Oil Issues: Shale and OPEC at Odds – 4/5/16

Cheap oil and other oil issues are having big effects on the balance of US trade. The rise of shale threw into flux everything people thought they knew about the energy trade between OPEC and the United States.

This year, the average price per barrel of imported crude slipped to $27.48,  the lowest its been since 2003, rebounding back above $40 only recently. Fueled by a shale drilling boom, abundant domestic oil at low prices drove petroleum imports to the lowest level in nearly 15 years. And the U.S. registered its highest trade surplus on record with OPEC nations, a record $1.8 billion, compared to the last 30 years in which the U.S. has only posted a surplus two other times.

OPEC nations like Saudi Arabia and Venezuela have had their budgets devastated by a rise in U.S. oil production and a Chinese-led demand slowdown which resulted in the current global energy glut. OPEC officials continued pumping at record levels even during oversupply in an effort to maintain market share while the low prices forced out U.S. competition, a plan that ultimately backfired as shale drillers showed surprising resilience.

Pacts to freeze production to support prices are often mentioned though no real results are expected from talks between OPEC nations and Russia. Saudi Arabia, by far the largest producer of OPEC, has made its participation, laughably, contingent on the participation of Iran. Meanwhile Iran, after years of sanctions, is commited to increasing its output by over a million barrels. Influential Iranian officials have already made it clear that the government intends to claw back market share from regional rival Saudi Arabia. On top of tensions within the group, Russia with its desperate need for income and history of abusing output reduction deals is unlikely to follow through on its role in the freeze even as it already pumps at record levels.

A report last week from the U.S. Energy Information Administration highlights why any pact made for the purpose of propping up prices is destined to fail.

well age

Over 48% of U.S. oil production, not including Alaskan output, came from wells less than two years old. This youthfulness is because relatively quick to start shale oil had an explosive growth spurt going from 500,000 barrels a day in 2009 to a peak of 4.6 million last May, only declining as the glut gutted investment spending. And even now a vast number of partially drilled wells are being prepared for the time when $60 a barrel oil returns. The return of U.S. shale producers is inevitable so long as people need oil and next time they’ll have all the efficiency and a fraction of the debt they have now.

Of course, whatever the far future may hold for U.S. shale, the near future is going to be excruciating. According to monthly data from the EIA, the current level of U.S. output is at its lowest since October 2014 as spending cuts and idled rigs weigh on producers. Still, low prices are culling fewer companies than anticipated, as crude hedges are being locked in at prices as low as $45 a barrel, indicating break-even prices far below old estimates. Naturally, a break-even point even as low as $45 a barrel isn’t much comfort when the price per barrel is $40 or less.

The inability to turn a profit at current prices has many U.S. oil and gas producers very dependent on the generosity of lenders. Unfortunately for many, redetermination season – when banks reassess credit lines – is fast approaching. The last round of reassessments was surprisingly lenient, but this time around many more companies will likely be forced into desperation financing or bankruptcy filings when faced with estimated reductions of up to 20% to 30% on average. Such sharp cuts to credit lines are in part because of past leniency though there are two other factors in play. The first is that price hedges are running out. Even the most forward thinking derivative agreements are expiring now that prices have been low for so long. The second is that since exploration and drilling have slowed, new reserves cannot be counted on as collateral for loans.

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