Saudi Arabia’s Oil-Price War Is With Stupid Money
By Art Berman, SRSrocco Report
Saudi Arabia is not trying to crush U.S. shale plays. Its oil-price war is with the investment banks and the stupid money they directed to fund the plays. It is also with the zero-interest rate economic conditions that made this possible.
Saudi Arabia intends to keep oil prices low for as long as possible. Its oil production increased to 10.3 million barrels per day in March 2015. That is 700,000 barrels per day more than in December 2014 and the highest level since the Joint Organizations Data Initiative began compiling production data in 2002 (Figure 1 below). And Saudi Arabia’s rig count has never been higher.
Figure 1. Saudi Arabian crude oil production and Brent crude oil price in 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc
Market share is an important part of the motive but Saudi Minister of Petroleum and Mineral Resources Ali al-Naimi recently emphasized that “The challenge is to restore the supply-demand balance and reach price stability.” Saudi Arabia’s need for market share and long-term demand is best met with a growing global economy and lower oil prices.
That means ending the over-production from tight oil and other expensive plays (oil sands and ultra-deep water) and reviving global demand by keeping oil prices low for some extended period of time. Demand has been weak since the run-up in debt and oil prices that culminated in the Financial Collapse of 2008 (Figure 2 below).
Figure 2. World liquids demand (consumption) as a percent of supply (production) and WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars, 2003-2015. Source: EIA, U.S. Bureau of Labor Statistics, and Labyrinth Consulting Services, Inc.
Since 2008, the U.S. Federal Reserve Board and the central banks of other countries have further increased debt, devalued their currencies and kept interest rates at the lowest sustained levels ever (Figure 3 below). These measures have not resulted in economic recovery and have helped produce the highest sustained oil prices in history. They also led to investments that are not particularly productive but promise higher yields that can be found otherwise in a zero-interest rate world.
Figure 3. U.S. Federal Funds rates and WTI oil prices in January 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc.
The quest for yield led investment banks to direct capital to U.S. E&P companies to fund tight oil plays. Capital flowed in unprecedented volumes with no performance expectation other than payment of the coupon attached to that investment.
This is stupid money. These capital providers are indifferent to the fundamentals of the companies they invest in or in the profitability of the plays. All that matters is yield.
The financial performance of most companies involved in tight oil plays has been characterized by chronic negative cash flow and ever-increasing debt. The following table summarizes year-end 2014 financial data for representative tight oil-weighted E&P companies.
Table 1. Summary of 2014-year end financial data for tight oil-weighted U.S. E&P companies. Money values in millions of U.S. dollars. FCF=free cash flow (cash from operations plus capital expenditures); CF=cash flow; CE=capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc.
Some rationalize the negative free cash flow as an expansion of capital base that will result in future profits. The following table shows that over the past 4 years, tight oil negative cash flow increased and has reached a cumulative of more than -$21 billion for the representative companies. Almost half of that negative cash flow took place in 2014.
Table 2. Summary table of cash from operations and capital expenditures for tight oil-weighted U.S. E&P companies. Values in millions of U.S. dollars. Source: Google Finance and Labyrinth Consulting Services, Inc.
The average U.S. oil price from January 2011 through year-end 2014 was $95 per barrel. First quarter 2015 performance at $48.50 WTI will be a disaster that makes the previous 4 years look good.
How long do the losses continue before the cheerleaders of shale plays admit that the enterprise is not profitable? Only the more diversified integrated companies like ConocoPhillips, Marathon, and OXY show meaningful long-term positive cash flow. If companies could not show positive cash flow at $95 per barrel, what price is necessary and what will that do to the world economy?
Some of my readers dispute the poor economics of these plays based on incorrect notions of break-even profitability–some believe that tight oil plays are profitable at $35 per barrel oil prices (see comments from my last post).
Following are two slides taken from Schlumberger CEO Paal Kibsgaard’s recent presentation at the Scotia Howard Weil 2015 Energy Conference held in New Orleans. These slides present a well-informed and objective view of how tight oil plays compare to other plays.