Not much has changed in the oil markets. The price of oil rose briefly above $40 a barrel but has since fallen in the face of massive stockpiles, lackluster freeze talks, and sustained output from US drillers.
Bloated stockpiles of crude oil and oil products are one of the largest obstacles to a price recovery. A U.S. government report showed crude supplies reaching the highest level in more than eight decades on surging imports. At 532.5 million barrels, U.S. crude oil inventories are at historically high levels for this time of year, according to the EIA Weekly Petroleum Data for the Week Ending March 18, 2016. Even if oil production is declining, prices will be slow to recover until those stored barrels start moving.
Abroad, talks between OPEC members and major non-OPEC oil producer Russia over a possible freeze of output at current levels continue; however, Iranian resistance is putting a damper on any hopes for real results. Iranian officials openly mock the idea that they cap output at sanction-levels.
“Recent Iranian statements make it crystal clear to the market that they aren’t about to freeze production,” said Mike Wittner, head of oil markets at Societe Generale SA in New York. “There had been questions about how significant a freeze would be even if they took part. A freeze excluding Iran will do next to nothing about supply.”
Iran is committed to bringing production back in line with pre-sanction levels. This move is not unreasonable. Other countries, many of which are already producing at near maximum levels, cannot hope to push Iran into an agreement so clearly against Iran’s interests, especially since Russia and other OPEC nations have a history of failing to follow through on pledges to cap or cut production.
In the likely event that Iran refuses to limit output, a deal between other producers could still occur given the desperation of nations like Russia and Saudi Arabia whose budgets depend heavily on oil revenues. Meanwhile, crude production is falling in Nigeria and Iraq as a result of insurgent attacks on pipelines; however, the damages are a temporary disruption with some lines already repaired since the attacks. Data from the International Energy Agency show production from the 15 countries discussing a cap would decline even without a freeze with the combined output of the group dropping by 200,000 barrels a day in 2016 because of investment cuts and lackluster demand.
In spite of low prices for oil, drilling has continued at unexpected levels. Oil company executives pay is tied to production because oil stocks are treated as growth stocks. The people making the decisions of when and how much to pump have a monetary incentive to keep pumping to give the impression of future potential even when short run prices are making expansion unprofitable. Large U.S. energy producers base between 15% and 75% of executives’ bonuses on production and reserve growth, based on a Wall Street Journal analysis. Still, after massive write downs on assets and other sobering events during this oil price collapse, companies are beginning to change their compensation structures, as well as their commitment to expansion at any cost.
United States oil production is dropping fast, by more than 500,000 barrels a day since last spring and the oil rig count has fallen by roughly 75% from the 2014 peak. Production costs have fallen almost quickly as crude prices because service companies have been forced to lower their rates and drillers have developed more efficient well designs. Lower costs mean shale producers are likely to ramp up output again and do so quickly; they can drill and frack new wells within a matter of months compared to the years needed for conventional wells. As a result of efficiency gains, the price range that allows output to be profitable has fallen by about $10 since last year to $45-$55 a barrel, said Olivier Jakob, managing director at consultant Petromatrix GmbH.
EIA estimates that oil production from hydraulically fractured wells now makes up about half of total U.S. crude oil production.
But as oil prices show some signs of stabilizing, American producers and oilfield-services companies warn that a jump-start may not be possible due to broken balance sheets, too few workers, or too much idled equipment. Close to 60% of the fracking equipment in the U.S. has been idled during the downturn, according to IHS Energy, which estimates it would take two months for some of that equipment to return. In addition, after the pain of the downturn, many companies are vowing to be more cautious. Still, US oil producers have built up an inventory of drilled but un-fracked wells, which could translate into a quick burst of new output.
“We need a lot of investments just to stand still,” Atkinson said at the launch event of SIEW 2016. “There’s danger as we are reaching a point where we are barely investing upstream. If investment doesn’t resume in 2017 and 2018, we can see a spike in oil prices as oil supply can’t meet demand.”
“Missing barrels are one of many oil-market myths cited by bulls,” Morgan Stanley analysts including Adam Longson said in the note. “The theory is that oil demand is understated because OECD inventories do not capture the full imbalance. However, just because you can’t see them, doesn’t mean they are not there.”