The Fuse

IHS Analysts: “Small Mountain” of Cash Looking for the Bottom of the Cycle

by Leslie Hayward and Matt Piotrowski | February 24, 2016

It’s no secret that oil production across the world is under stress due to low prices, but the big question that speakers and attendees at IHS CERAWeek are asking is how quickly the rebalancing will occur and what the industry will look like several years down the road. In order to survive, companies or countries must either cut costs, borrow money, or shut down production. So far, oil markets have seen a combination of the three.

A group of IHS experts tried to shed some light on these issues and others at the conference on Tuesday. Below are some key takeaways.

No drought in capital markets

There hasn’t yet been a drought in capital markets in energy. In fact, a mountain of cash is on the sidelines waiting for the bottom of the cycle to invest in companies that are cash-strapped.

There is a “small mountain” of cash from private equity waiting on the sidelines, “looking for the bottom of the cycle.”

When asked about the impacts of the “capital drought,” or a shortage of investment to keep companies afloat, Raoul LeBlanc of IHS said, “There hasn’t been one.” He added that there is a “small mountain” of cash from private equity waiting on the sidelines, “looking for the bottom of the cycle,” suggesting that as capital markets perceive an opportunity to profit from the upswing in prices, money will keep flowing to beleaguered producers.

Many analysts had expected capital markets to dry up in the shale sector, forcing companies to go into bankruptcy and undermine production. But so far, even though there has been a string of bankruptcies, the unprecedented access to capital has kept companies afloat.

No systemic risk to financial markets

According to the panel, defaults from producers might cause issues for some regional banks, but don’t pose a threat to the global financial system. “The oil world is not that big.”

According to Raoul LeBlanc: “There are some financial institutions that specialize in energy loans, and some of them might be in trouble. But while it hurts the financial system, I don’t think it’s a structural risk.”

U.S. shale’s resiliency

LeBlanc, who noted that U.S. oil production could have held flat at $43, emphasized the “hogs and dogs” in U.S. shale. Hogs are the high productivity wells, while dogs are higher cost and lower productivity. “There’s a small number of good wells, and a large number of bad wells. You’re always running up a down escalator,” LeBlanc said, to describe the need for continuous investment to sustain shale oil production.

$30 should do the trick

According to LeBlanc, “In 2015, dropping from $100 per barrel to $50 per barrel was enough to slow the U.S. shale growth juggernaut. But it wasn’t enough, and now we need to eliminate barrels. We think that $30 per barrel does the trick.”

Roger Diwan said, “Prices have to be low enough to impact the cash available to a company. We calculate that there have been $2 trillion in capex cuts already—although about 40 percent of that is because of lower production costs.” He added: “Right now we are seeing the holy trinity of low cost, cash suffocation, and the reactivity of the barrel. High cost producer or wells in the world are starting to be under real stress, and the real question is how fast we see these wells being taken down, being capped.”

However, he noted that these volumes are “invisible,” creating a lag between when these volume are taken offline, and when the market reacts to their removal.

Invisible barrels first to get hit

These “invisible barrels” include oil produced in countries which do not provide transparent production data, or stripper wells in non-OECD countries, Russia, and China. By IHS estimates, some 2 mbd of global production is provided by stripper wells.

The second tranche of decline will be high fixed cost barrels coming from tertiary recovery—big basins that came online in the 1980s

What will decline after the stripper wells? According to Diwan, “The second tranche of decline will be high fixed cost barrels coming from tertiary recovery—big basins that came online in the 1980s. The North Sea, Mexico, places where production is going down, and you need to significantly reinvest to slow the decline rates.”

He continued: “The third place where we will see declines are those where you have a quality or location penalty. You have a long very long pipeline, or a very heavy barrel that sells for a $10 or $15 discount to existing prices. They are selling for so little—these barrels are very challenged. How quickly they will disappear is almost impossible to tell. It depends on the company’s behavior, who owns them, the country, the tax regime, etc. I still think they are invisible because if you lose 10 thousand barrels in Peru and 5 thousand in Bolivia, in the long term they matter, but it takes time to notice they disappeared, and by then we will have real momentum into the decline in production.”

OPEC is in hibernation

“OPEC is dormant for now. Minister Naimi was quite clear this morning that we should not confuse a freeze with production cuts.”

Bhushan Bahree of IHS echoed the strongest sentiment of the day, “OPEC is dormant for now. Minister Naimi was quite clear this morning that we should not confuse a freeze with production cuts.” He said that the cartel is currently “in hibernation” and that now there is technically no difference between OPEC and non-OPEC producers, as all are acting in their own interest and managing their resources according to price.

Demand takes some hits

Global oil demand grew by a robust 1.7 mbd last year, but is set to take a hit in 2016, largely due to slower growth in emerging markets. Slower economic growth is hitting diesel the most, which is in turn hurting refineries that upgraded over the past decade to run more distillate fuels. In 2015, which “caught the refining industry by surprise,” said IHS’s Kurt Barrow, who said the healthy demand growth was underpinned in large part by the U.S. and gasoline consumption throughout the world—rather than diesel. A combination of weaker demand for diesel and high refinery utilization to meet gasoline demand have brought about a global glut of refined products. While the the crude overhang will persist for some time, so will a large oversupply of gasoline and diesel.

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