energy industry from a reliable source of growth and profits to a feeding ground for “distressed M&A” sharks going after producers teetering on bankruptcy. Low demand and robust output continue to put pressure on all fossil fuel producers.

Emerging markets have accounted for the majority of oil consumption since 2014 with almost all new demand set to come from countries such as China and India, according to the International Energy Agency. While the US is still the largest consumer of oil by a large margin, consumption by the BRIC economies (Brazil, Russia, India, and China) as well as disproportionately high usage by major producers in the Middle East i.e. Saudi Arabia has become a much bigger portion of total consumption. In other words, many countries benefiting from oil exports also make up a large portion of total oil demand. And those countries’ economies are now at best slowing or at worst experiencing major contractions.

Sluggish growth in emerging markets will add to the downward pressure on oil prices. As Christopher Bake, a member of the trading house Vitol’s executive committee said at International Petroleum Week in London, ““I don’t think we can rely on low prices driving much incremental demand from this point. A lot of…demand destruction has occurred in the commodity-based economies.” Mr.Bake’s statement implies that the drop in prices will crimp demand growth from the countries that were expected to make up for lackluster demand growth from the US and Japan. Falling vehicle miles traveled and more fuel efficient vehicles were already a very real danger to oil’s primary role as the essential transportation fuel source in developed countries forcing oil companies to rely on emerging markets to prop up demand and, by extension, oil prices. Now that demand is in jeopardy.

On the supply side, skepticism taints any mention of a deal to reduce output. The desire to keep pressure on US shale drillers, OPEC infighting, and the high probability of members and non-members cheating on any deal actually reached has reduced OPEC’s price regulating power to zilch.

Fights for market share have contributed substantially to the current flood of oil. US shale oil was able to rise to prominence during hypo-$100 a barrel oil and win over a chunk of OPEC’s customer base.

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In response, Saudi Arabia has led OPEC in a do-nothing strategy as oil prices fell in the hopes that the industry would not be able to sustain itself for long… this was not the case. US shale has lasted far beyond expectations on easy credit and increased efficiency while additional threats to the Saudi market share in the form of Russia and Iran standing ready to replace whatever output cuts are made.

Pessimism over the current situation is common among energy industry experts. Many analysts have given up on trying to guess a particular price for oil at 2016’s end. Ian Taylor, chief executive of the world’s largest oil trader, Vitol Group PLC, has predicted that even if oil prices rebound from their current lows to around $48 a barrel by year’s end, they could languish between $40 and $60 for five to 10 years. While analyses by Goldman Sachs Group Inc. and Citigroup Inc put the price at $20 a barrel to see a complete shut off of production for most shale oil production since new owners who gain assets through the upcoming tide of bankruptcies won’t have the same debt burden weighing on current owners. The annual International Petroleum Week saw experts make all these points and more.

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