Source: Bloomberg
Oil’s Deep Dive
December 17, 2015 12:30pm by Barry Ritholtz
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Can you say “predatory pricing”? I knew you could.
This looks much more like the 1980s to 90s to me than the 2000s. The 1980s and 90s saw lots of new oil sources come on line ranging from the North Sea, Canadian oil sands, Alaska, Venezuela, Soviet Union break-up etc.
Now we are seeing lots of new countries coming into play as well as new technologies such as shale, which is kind of like the oil sands for total available oil but can be turned on much quicker. So we were losing capacity for a while in the 2000s with older oil fields such as Alaska and North Sea maturing and declining in capacity but now there has been a world-wide capacity expansion. Since many of those countries really need revenue, they will pump as long as prices are above their marginal cost. It could go on for a decade or two, especially if alternative energy continues expanding its foothold controlling demand for oil.
Keep in mind that inflation-adjusting the $10.72 in the late 90s makes it dramatically lower than the $10.42 in 1985 in real dollars. We saw that in things like the US/CDN exchange rate that plunged from the early 1980s to 1999. If inflation stays low, then we could see oil hovering in the $30s and $40s for years with the occasional teaser spike to $60 and the occasional trading plunge to $20.
The price of oil, as of any commodity, ultimately settles on the full cycle cost of production – which is the current cost of lifting the oil, administrative costs, interest on debt, and the cost of new exploration and development to replace the consumed asset.
In the States the best estimate is lift costs of around $13-14 per boe (barrel of oil equivalent); administrative costs around $4-5 per boe; interest expense per boe about the same (yes, that high debt service is the norm for most American E&P companies).
That gives a core cost, exclusive of any profits of $21-34, for most companies. Likely twice to triple that for a number of smaller companies, and the Canadian oil sands producers. That price range doesn’t include any profits at all.
Now add replacement cost: Tricky to calculate, with a broad range of about $25-50 per boe.
For a company to remain viable, it must try to replace its production, otherwise its reserve will be drained off, and it has to shut its doors.
So, not counting any profitability. Oil below, say, $46 will gradually destroy most of the E&P industry in the United States. Realistically, oi much below $70 is as bad as oil below $12 was in the late 90’s. Yes, the cost of development and production in the oil biz has grown much faster than the average rate of inflation.
As with so many economic issues, it’s far more complex than most people know, and perhaps can understand easily.