Returning To Market Balance: How High Must Prices Be To Save the Oil Industry?

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Returning To Market Balance: How High Must Prices Be To Save The Oil Industry? Art Berman Labyrinth Consulting Services, Inc. Ray Leonard Hyperdynamics Lafayette Geological Society Lafayette, Louisiana May 18, 2016


HowHighMustPricesBeToSaveTheOilIndustry?• Theglobaloilmarketisreturningtobalancemorequicklythanpreviouslyexpected.• Thatshouldmeanhigheroilpricesbuthowhighmustpricesbetosavetheindustry?• ThepricerallythatbeganinlateJanuary-earlyFebruary2016seemstohavesubstance

althoughoutsizedinventoriesshouldlimitupwardpricemovement.• RecentoutagesinKuwait,Nigeria,VenezuelaandCanadahaveunderscoredthefragilityof

supplydespitetheprevailingproductionsurplus.• Theweakglobaleconomywillbeanimportantcheckonpricerecovery.• Datasuggeststhatoilproducersneedpricesinthe$70-80rangetosurvive.Thatisunlikelyin

thenextyearorso.• Ifaweakenedworldeconomycannotsupportthoseprices,wemayseesupplydwindleinafew

yearstolevelsthatcausepricespikesthatcannotbeabsorbed.• Withouttimelypricerelief,thefuturelooksgrimforanindustryonlifesupport.


Oilmarketsaremuchclosertobalancethanpreviouslythought

• MajorEIArevisionstoworldoilconsumptiondataprovideanewperspective.• Theworldwasover-suppliedbyonly570kbpdofliquidsinAprilcomparedtoEIA’searlier

estimateforMarchof1,450kbpd.• ThatMarchestimatehasnowbeenreviseddownwardto970kbpd.• February’sover-supplyhasbeenreviseddownwardfrom1,180to240kbpd.• MarketbalancehasbeenslowlyandgenerallyimprovingsinceNovember2015.• Thebiggestconcernsforadurablepricerecoveryareoutsizedinventoriesandaweakglobal

economy.

0.58

0.20

0.81

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0.81

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1.78

2.09

1.85

2.39

0.48

2.81

2.16

3.04

1.95

1.47

2.00

1.27

2.23

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2.19

2.49

1.18

1.45

1.71

0.57

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0.77

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1.03

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-0.23

0.78

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1.80

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0.31

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1.80

2.86

1.61

1.31

1.94

1.17

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3.02

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2.70

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MillionsofBarrelsofLiquidsPerDay

Comparison ofWorld Liquids Balance,AprilvsMaySTEO

April2016STEOBalance May2016STEOBalance

Source:!EIA&!Labyrinth!Consulting!Services,!Inc.

April!2016!STEO!Supply!minus!Consumption

May!2016!STEO!Supply!minus!Consumption

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Market!Balance!(Supply!minus!Consumption!Millions!of!Barrels!of!Liquids!Per!Day)

Brent!Price!($/Barrel)

EIA!Market!Balance,!Brent!Price!&!Forecast

MarketBalance BrentPrice


Market!Balance

Brent!Price

Improving!market!balance

Minor!market!balancedeficit!by!mid-2017

Brent!price!below!$60/ barrelthroughend!of!2017


Consumption&DemandGrowth

• EIAadjustedworldconsumptiongrowthfor2016upwardto1.4mmbpd.• Itsestimatefor2017isnowaverystrong1.54mmbpd.• IEAdemandestimatefor2015is1.83mmbpd—strongestdemandgrowthsince2010after

recoveryfromnegativegrowthduring2008-2009FinancialCollapse.• IEAacknowledgesstrong1.41mmbpdQ12016demandgrowthbutmaintainsis1.24

estimateforfull-year2016becauseofconcernsabouttheglobaleconomy.• Demandgrowthbecauseoflowestrealoilpricessincethe1990s.• Demandislikereserves—aquantityataprice.• IshareIEA’sconcernespeciallyathigheraverageoilprices.

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Millions!of!Barrels!of!Liquids!Per!Day!Per!Year

EIA!Annual!Consumption!Growth!and!Forecast



WhatDoesMarketBalanceMeanForPrice?

• Oilmarketsareneverinbalance.Producersalwaysover-shootorunder-shootwithsupply.• Balanceissimplyazero-crossingfromonestateofdisequilibriumtothenext,fromsurplusto

deficitandbackagain.• Since2003,oilmarketwithin+/-0.25mmbpdofbalance16%ofthetime.Theaverageprice(2016

dollars)forthatnear-marketbalanceratewas$82perbarrel.• Butthatwasessentiallytheaverageoilpriceof$78perbarrelfortheentireperiod.


