Musings: Failure To Cut Production Puts Pressure On E&P Operations

Hess To Form MLP For North Dakota Oil, Gas Transport Assets
G. Allen Brooks examines the factors influencing global oil demand in light of OPEC's recent "war on shale".

This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.

According to comments from OPEC Secretary General Abdallah Salem al-Badri during a press conference following completion of the organization’s meeting, "We're not sending any signal to anybody...We have to wait and see how the market will settle. As I've said many times, don't panic." He further commented that “the ministers are happy.”

It is hard to believe that all 11 oil ministers representing the members of the Organization of Petroleum Exporting Countries are happy with the outcome of their 166th meeting since several ministers – Venezuela and Nigeria in particular – had argued vehemently prior to the meeting for a cut in the group’s production in an effort to shore up global oil prices. What they can take comfort in is that they have made 7.15 billion people living on the planet happy since the cost of energy will be lower in the future, which should help the living standards of those people.

For those who operate in the energy business, the task for the past few weeks has been to try to predict both what OPEC would do at the meeting and whether the group would change the recent trajectory of oil prices. If so, then everyone’s business strategy would remain largely in place – plan on more shale drilling, expect large oil companies to resume their long-term offshore and Arctic drilling plans and energy-consuming companies would continue to build new manufacturing plants in relatively low-cost energy markets such as the emerging United States.

On the other hand, if that oil price trajectory continued, managements needed to begin dusting off their game plans from prior downturns to determine the series of steps they needed to start executing. They needed to anticipate where their customers would focus spending reductions in their drilling programs – shale, deepwater or Arctic regions? How much would oil and gas companies plan on cutting their capital spending plans for 2015? How many service company employees would need to be eliminated in order to match company capacity with the anticipated business activity going forward?

Since the late 1970s, the oilfield service industry has become more proficient managers of industry downturns. It seems to be the industry growth phases they have a more difficult time managing, maybe because they haven’t had as much time to learn or they tend to be swept up in the euphoria of the era.

The investment community, along with the business press, has turned the recent decline in global crude oil prices into a search for absolutes about the energy business. Everyone wants to know exactly what oil price makes new shale wells uneconomic – assuming that all oil and gas company managements are true capitalists who will only do something with the assurance that it is economically profitable. The challenge is that not every oil and gas company is alike. Major integrated oil companies (IOCs) such as Exxon Mobil Corp. (XOM-NYSE) and Chevron (CVX-NYSE), to name a couple, operate with a mandate to ensure future oil supplies for their refineries well into the future, which means they make decisions today on projects that may not begin producing oil and gas for up to a decade in the future. Who is willing to put a price estimate on crude oil in November 2024? Probably only an idiot would. Those of us who have spent our business careers making forecasts understand that every forecast will be wrong – we just don’t know exactly how it will be wrong. What we hope is that our forecast puts us in the ballpark in which the actual price lands. That means we need to focus on possible future industry dynamics and how those dynamics might be influenced by geopolitical, economic and demographic trends and events.

One area that has been receiving an immense amount of interest is the profitability of the shale plays in the United States. The interest is due to the fact that these plays have changed the nature of the domestic oil and gas business from one of inexorable decline into rapid growth. The shale revolution is responsible for making the U.S. into a global energy powerhouse capable of making the country energy self-sufficient if one believes the optimists. Since the shale plays emerged a decade ago as the new industry driver, E&P producers have been proclaiming how profitable they are. Existing producers, and all the new companies being established by private equity investors, have claimed that they needed to pour all their cash flows into the shale projects in order to capture the future profits to be earned from the plays. The challenge has been that for most of this period, producers have failed to generate meaningful free cash flows. This has meant that the producers had to rely on outside capital to fund their exploration and development activities. That dependence could become a significant drag on future profitability of these companies given the oil price decline, and for those companies with highly-leveraged balance sheets, it could result in their eventual demise.


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