At the moment, about 5 million barrels of oil produced worldwide each day is not fetching high enough prices to cover the costs of getting it out of the ground, based on Brent crude at $25 a barrel. “These operations have been losing money on every barrel they produce,” IEA analysts noted. As of late, however, the Brent front-month June recovered to around $33.70 a barrel, loosening the squeeze on upstream companies.
Still, in the new environment, projects considered low cost yesterday (i.e. those that are viable at around $35 to $45 a barrel already look high cost today. “The scope of cost reductions is limited because much of the efficiency gains have already been harvested,” analysts noted. “As a result, the current declines in investment are translating more directly into cutting back activity.”
Cash-strapped wildcatters are losing out
Cutbacks and production shut-ins are especially stark among some smaller independent U.S. upstream companies, dubbed wildcatters that are often engaged in shale fracking. Many wildcatters are debt-financed and were already facing strong demands from investors to shore up business models and improve cash flow before the latest price crash.
For vulnerable producer economics, the looming global recession poses a great risk. The IEA’s initial estimates of 50%-85% drops in net income for selected producer countries in 2020, compared with 2019, “were dramatic already.” But analysts now warned “these declines could be even greater depending on the final extent of the demand drop and the economic slowdown.”
Economics of oil production are, however, not necessarily indicative as to which operations will be shut in. Some more robust and financially sound producers may continue pumping oil and associated gas even if they are losing money. This tends to occurs it the costs of shutting down production are higher than the operating losses.
Bankruptcies and takeovers more likely
Hard-nosed producers may opt to wait and see if weaker rivals go out of business, which would improve the environment for those who stay in the game. Some large players might even be hoping to acquire a cash-strapped wildcatter at a bargain price.
However, there is now an additional, even more pervasive threat facing many producers, irrespective of their operating costs or strategies. “As demand plummets, the entire supply chain of oil refining, freight, and storage is starting to seize up, making it increasingly difficult to push new supply into the system,” IEA analysts warned. Much the same holds true for the natural gas supply chain.
Changes in oil markets ripple across all parts of the energy sector, notably on the natural gas due to oil-indexation of many long-term gas supply contracts. Over the next 6-9 months, the current rock-bottom oil prices filter through into gas contract prices and at oil around $30/bbl, many gas suppliers would struggle to cover their operating costs.