$50/bbl: The 'Goldilocks' Oil Price?

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March 2016 Casey Sattler

The recent return of $40 per barrel Brent may be shaky, but its rise has succeeded in stirring up fresh discussions as to what price the oil industry could function healthily at for a sustained period of time within a "lower-for-longer" environment. In an exclusive interview with Energy Intelligence last year, Exxon Mobil Chief Executive Rex Tillerson explained that the rapid arrival of $100 oil masked the underlying break-even prices of many new sources of supply since it effectively made everything economic to develop. As such, the collapse in oil prices since mid-2014 has forced the industry into an important "price discovery process" (PIW Sep.7'15). What the industry has discovered in the past 20 months is that production is far more resilient at lower oil prices than anticipated. It has also learned that oil in the low $30s -- as it had been for much of early 2016 -- is a nonstarter. It is a price that causes extreme and unsustainable financial pain for the vast majority of industry players, with producers unable to self-fund functional businesses and nations unable to cover social budgets. A $40/bbl oil price offers some breathing room, but $50/bbl? That, it appears, would offer significant, sustainable relief. It could be the Goldilocks price, not too low and not too high.

It is not a given that $50 is the "perfect" oil price. Brent hasn't been priced consistently around $50/bbl in half a year, and the pain much lower oil prices have dealt in the interim has changed the landscape. For example, ratings agency Fitch recently said that the default rate among high-yield US E&P firms is expected to hit 30%-35% by the end of 2016. Scott Sheffield, CEO of Texas Permian Basin giant Pioneer Natural Resources, believes more than half the US independent sector could enter "some kind of Chapter 11 or bankruptcy" if the downturn lasts another one to two years (EIF Mar.2'16). Meanwhile, beleaguered Opec producer Venezuela is veering ever faster toward default and the Mideast's Gulf Cooperation Council countries face a current account deficit equivalent to 10% of GDP this year, according to ratings agency Moody's.

Still, a consensus is emerging that $50 oil is at least a practical price for the industry to work with. It is the presumed point at which the recent hemorrhaging can be stemmed, while also preventing a sharp rebound in short-term production, which would only sink the price once again.

This view is emerging from oil ministries and corporate boardrooms alike. Opec delegates tell Energy Intelligence that there is broad support for oil prices around this level, with $60 seen as too high since it would drive renewed growth in US light, tight oil. Shale leaders seem to agree on that trigger price, with Pioneer's Sheffield saying last month that $60 is the threshold at which the sector can return to growth.

Indeed, with various analysts and E&P CEOs of the view that $50 oil will stop US shale production from shrinking but also keep it from growing, such a price would effectively bring a heavily fragmented US upstream on board with the production "freeze" that 15 Opec and non-Opec members aim to negotiate at an Apr. 17 meeting in Doha. Opec trio Qatar, Saudi Arabia and Venezuela, as well as non-Opec Russia, first discussed the notion of a coordinated freeze in February in the hope that prices would recover to $50 by the end of the year without Opec members having to cut production and thus give up recent gains in market share.

The Western majors are also coming around to the idea that $50 "works," with Chevron's investment strategy, updated this month, targeting a $50 break-even price for capital expenditure and dividends by 2017 (EIF Jan.13'16). Eni's own strategy update this month revealed that the Italian major can internally fund its capex this year at $50 oil (divestments will cover dividends). Norway's Statoil has meanwhile succeeded in shifting its post-2020 operated development portfolio from one in which just 29% of projects could break even below $50/bbl in 2013, to one where over 80% works below that price.

Wishing Won't Make It So

Of course, just because a price is desired doesn't mean the market will move there out of convenience, and numerous headwinds have already started to break crude's momentum above $40. For one, much of the recent rally that helped Brent return to $40 in the first place can be traced to speculators wanting to ensure they weren't caught on the wrong side of the trade should oil markets start to rebalance as several Opec and non-Opec producers discuss a potential output freeze. Crude has also gotten caught up in a broader "risk on" investment wave that has sent most commodity prices higher.

Market psychology can be a powerful force and could well bring $50 oil into view sooner than fundamentals suggest, and support that price for some time (EIF Feb.10'16). But such psychology can also quickly deflate if the investment thesis stalls, and other external factors such as a stronger dollar could offer too much resistance for oil prices to ride higher (EIF Mar.23'16). Already last week Brent fell back below $40 as reports of another build in US crude stocks revived fears of the formidable global surplus.

Indeed, at some point, oil market fundamentals cannot be ignored. Supply and demand remain out of balance by more than 2 million barrels per day, and an estimated 870 million bbl of accumulated surplus oil will come out of storage at some point in response to higher prices. What's more, a growing inventory of drilled but uncompleted wells (DUCs) in US shale could be tapped to quickly dump significantly more oil onto the market than anticipated, at least for awhile. According to Energy Intelligence's Research & Advisory group, there are an estimated 4,000 to 5,000 DUCs across the US, up from 3,000 to 4,000 as of May 2015 (WEO Mar.23'16).

It is unclear where oil markets will go next. For now, producers will take $40 for as long they can (EIF Mar.2'16). If the price can make its way to $50 one way or another, it could provide another critical price discovery lesson for the industry as it navigates the lower-for-longer era.

Casey Sattler is news editor for Western Hemisphere at Energy Intelligence. This article appeared originally in EI Finance.

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