The price of oil has dropped from $115 in mid 2014 to $30 a barrel today. That’s a 74% drop in prices with the price of oil now at a 13 year low. This article has been written to give suppliers into the industry an overview of why this is happening, the risks, the outlook and a suggested approach to assess customer risk.
Industry Overview
The main reasons for a price slump are the following:
- Iran, who is a major conventional oil producer but has been frozen out for almost a decade due to sanctions, is about to return to the oil market.
- There is a battle between conventional oil producers and new shale producers
- The shale oil industry has created new major producer countries such as the USA.US Shale has been on a production boom
- In Feb 2009 it produced 5.1m barrels per day
- In Apr 2015 it produced 9.7 barrels per day
- The Chinese economy is slowing down as its building boom is slowing down. China is a major importer and consumer of Middle East oil.
- OPEC which is a cartel of oil producers is losing its ability to manage supply in order to maintain world oil prices.
- Saudi Arabia, who was conventionally the influencer in price setting as it would adjust its production so as to control the world oil price, is now not prepared to cede market share so as to subsidise higher cost producers such as shale oil producers.
Conventional Oil vs Shale Oil
- The average cost to set up shale well is $5 million. The average cost to set up a deep sea oil rig is $170 million.
- The average lifespan of a shale well is 5 months. The average life span for a conventional oil well is 5 years.
- Shale oil requires price of $60 in order to be break even. On average conventional oil is $35 to be break even.
- Saudi Arabia only needs the price to be $10 to break even.
Why did Shale Oil become such a player?
There are four main reasons:
- Unique combination of high oil prices and cheap money
- With oil getting a price of over $100 a barrel this made it viable to invest in new drilling technologies
- The financial crash of 2008 has led to cheap central government interest rates
- Advances in Fracturing & drilling technologies
- Access to easy cheap finance
- Today the top 60 USA independent oil companies have debts of $206bn while in 2006 (10 years earlier) the debt was only $100bn.
- With low interest rates investors were looking for new areas to main gains
- Oil was considered a low risk investment.
- US government Energy Policy
- After 9/11 the US government wanted to move away depending on the Middle East to provide it with energy solutions for its economy.
- The USA government has an stated goal of becoming energy self-sufficient.
So what is now happening to Conventional Oil Producers?
- Today there is about a 2% oversupply in the market. This is unlike the 1980’s where there was an oversupply north of 20%.
- OPEC countries are starting to demand that Saudi Arabia cut production. Nigeria and Venezuela have been to the fore in demanding cuts in production.
- Russia, the second biggest oil producer, is now starting to consider oil production. It requires the price of oil to be around $100 per barrel in order to balance is government budget.
So what will happen to Shale Oil Producers?
Shale Oil producers are battling to stay alive as the low oil price is crushing their market.
- Over the last 12 months the costs of drilling and completing a shale well has been slashed by 35%-40%.
- The markets feel that oil & shale groups will not survive
- In the USA – 12 of these 60 companies have debts in excess of 20 times EBITDA
- S&P have graded them as –B….high risk of default
- Its estimated that 50 (33%) of the 155 oil producers could default on their debts
- So to survive this oil companies have done the following
- Halted capital expenditure on new drilling
- Shed jobs, the US alone has shed over 86,000 jobs. Canada has shed over 50,000 jobs.
- Some companies will have to sell off their prized assets simply just to survive
- The number of rigs drilling oil wells has fallen by 68%. In Oct 2014 there was 1593 oil rigs in Jan 2016 it is now only 510
Analysts say that prices need to reach $50-$60 per barrel to restart new drilling and expand the industry. However the cost for the industry to expand will now be a lot higher
- The cost of labour will go up as new staff will need to be hired from other areas
- The cost of training will go up as all these staff will need to be retrained
- The cost of debt will be higher as the Fed has increased the interest rates
- The cost of money will be higher as the risks now need to be factored in.
Approach to assess customers
Using this three stage approach will enable your company to conduct a risk an assessment of each customer:
- Most industry insiders who are on the ground know which companies are likely to survive and those that are in trouble. Speak with individuals who are associated with the industry and get their observations and opinions.
- If there are major changes within your customers finance department and payments processing times, this is a strong flag indication of potential issues. Talk to you payments and finance team.
- If your customer’s sales numbers do not reflect current market trends, find out why. Talk to their purchasing team to establish their current purchasing strategies and reasoning behind it.
Conclusion
Indeed it is interesting times within the Oil Industry. As a supplier you may be caught up in an industry which is undergoing major change and reform as the conventional producer’s battle with new entrants so that they can maintain control of this industry.
As there is no previous experience to fall back on everybody should be wary of who is being affected by the major price changes. Just like the banking crisis there will be causalities from the big boy’s right down to the small boys.
The best piece of advice is to keep cash plus keep costs down.