WhatDoesMarketBalanceMeanForPrice?

• Marketbalanceoccurredineverymonthlyaverageoil-priceexcept$130perbarrel.• Althoughpricesabove$90perbarrelrepresent37%ofnear-marketbalancepricesfrom2003to

2016,oilpricesalsoaveragedmorethan$90perbarrel36%ofthetimeduringthat15-yearperiod.• Marketbalancereflectswhateverpricethemarketdeemsnecessarytomaintainsupplyatthe

time.• Noclearcausalrelationshipbetweenmarketbalanceandspecifichigherorloweroilprices.• Balancemerelyrepresentsthemidpointbetweenpricesoneithersideofthedisequilibriumstates

thatitdemarcates.• Wethink$90-100wasnormalbutthemarketwasindeficit.Movingtowardmarketbalanceand

beingonthedeficitsideofmarketbalancearehardlythesamething.

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Cumulative!Percent

Frequency

Oil-Price!Bins!($/Barrel)

Oil!Price!Histogram!at!+/ -0.!25!mmbpd!of!Market!Balance

Frequency Cumulative%

Source: EIA&LabyrinthConsulting Services,Inc.


$137

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rabia

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ater

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ianCore

UAE Iraq

EagleFordCore

BakkenCore

Lower-CostAvg

ExistingOilSands

Kuwait

Break-EvenPrice(DollarsPerBarrel)

Projected2016Break-EvenOilPricesforOPEC&UnconventionalPlays

Source: IMF,RystadEnergy,Suncor, Cenovus,COS&Labyrinth Consulting Services,Inc.

$70-80!Near-Term!SurvivalRange!Minimum

ThePriceProducersNeed

• Lower-costoilproducersoftheworldneed$50-80perbarrelandanaveragepriceof$65perbarreltobreakeven.

• $70-80isaminimumpricerangefornear-termsurvivalofmoreefficientproducers—somewillstilllosemoneyatthoseprices.

• ExistingCanadianoilsandsprojects,andBakkenandEagleFordShalecoreareasareamongtheverylowest-costmajorplaysintheworld.

• ForalloftheOPECrhetoricaboutthehighcostofunconventionaloil,fewOPECcountriesarecompetitivewithunconventionalplayswhenOPECfiscalbudgetarycostsareincluded.


TightOilCompaniesonLifeSupport

• Alltightoil-weightedcompaniesthatIfollowhadnegativecashflowinthefirstquarterof2016exceptEPEnergyandOccidentalPetroleum.

• Ninecompaniesincreasedtheircapex-to-cashflowratioscomparedwithfull-year2015resultsandsixincreasedthatratiobymorethan2.5times.

• Companiesspent$1.90incapexforeverydollartheyearned.In2015,theyspent$0.60abovewhattheyearned.

• Averagedebt-to-cashflowratiofortightoilcompaniesincreasedmorethan3-foldto10,upfrom3in2015.

• Energyindustryaverage1992-2012was1.53and2.0wasastandardthresholdforbankstocallloansbasedondebt-covenantagreements.


HowHighMightOilPricesGo?

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Market!Balance!(Supply!minus!Consumption!Millions!of!Barrels!of!Liquids!Per!Day)

Brent!Price!($/Barrel)

EIA!Market!Balance,!Brent!Price!&!Forecast

MarketBalance BrentPrice


Market!Balance

Brent!Price

Improving!market!balance

Minor!market!balancedeficit!by!mid-2017

Brent!price!below!$60/ barrelthroughend!of!2017

• Currentpricesaround$48perbarrelabigimprovementfromJanuarywhenpriceswere<$30.• Nevertheless,allproducers–companiesandexportingcountriesalike–arefailingandprobablyneed

sustainedpricesinthe$70-80perbarrelrangetosurvive.• Thatisastretchfromthemid-upper$40’sresistancelevelofthepast10monthsorso.• EIA’sforecastdatasuggestaminorsupplydeficitbythesecondhalfof2017.• Brentforecast,however,istoremainbelow$60perbarrel.


InventoriesRemainaSeriousObstacletoSustainedHigherPrices

• U.S.stocksarenearrecordhighlevelsof543millionbarrels:61millionbarrelsmorethanatthistimein2015and137millionbarrelsmorethanthe5-yearaverage.

• OECDstocksarealsoatrecordlevelsof3.13billionbarrelsofliquids.• CushingandGulfCoastcombinedstorageisat93%ofworkingcapacity.• Cushingcontinuestoincrease.• Itisdifficulttoimagine$70-80oilpricesuntilthisoverhanddissipatesandthatmay

takeayearassumingitisfallingnow.


