Spending Cuts Ahead

Jim Brown
Printer Friendly Version

U.S. energy companies are announcing drastic spending cuts for 2015 because of the lower oil prices. Barclays said companies in North America could cut by 30%. Several have already announced cuts of that magnitude with others in the 30-35% range. A few have slashed spending by 50% or more because they lost their funding and access to the debt markets.

Around the globe analysts expect about a 10% decline, which would be about $100 billion. Based on the various reports I have read in the last couple weeks I would put it more in the $250 billion range. It is one thing to cut spending on day to day projects like existing drilling programs. It is another to shelve or postpone projects that are just now receiving funding decisions.

Simmons & Co said investment decisions for new multibillion dollar projects average about 80 per year. In 2015 they expect that to decline to less than 20 projects. Companies don't want to commit to projects costing $5 to $20 billion with oil and gas prices falling. Since the reserves are not going anywhere there is no harm in putting the decision off for several years until oil prices recover. The postponement of more than 60 new projects could be worth $200 billion in spending that was not cut but just not approved. Barclays said this will be only the 7th time in the last 30 years that spending declined. They also pointed out that each time it rebounded by more than 10% the following year. Production cuts raise oil prices and the cycle repeats.

Once oil prices return to much higher levels these projects will be pulled off the shelf and reconsidered. If they are approved then it will be 5-7 years before they begin producing. These large projects can't be turned on and off instantly. It takes long years of planning and construction before oil can be produced. If prices decline again before they are completed the owners will suffer. Once the money is spent the oil has to be produced to make the debt payments and pay the bills to operate the projects. This is why it may be several years before they are reconsidered because nobody wants to spend billions on a project that will end up lsing billions.

Credit Suisse had previously expected U.S. oil production to rise +1.3 mbpd in 2015. Now they are expecting only a 500,000 bpd increase. I would not be surprised if we are producing less oil by year end than we are producing now. The only reason we were increasing production was the rapid rate of drilling new wells at 9,500 per quarter. If that falls to 7,000 per quarter or less then new production will not be able to keep up with the high decline rate of existing wells.

BHI said there were 9,544 onshore wells drilled in Q4, down -22 from Q3. Compared to Q4-2013 the number rose +461 wells or 5%.

The average onshore rig count for Q3 was 1,856, up +14 rigs from Q3 and +159 rigs over Q4-2013. On average the onshore rigs drilled 5.14 wells each in Q4. Slower drilling rates in the Eagle Ford, Marcellus and Haynesville weighed on the average.

The 18 year low of 310 gas rigs was set on April 4th, 2014. The peak was 936 in 2011. The U.S. rig count peaked at 4,530 in 1981 and bottomed at 488 in 1999. Oil was selling for $10 a barrel in 1998 as a result of Saudi Arabia's price war with the rest of OPEC. Yes, this has happened before.

Active rigs are falling at the fastest rate in two decades. Active rigs fell -61 last week to 1,750 and are now down -181 from a peak of 1,931 on September 26th. Each rig averages 5.15 wells per quarter so that means we are already going to see 932 fewer wells this quarter and the carnage is just beginning. Helmerich & Payne (HP), the largest contract driller in the U.S. reported early terminations on 4 rigs last week and they are expecting another 15-20 over the next few weeks. Pioneer also reported early terminations on 4 rigs. Barclays is projecting a decline of more than 500 active rigs in 2015. That would be more than 25% of the current fleet.

Much of the U.S. growth over the last several years has come from the surge in shale drilling. That is going to come to a screeching halt if oil prices remain in the $50 range and there is a good possibility we could see even lower numbers.

The drop in oil prices is beneficial for consumers but it is going to take a huge toll on energy workers. The Dallas Fed projects a loss of -125,000 energy jobs over the next six months and probably another -50,000 jobs in industries that will be hurt by the decline in the energy sector. Ensign Oil laid off 700 workers last week as a result of cancelled contracts for their drilling rigs. U.S. Steel laid off 700 workers and closed two tubing plants because of falling demand from the energy sector. In Mexico more than 10,000 workers in the energy service sector were laid off with the potential of that rising to 50,000 in the coming months. This is just the tip of the iceberg. The rig cancellations and layoffs are just beginning and we could see GDP decline by the end of the year by as much as 1.5 points.

The first oil company to file bankruptcy as a result of the price decline was WBH Energy, a private Texas drilling company. They filed bankruptcy last week with debts of $50 million as a result of the decline in oil prices. There will be many more.

