The global oil market is returning to balance based on the latest data from the EIA. That should mean higher oil prices but how high must prices be to save the industry?
Data suggests that oil producers need prices in the $70-80 range to survive. That is unlikely in the next year or so. Without more timely price relief, the future looks grim for an industry on life support.
EIA Revises Consumption Upward
Major EIA revisions to world oil consumption* data provide a new perspective on oil-market balance.
The world was over-supplied by only 570 kbpd of liquids in April compared to EIA’s earlier estimate for March of 1,450 kbpd; that March estimate has now been revised downward to 970 kbpd (Figure 1). February’s over-supply has been revised downward from 1,180 to 240 kbpd.
These revisions indicate that oil markets are much closer to balance than previously thought.
Figure 1. EIA world liquids market balance (supply minus consumption). Source: EIA and Labyrinth Consulting Services, Inc.
EIA adjusted world consumption growth for 2016 upward to 1.4 mmbpd. Its estimate for 2017 is now a very strong 1.54 mmbpd (Figure 2).
Figure 2. EIA annual consumption growth and forecast. Source: EIA and Labyrinth Consulting Services, Inc.
IEA’s demand growth estimate for 2015 is 1.8 mmbpd but the agency maintains its 1.2 mmbpd estimate for 2016 based on concerns about global economic growth.It is easy to be skeptical about these new revelations but reports by both groups have been pointing toward improving market balance for some time.Oil Prices and Market Balance
Oil markets are never in balance. Producers always misjudge demand and either over-shoot or under-shoot with supply. Balance is simply a zero-crossing from one state of disequilibrium to the next, from surplus to deficit and back again.
Since 2003, the oil market has only been within 0.25 mmbpd of balance 16% of the time. The average price (2016 dollars) for that near-market balance rate was $82 per barrel (Figure 3).
Figure 3. World liquids market balance (supply minus consumption), 2003-2016. Source: EIA and Labyrinth Consulting Services, Inc.
But that was essentially the average oil price of $78 per barrel for the entire period (Figure 4).
Figure 4. CPI-adjusted WTI prices, 2003-2016. Source: EIA and Labyrinth Consulting Services, Inc.
In fact, market balance occurred in every monthly average oil-price bin in Figure 5 except $130 per barrel. Although prices above $90 per barrel represent 37% of near-market balance prices from 2003 to 2016, oil prices also averaged more than $90 per barrel 36% of the time during that 15-year period.
Figure 5. Brent oil price histogram at plus-or-minus 0.25 million barrels per day of world liquids production. Source: EIA & Labyrinth Consulting Services, Inc.
In other words, market balance merely reflects whatever price the market deems necessary to maintain supply at the time. There is no clear causal relationship between market balance and specific higher or lower oil prices. Balance merely represents the midpoint between prices on either side of the disequilibrium states that it demarcates.
Our recent memory is of $90-100 per barrel prices so we think that was normal. When those prices prevailed in 2007-2008 and in 2010-2014, the disequilibrium state of the market was largely deficit. Moving toward market balance and being on the deficit side of market balance are hardly the same thing.
The Price Producers Need
Lower-cost oil producers of the world (Kuwait through Deepwater in Figure 6) need $50-80 per barrel and an average price of $65 per barrel to break even. Probably $70-80 is a minimum price range for near-term survival of more efficient producers allowing that some will still lose money at those prices.
Figure 6. Projected 2016 break-even oil prices for OPEC and unconventional plays. Source: IMF, Rystad Energy, Suncor, Cenovus, COS & Labyrinth Consulting Services, Inc.
Existing Canadian oil sands projects, and Bakken and Eagle Ford Shale core areas are among the very lowest-cost major plays in the world. For all of the OPEC rhetoric about the high cost of unconventional oil, few OPEC countries are competitive with unconventional plays when OPEC fiscal budgetary costs are included.
Tight Oil Companies On Life Support
Despite this relatively favorable rating, most unconventional producers are on life support at current oil prices.
All of the tight oil-weighted companies that I follow had negative cash flow in the first quarter of 2016 except EP Energy and Occidental Petroleum (Figure 7). Nine companies increased their capex-to-cash flow ratios compared with full-year 2015 results and six increased that ratio by more than 2.5 times.
Figure 7. First quarter 2016 and full-year 2015 tight oil E&P company capital expenditure-to-cash flow ratios. Source: Google Finance and Labyrinth Consulting Services, Inc.
On average in 2016, companies spent $1.90 more in capex than they earned while in 2015, they spent $0.60 more than they earned. The percent of negative cash flow has increased more than three-fold so far in 2016 compared with 2015.
The good news is that about half of the companies (Apache, EOG, Laredo, Continental, Statoil, and Diamondback) only increased negative cash flow slightly despite falling revenues. The bad news is that the rest (Marathon, Whiting, Pioneer, Murphy, ConocoPhillips and Newfield) did not.
The debt side of first quarter earnings is far more disturbing. The average debt-to-cash flow ratio for tight oil companies increased more than 3-fold to 10, up from 3 in 2015 (Figure 8).
Figure 8. First quarter 2016 and full-year 2015 tight oil company debt-to-cash flow ratios. Cash flow was annualized based on first quarter data. Source: Google Finance and Labyrinth Consulting Services, Inc.
Debt-to-cash flow is a critical determinant of risk from a bank’s perspective because it measures how many years it would take to pay off debt if 100% of cash from operations were used for this purpose. This means that it would take these companies an average of 10 years to pay down their total debt using all cash from operating activities.
The energy industry average from 1992-2012 was 1.53 and 2.0 was a standard threshold for banks to call loans based on debt-covenant agreements. That threshold increased in recent years to about 4 but 10 years to pay off debt is clearly beyond reasonable bank exposure risk.
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