The price of oil has halved in six months, adding further unknowns to an already unpredictable global economic and political climate. From a high cost base in the North Sea to North American shale, ISIS to US energy policy, countless factors are affecting the market and the future of the industry. Staying informed and developing a strategy can be difficult when headlines are so contradictory. While many companies batten down the hatches, Fifth Ring looks to interpret the facts, considering who is most at risk from the downturn, and who can embrace it as an opportunity.
How did we get to sub $50 a barrel?
Last year the US reached its highest level of oil production in three decades, surpassing Saudi Arabia as the world’s largest producer. The growth of US shale oil brought a new source into the mix and heralded a potential loss of market share for existing exporters.
It has been reported that, generally, oil production costs in the Middle East are around $17 a barrel. That’s significantly cheaper than even the most efficient unconventional wells. So when the Organisation of the Petroleum Exporting Countries (OPEC) agreed not to reduce its production quota of 30 million barrels a day at the end of November 2014, allowing the market to find its own financial level, its hope was that its members would survive the price drop and make many US shale plays economically unviable.
At the same time, global demand for oil has fallen. The International Monetary Fund (IMF) has reduced its predictions for global economic growth, citing China’s slowdown and the early stages of a Russian recession. High levels of production in anticipation of Chinese demand created a glut that it will take several months to work through, even if production is cut. Only when the surplus is gone might we see the oil price rise again.
What does this mean for OPEC?
Saudi Arabia is responsible for one tenth of oil supplied globally and is the dominant voice of OPEC. Saudi Arabia has led the opposition to production cuts - but there are other OPEC members that do not share the same view. Venezuela, already suffering a massive fiscal deficit, is paying back loans to China that are unmanageable unless there is a sharp rise in oil price in the near future - probably to around $130 a barrel. The economies of Bahrain, Nigeria and Iran break even at a similar price.
And the Saudis will feel the pain too. Despite Middle East oil production costs being low, Saudi Arabia’s budget was planned for an oil price of $95 to balance its budgets. Every day that OPEC exceeds its production quota, while undoubtedly making the US shale plays sweat, is another day of losses for the Saudis. However, with a reported $750 billion in foreign exchange reserves, Saudi Arabia can keep this up for a while.
What’s going to happen in the rest of 2015?
The International Energy Agency (IEA) expects supply to rise by more than a million barrels a day this year, so a price increase doesn’t look to be right around the corner. A lot of investors are betting on further falls, assuming Libya’s return to productivity and US production continuing to climb. American growth looks likely, as the US reached 397.9 million barrels in the week ending January 16th. Well output is rising, even as US companies begin to idle their rigs - the number of land rigs operating in the US has dropped by nearly 14 % in the last two months. The effects are not obvious though, as improvements in drilling technology are bringing significant growth in production levels. New wells in areas such the Bakken in the US are achieving double the oil production levels of three years ago.
Although Abdalla El-Badri, OPEC’s secretary general, denies that its current actions are targeting US shale drillers, revolving instead around economics, the two are really one and the same. American shale’s effects have been so great that they represent an economic change that OPEC can’t react to without making shale unprofitable. It’s possible that Saudi Arabia will cut production once enough US shale wells have shut down for them to consolidate their position as the world’s leading oil producer.
It’s a position of dominance that is hard to keep hold of, even with Saudi Arabia owning some of the world’s largest and most easily tapped oilfields. The US may actually have to reduce its own target of achieving energy self-sufficiency within two decades. Introducing more shale oil to the market has forced a price drop that renders a number of plays no longer viable. Only the more productive regions can afford to operate, breaking even at around $50 a barrel. Optimists think that as investment in shale is cut, oil prices will recover.
In the past, when production outstripped demand, the price of oil dropped until either demand grew, or production was capped. OPEC’s production quota is one measure that stabilises the price, but in the absence of an imposed fix, the market is finding its own way. At present it looks like it may have settled just under $50 a barrel, but Claudio Descalzi, Chief Executive of Eni, foresees a sharp reversal of the current price collapse. As the oil industry cuts capital spending in 2015 in response to low prices, shortages will be created in the future. The decommissioning of long-term projects can’t easily be started again in the way that shale wells can, so in four or five years time Descalzi suggests we could see a surge in oil prices, perhaps to $200 a barrel.
