Making the numbers work at lower oil prices

The current global low oil price landscape creates questions such as, “Is oil exploration still attractive at $50 per barrel?”  This article will explore recent thoughts from oil industry experts.

Reuters reported on March 5, 2017 that the “Titans of oil world meet in Houston after two-year price war”.  Last November, OPEC agreed to a historic cut in output resulting in a 12-year low oil pricing backing up many shale producers to a wall.  As the Middle Eastern producers are cutting production, the U.S. producers are increasing production.  The West Texas Permian Basin is now the hottest U.S. shale oilfield.  U.S. land drilling rigs are up 55% over the past year, mostly in the Permian.  On March 3rd, U.S. crude futures closed at $53.33 per barrel.  According to Reuters, new investments in shale production put a lid on the recovery.  As the U.S. keeps increasing production, oil prices may not even reach $60 per barrel in 2017.

Last February 17, the ZeroHedge site discussed, “Why Sub $50 is more likely than $70 oil”.  Not a very optimistic forecast for oil industry prices.  Their article explained that during the previous week, 13.8 million barrels were added to U.S. surpluses making it the second largest addition in history.  In the meantime, 130 horizontal oil drilling rigs were added since OPEC’s last price cut in September, 2016.  This increase of U.S. barrels created a supply surge which contributes to lower prices.

The key for solving the low prices is inventory as most analysts believe that OPEC cutting production will result in higher prices.  Since overproduction causes lower oil prices, lowering output should result in higher pricing.  However, production is not the same as supply while consumption is not the same as demand.  Surplus supplies can lead to moderate flows if managed correctly thus affecting oil prices.  The proper usage of surplus in times of great demand provides supplies able to meet consumption.

Over-production was the problem

ZeroHedge claims that the global oil price collapse in 2014 was the result of overproduction by Canada and the U.S.  At the time, both countries contributed 44% of the global increase in crude oil supplies.

Don’t expect $70 oil prices in 2017

According to ZeroHedge, the recent OPEC freezes and production cuts only provided a small reprieve for oil prices over the next year.

Last February 5th, a Wall Street Journal article reported new records in long crude oil futures sales in January.  The WSJ article speculated oil price increases due to the end of oil oversupplies.  However, ZeroHedge questions the accuracy of the forecast based on the history of increased long futures following sinking oil prices.

The Canadian Business website on July 4, 2016 published an article titled, “Why it could be time to invest in oil companies again”.  While oil prices sunk to $27 USD a barrel in February 2016, Canadian producers were losing money.  However, when oil prices reached $50, Canadian investors became optimistic.  Yet, as Randy Ollenberger of BMO Capital Markets pointed out, even $50 wasn’t high enough for a full recovery.  Since oil and gas prices remained low, buyers of oil industry stocks could pick the oil companies who are able to stay the course during the pricing crisis.

The Canadian Business site suggested that future oil investors must believe these oil and gas stocks will improve.

The OilPrice website on June 10, 2016 reported that “Oil is set to rally beyond $50” due to oil prices lingering above $50 during the first week of June.  They even quoted Reuters projecting global refining demands reaching near 102 million barrels per day, an all time high by August.  OilPrice concluded that record demand combining with falling supplies offered a clear sign of bullish moments coming for crude oil.

However, OilPrice also reported that skepticism existed.  Analysts from S&P Global and Argus media were not convinced of imminent higher prices.

When oil prices hit $50 last June, Continental Resources (NYSE: CLR) began renewed drilling of their uncompleted wells in the Bakken region.  But, they chose to wait until oil prices rose to $60 before redeploying new rigs for fresh drilling.  Harold Hamm, the company’s chief, predicted a possible rise to $70 per barrel later that year.  Around the same time, Bloomberg reported that investors were buying contracts paying only if oil prices surpassed $100 a barrel over the next few years.

The Financial Times website on April 4, 2016 reported that, “US oil and gas sector reboots to survive”.  A rebound in crude oil prices over the past couple months created a glimmer of hope for U.S. oil companies.  Due to mounting debts during the North American shale boom of the past decade, once the boom ended, only the debts remained.  The future looked bleak for U.S. oil companies as hedges dried up and banks were expected to reduce borrowing while bond markets closed up except for the strongest companies.  Even if the oil prices rose to $50, many companies would still remain in trouble according to Jeff Schiegel of the Jones Day law firm.

Many oil companies were filing for bankruptcy because they couldn’t pay their outstanding debts.  Since September of 2014, the number of oil rigs dropped 77% at their lowest levels since 1940 which resulted in U.S. oil production reductions.

A Financial Times article predicted that the critical level to be $60 a barrel in order to see a revival in oil drilling.  At $50 a barrel, only around 14% of potential shale wells located in the Permian Basin would find it feasible to drill.  And at $60, around 40% would find it viable to resume drilling.

Espen Erlingsen of Rystad Energy consulting firm, predicted that U.S. shale companies have to use their cash flow to cover their capital spending until the prices reached up to $50 a barrel.

The future for oil exploration companies

Back in November of 2015, Hannam & Partners published a report titled, “Why buy exploration at $50 oil”.  In furtherance of more oil exploration, this report offered the following reasons:

• Exploration is cheap because many explorers suffered losses. They listed 15 global oil companies who lost over $6.7 billion during the past three years. So, there is less competitors in the oil exploration industry.
• History demonstrates that valuation upside correlates to the stability of oil prices. Now that some oil exploration companies are worthless on paper, an opportunity exists for investing as eventually oil prices will rise.
• Oil exploration companies have limited access to capital markets. This creates opportunities for new capital insertions.
• Global exploration companies seek to divest assets in order to raise capital. There is a fire sale going on amongst oil exploration companies seeking new capital.
• Exploration costs are low because oil exploration companies slashed their costs to become competitive.
• Now is the perfect time to invest in oil exploration companies who have experienced teams.
• As the market experiences stable oil prices, the valuations of oil exploration companies will rise.

The hotspots for future O+G drilling

The Hannam & Partners Report recommends the following regions as the hotspots for future drilling:

• Upper Arctic Regions

• Central Russia

• Mexico

• Offshore Brazil

• Australia Unconventional

• Central Africa

• Onshore East Africa

• Offshore Caribbean & South America

Conclusion

Is oil exploration still attractive at $50 per barrel?  Most analysts tend to say “No”.  Many predict that an increase to at least $60 could trigger the start of a recovery.  But, with the U.S. increasing oil production, $60 may not be achieved in 2017.

Investing in oil exploration companies now while the market is low appears to be viable.  There are eight regions which can become “Hotspots” for future oil drilling.