The drop in oil prices is especially painful for the large producers. Every $10 drop in crude prices costs Exxon $2.8 billion in annual cash flow. Chevron loses -$3.85 billion for the same decline because they are more crude dependent. The U.S. may be the best house on the economic block but a sharp decline in the energy sector could drag us down into the slums with everyone else.

Saudi Prince Alwaleed bin Talal was quoted in an interview this weekend as saying we would never see $100 oil again. My comment was that never is a very long time and I don't think he was really focused on the topic. EVERY time in the past that oil production got ahead of demand the prices fell and rigs were stacked. EVERY time prices rebounded to exceed the prior highs except for the financial crisis. We have not yet returned to the $147 highs but eventually we will. It is only a matter of time. We consume 33.215 BILLION barrels of oil per year and only discover about 3 billion. Do the math. Eventually demand will exceed production again and prices will spike.

The good news for the economy is that the average family is getting a transportation tax refund of about $1,000 this year. That is the amount they are saving from the estimated cost of gasoline at the level before the oil crash began. Analysts claim the average family spends $2,912 dollars per year on gasoline. Saving $1,000 of that is a huge stimulus program. With 117 million households in the U.S. that represents $117 billion in spendable cash that will be put back into the economy. Gasoline prices declined to a nationwide average of $2.18 on Friday. I paid $1.79 in Colorado on Thursday.

Oil prices are also declining because the dollar it at the highest level since 2005 and just a couple ticks higher will put it at 2003 levels. Since oil is priced in dollars it takes fewer dollars to buy a barrel than it did as recently as May. The dollar index hit a low of 78.90 in May. It hit a high of 92.52 on Thursday. That is a 17.2% rise in 8 months. Crude oil was $107 in June and the rise in the dollar equates to a -$18.04 decline in oil prices even without the current surplus. That means more than a third of the -$57 decline was due to the rise in the dollar.

Large oil tankers called Very Large Crude Carriers or VLCCs (2 million barrels) are in high demand. Oil companies and speculators are leasing them to store oil. One company said they were asked to lease ten last week for storage. Multiple tanker operators have also reported a surge in requests for storage tankers. With higher prices on futures contracts several months out, speculators can buy oil now and sell it at the futures price for later delivery. Their profit is the spread minus the cost of storage. The December WTI contract is over $55 today.

Oil Inventories

Oil inventories declined -3.1 million barrels for the week ended Jan 2nd. This was the last week in 2014 and refiners were flushing oil through the system as fast as possible to avoid property taxes.

Proof of that came from the +11.2 million barrel rise in distillate inventories and the 8.1 million barrel gain in gasoline inventories. Gasoline inventories have risen for more than 8 consecutive weeks.

Refinery utilization declined slightly to 93.9% and I expect it to drop off sharply over the next two weeks.

Cushing inventories rose to 32.1 million barrels and a multi-month high. U.S. production has been relatively flat at 9.13 mbpd for the last 4 weeks. I expect it to remain at that level until it begins declining in the months ahead. Winter weather always slows production growth and by the time the weather warms we should see the impact of the drilling decline.

Gasoline demand dropped sharply by -800,000 bpd for no particular reason. I am guessing it had to do with the drop in shopping after Christmas. The frantic race from store to store and then driving to grandma's house was over.

Distillate demand also declined by more than -300,000 bpd. That is probably related to the post Christmas calm as well.

In the graphic below green represents a recent high and yellow a recent low.

Propane inventories declined by -1.59 million barrels to 75.65 million. Demand rose slightly from 1.27 mbpd to 1.35 mbpd. With the cold weather this week and last we should begin to see higher demand over the next several weeks.

Natural gas inventories declined -131 Bcf to 3,089 bcf. Inventories are now -2.1% below the five year average at 3,156 Bcf and +8.8% above year ago levels at 2,839 Bcf. There were big declines in the last four weeks in 2013 and that offset the mild weather we have seen over the last several weeks. The recent cold weather should put the numbers back into relative sync.

The blue line in the chart below shows the current inventory relative to the five year average.


The market was extremely volatile last week and closed in the middle of its recent range but still down for the year. January is normally a strong month and the first week does have a history of volatility so we can't really make a market call for the coming week. This is option expiration week so anything is possible.

Jim Brown

Send Jim an email