Continental Resources CEO Harold Hamm has predicted that we’ll see the oil price rise much sooner than that. He thinks that observers are not factoring the speed that oil companies are scaling back into their forecasts. Cuts among oil companies have hit exploration budgets and new projects first. BP and BG Group are planning a $21bn reduction in capital spending, having seen a 73% drop in earnings from their upstream operations. Hamm thinks that US oil production will decrease this year, and we’ll see the price climb.
At the other end of the spectrum, chief executive of BP, Bob Dudley, foresees low prices for as long as two or three years. Prince Alwaleed of Saudi Arabia has said that oil will never top the $100 a barrel threshold again. If they are right, the North Sea will become increasingly unattractive to oil companies. Even before the price plummet, the costs base for extraction in the North Sea made it a tough environment to remain competitive in and a number of service companies began to reduce their contractor rates. If the cuts are too severe and no incentives are given encouraging companies to stay, a recovery may never be complete.
However long we hover around the $50 a barrel mark, one thing is for certain: times are going to be tough for many companies. When John D. Rockefeller wanted to stabilise the oil industry, he set such low prices at Standard Oil that many competitors went bust. What he described as ‘a good sweating’ is happening now across the world. Dick Evans, CEO of Cullen/Frost said recently in an interview that some oil companies have built up too much debt and will not survive the low prices. He says, “It’s been too hot for too long. There’s been too much money chasing too few deals. This is going to clean it up.”
The North Sea will likely see a significant reduction in activity this year. Large-scale projects will see delays, although long-term natural gas and oil projects are unlikely to be prematurely scrapped, due to the costs involved. Cutbacks will be to the development of new fields and delays to projects that are not yet out of their appraisal phase. Companies in the North Sea will have to improve production from their existing wells if they are going to survive. The drop in price may provide bargains for those picking up equipment in a struggling market, or looking to make improvements to rigs in the downtime.
What does this mean for you?
So should you hunker down and wait for things to get better? Opinions about the future of oil are mixed and it’s impossible to say how soon and how significantly the price will recover, but we have become used to the cyclical nature of the industry and the consensus is that things will improve.
In a recent interview with The Times, Sir Ian Wood considered the current situation as the biggest crisis that the oil and gas industry has faced since the early 1970s. He said that the the next 18 months will determine the future of Aberdeen’s oilfields. The possibility of oil prices settling around $50 a barrel threatens the city’s future, and the £40bn contribution the oil industry makes to the UK economy. Without a government response to the low prices, led by a tax reduction in the immediate future, Big Oil will have no incentive to stay. We need to act now to be in a good position after the recovery.
Just as the government needs to invest in North Sea oil to secure Aberdeen’s status as an energy hub, so must companies act now to be in a good position when the market rallies. But how do you come out of a downturn as a market leader? We have found that companies that are entrepreneurial by nature and that take a strategic view of marketing as an investment are more than likely to outperform competitors.
Nike is a good example of this. Between 1988 and 1992, the sports brand increased its marketing by more than 300 per cent. Some great advertising was introduced over the period, which saw the ‘Just Do It’ campaign launched. The result was that Nike succeeded in multiplying its profits by a factor of nine. They took market share from their competitors and positioned themselves for global brand dominance.
When budgets are tighter, marketing often feels the pinch first, and sharply. But companies that invest in their communications during tough times can increase their market share, putting them in a great position when the economy picks up again.
That’s where we can help.
Fifth Ring is the leading integrated B2B marketing communications agency for the global energy industry. We are ideally placed to help you maximise your marketing budget, creating effective and efficient campaigns during the tough times, as well as the good. There are no easy answers to the question of when the price of oil will rise, but the seven simple questions below will make sure you’re ready for it...