Operating in a World of $50 Oil

Operating in a World of $50 Oil
With low oil prices showing little signs of a turnaround, some industry players shared their views on operating in a $50 a barrel oil market at a recent Singapore forum.

While hopes for a reversal in oil prices may have faded just after mid-August when U.S. crude oil futures slipped to a six-and-a half year low, the battered petroleum industry continues to plod along in its search for ways to steer through these difficult times.

Last month, some industry players met in Singapore for the 14th Annual Marine Money Singapore Ship Finance Forum, where there was a discussion on dealing with the impact of oil at $50 a barrel. Rigzone takes a look at the key issues under scrutiny at the forum, including the future direction of oil prices, the impact on the offshore support vessels market and oil consumption in China – the primary driver for global demand growth in recent years.

To recap, global oil prices have lost around half of its value from a year ago due mainly to a supply glut, a development exacerbated by the decision of the Organization of Petroleum Exporting Countries (OPEC) in November 2014 not to reduce production so as to protect their market share. The prolonged supply glut weighed on global oil prices, culminating in U.S. crude futures falling to $40.46 a barrel Aug. 19 – the lowest since March 2009.

Mixed Views on Oil Prices

Panelists at the Singapore forum held different opinions on the future direction of global oil prices. They singled out various factors for the current malaise in the oil markets, including weak demand caused by low global economic growth and the surge in U.S. shale production. But the panelists agreed that the industry downtrend stemmed mainly from OPEC’s stance on keeping unchanged the cartel’s oil production level.

“If you look at what’s happening today, it’s a plan, it’s a strategy, it’s a plot and you can call it what you want. OPEC has a strategy here. It’s just not the force of market pressure. This is a strategy to drive the price of oil down, drive out the producers/competitors that have more expensive recovery, like the Russians, North Sea and U.S. shale production. So that’s what I think the difference is and it’s working,” Kenny Rogers, head of Chemical Transport Logistics at Aurora Tankers/IMC Industrial Group, said.

Panelists were uncertain when global oil prices would recover given the unpredictable nature of the markets.

“At the very peak in 2008, Goldman Sachs [Group, Inc.] said oil would go to $200 [a barrel] and of course it crashed to $37. Only last week they say it will go to $20. I don’t really know. It’s anybody’s guess I believe,” Geir Sjurseth, Managing Director and Head of Offshore Finance at Germany’s DVB Bank SE, said.

He was referring to the last major financial crisis, when global benchmark Brent oil futures peaked at around $145 a barrel in July 2008. At the moment, industry players are unsure whether the oil prices have bottomed.

“No one has ever suggested an alphabet to describe this crisis. The last time [the 2007-2008 crisis] it was all about a V-shaped recovery, a W-shaped recovery or a U-shaped recovery. But there’s no alphabet to describe what we are going through right now,” Fazel A. Fazelbhoy, CEO of Dubai-based Synergy Offshore FZ LLE, a consulting firm focused on the offshore energy and marine sector.

Lower Non-OPEC Supply Key to Market Recovery

With OPEC sticking to its current production quotas, prospects for a recovery in global oil prices will hinge on a reduction in supplies from major non-OPEC producers like those in Russia and the North Sea as well as U.S. shale producers. 

“In the short term, it’s going be a cut in supply which is required to help stabilize the oil price. Recent reports … have been proclaiming that OPEC won the oil price war as the non-OPEC producers have started to cut supplies, notably U.S. shale production, most of which makes a sizeable loss while the oil price is languishing in the $40-50 a barrel price range,” Simon Spells, a Singapore-based senior associate at international law firm Berwin Leighton Paisner LLP, told forum participants.

“OPEC itself was likely to respond by cutting back its own production, having achieved the objective of protecting its market share. And this in turn will allow supplies to fall further … which in the short to medium term will assist in leading to an increase and stability in the oil price,” Spells added.