GoodNews/BadNewsAboutComparativeInventories

• Comparativeinventoryisdeterminedbycomparingcurrentstockswithamovingaverageofstocksoverthepast5years.

• Thetwopreviouspricecyclesin2015werebothcharacterizedbyfallingcomparativeinventories.WhenC.I.patternsreversed,pricesfell.

• ThecurrentpricecycleshowsadecreaseincomparativeinventoriesforcombinedCushing&GulfCoast.

• Front-to-backfuturesspreadstypicallyfallwithdecreasinginventoriesbecauseshort-datedcontractsgainvaluecomparedtolonger-datedcontracts.

• Thepasttwocyclesendedbecauseproducersincreaseddrillingandproductionathigherprices.• CushingstockstypicallycontrolWTIpriceandcomparativeinventoriesatCushingarerising.

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riceSpread(DollarsPerBarrel)

ComparativeInventory(M

illionsofB

arrelsofCrudeOIl)&W

TIPrice($/Barrel)

Cushing+GulfCoastComparativeInventories

FuturesSpread WTI Comparative Inventory

Dec-June!2016!Futures!Price!Spread!(RHS)

Comparative!Inventory!(LHS)

WTI!(LHS)March!-August!2015!

Source:EIA,CME&Labyrinth Consulting Services,Inc.

August!- October!2015!Price!Cycle

March!-May 2016!Price!Rally

Falling!ComparativeInventories

Falling!ComparativeInventories


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NYMEXW

TIPrice($/Barrel)

NYMEXWTIPrice&WSJDollarIndex

WTINYMEXPrice WSJDollarIndex

$26!Support

$36!SupportWTI!(LHS)

Dollar Index!(RHS)

Source: EIA,WallStreetJournal&LabyrinthConsultingServices,Inc.

Longdollar!futures!bets!sold!on!doubts!about!Fed!rate!hikes

Declining!dollar!value

$48!Resistance

StrengthoftheU.S.DollarandOilPrices

• AnegativecorrelationbetweenthevalueoftheU.S.dollarandworldoilprices:agloballyconnectedeconomyinwhichcountriescompeteforinvestmentbasedoninterestratesandcurrencyvaluation.

• OiltransactionsaredenominatedinU.S.dollarsastheworldreservecurrency.• HigherU.S.interestratesfavorinvestmentsintheU.S.economyovercommoditieslikeoil.

Whenthedollarisstrong,oilpricesaregenerallylowerandviceversa.• Thecorrelationbetweenoilpriceandthedollarisespeciallystrongsince2015andpartly

explainspricecycles.• ThelatestpricerallybeganaftertheFederalReserveBankindicatedthatfurtherinterest

rateincreasesin2016wereunlikely.• Dollarhasbeenstrengtheningrecentlybutoilpricescontinuetorise.Lookforashort.


• LargereductioninE&Pinvestmentin2015andprobablyevengreaterin2016.• Deferredinvestmentsin2015equivalentto20billionbarrelsofreserves.• GlobalE&Pestimatedcapexfor2016is44%(-$412billion)of2014.• Asubstantialsupplydeficitwillresultinthenot-too-distantfuture.• Apricespikeseemsunavoidable.

TheBigPictureOnOilPrices:Under-Investment


• Thecurrentpricerallyseemstohavesubstancealthoughinventoriesareaconcern.• Theglobalmarketappearstobemovingquicklytowardbalancewithhigherconsumptiongrowth.• Recentoutagesunderscorefragilityofsupply.• Under-investmentduring2015and2016meansmuchhigheroilpricesinafewyears.• Anticipationoffuturesupplydeficitsaremovingpriceshigher.• Expectsimilarhighpricevolatilityandpricecyclingwithseveralupward-trending4-5monthcycles.• Pricesmusteventuallyreachthe$70to$80perbarrelrangetorestorebalancesheetsenoughthatinvestment

mayresume.Difficulttoimaginein2016or2017withoutsupplyinterruptionsoranOPECproductioncut.• Aweakglobaleconomyandweakerdemandathigheroilpricesarethebiggestriskstooil-pricerecovery.• Areturntomarketbalancedoesnotnecessarilymeanthatpriceswillreturntothe$70-80range.• Ifaweakeconomycannotsupportthoseprices,wemayseepricespikesthatcannotbeabsorbed.Thatmaybring

atraumaticendtotheAgeofOil.• Peoplewillhavetolearntogetbywithlessinafuturebasedonlowerenergy-densityfuelsandlowereconomic

growthpotentialthanoilhasprovided.

HowHighMustPricesBeToSaveTheOilIndustry?

Returning To Market Balance: How High Must Prices Be To Save the Oil Industry?

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