These sentiments were reflected in the “Short-Term Energy and Winter Fuels Outlook” released by the U.S. Energy Information Administration (EIA) Oct. 6. In it, the EIA forecast non-OPEC production, which expanded 2.3 million barrels of oil per day (MMbopd) in 2014, would grow by 1.3 MMbopd in 2015 – with the increase attributed to investments made when oil prices were higher. It estimated output would remain flat in 2016.

“Non-OPEC growth dries up to almost nothing; the Saudi strategy is working … It is has never been about a couple of months or a couple of quarters, but a couple of years, and that is how it is playing out," according to Michael Wittner, a New York-based analyst at Societe Generale, as quoted by Reuters Oct. 6.

In fact, a panelist commented that the current low oil prices could be a precursor to another rally in the market in the not too distant future.

“I don’t understand how no one has talked in the last three to six months what the decline rate of existing oil production [which could be] anywhere between 8 and 20 percent,” Fazelbhoy said, noting that capital spending has been cut by petroleum companies worldwide amid the industry downturn.

“If no new oil is being discovered and we have an absolute limit of new oil coming from 2014 through 2017, someone is going to wake up one day and say hey we need more oil. The reaction is going to be: you have lost over $100,000, capability has been decimated in the oil industry, in the oil services sector, including oil companies,” he explained.

“You have no infrastructure in place, no major oil fields discovered during this period … You have a declined rate of up to 20 percent and more in some cases, oil inventory goes down, then what? You are going to have this haywire Goldman Sachs prediction probably come true … The point is no one knows. I think $200 is perfectly logical [under such circumstances].”

Offshore Sector Faces Headwinds

The offshore sector, including the offshore support vessel (OSV) segment, serving the oil and gas industry is facing continued headwinds as its revenues are still under pressure from sharp cutbacks in capital spending by petroleum firms, causing delays and cancellations of several exploration and production (E&P) projects.

“$50 oil has decimated the offshore industry altogether. E&P has been growing at a rate of 12 to 14 percent per annum from 2008 onwards and it crashed down to 2 percent growth in 2014. Growth will fall 15 to 20 percent … in 2015 and by up to 25 percent in 2016,” Fazelbhoy said.

Meantime, he revealed that OSV utilization rates fell from 90 to 60 percent while day rates have fallen by around 30 to 60 percent. More downside pressure is expected for OSVs as 400 new vessels are poised to join the global fleet, a number that excludes the estimated 200 newbuilds in China.

While OSV utilization in the Middle East stays high at over 90 percent, largely a result of the OPEC-led strategy to keep oil production up, it has not shielded regional vessel operators from feeling the effects of a worldwide decline in day rates. Vessel day rates for OSV players dipped by more than 30 percent, according to the Synergy Offshore CEO.

Agreeing with the observation, Berwin Leighton Paisner’s Simon Spells noted that the offshore sector is now “coming to a stage where there is going to be some distress in that market and some restructuring required.”

He explained that banks are concerned about the financing arrangements with vessel owners, especially if the existing charter contracts are not being renewed, or renewed as expected, as these are often built into the requirements for existing financing facilities.

Chinese Concerns Eases, Slightly

Economists who spoke at the forum said they expected the economy in China to avoid a “hard landing”, easing concerns of a sharp curtailment in oil consumption in Asia’s largest, and the world’s number two economy after the United States, data from the International Monetary Fund indicated.

Operating in a World of $50 Oil

China’s currency devaluation in August and a sharp decline in its equity markets dented confidence in its economy, which – the EIA noted in its May report – accounted for about 43 percent of global oil demand growth in 2014 and an estimated 25 percent for 2015.

“The Chinese authorities have the tools necessary to keep the slowdown in economic growth gradual,” ABN AMBRO’s Head of Macro and Financial Markets Research Nick Kounis told the forum, adding that China’s economy is expected to grow by 7 percent in 2015 and 6.5 percent  in 2016, compared to 7.3 percent in 2014.

Another economist held similar views on the Chinese economy, highlighting the country’s importance despite the slowdown.

“China’s economy is slowing but not crashing,” according to Edward Lee Wee Kok, head of ASEAN Economic Research at Standard Chartered Bank. He added that “despite the concerns … about China in the near term … it’s hard to look away from this economy.”


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