Shale oil producers defy shakeout

By Robert Frank

Plummeting oil prices have put unprecedented pressure on energy producers in Canada and around the world. The shale oil revolution has hammered energy prices, driving producer margins below the cost of capital. Clearly, something has to give.

So far, American shale producers have defied a shakeout that had, early this year, seemed inevitable.

“Key OPEC producers expected a recovery and increased production,” recalled RBC Capital Markets managing director and chief commodities strategist Helima Croft. “Saudi production is up almost a million barrels, year over year, as is Iraqi production.”

“The Saudis tried letting the market set the floor—when they thought the floor was $75 a barrel,” she continued. “They were surprised by the resilience of U.S. production. If U.S. production ultimately proves unbreakable, then they really have a problem.”

Iran could also add to the oil glut in 2016, if it moves swiftly to meet conditions to end longstanding sanctions.

The lower-for-longer phenomenon that has emerged is literally a life-or-death issue for some oil producing countries.

“The wild card is whether régimes will remain stable in this environment,” Croft observed. “Cash enabled them to survive the Arab Spring. High expectations remain for social services and, if they can’t pay for them, they’re in real trouble.”

Countries like Iraq, Algeria, Libya, Nigeria and Venezuela are at particular risk political instability.

“Some of those countries will really struggle to meet their financial obligations at current prices, putting them at risk of political instability,” she said. “If they can’t cover wages and experience massive shortages, they could face food riots.”

“With four ongoing wars, the Middle East has never looked more unstable. Normally you have one, plus the Arab-Israeli conflict in the background,” Croft added. “The question is what has to give, and what will give first.”

Some Saudi royal family dissenters want OPEC to slash production, a new political wildcard. A two billion barrels a day cut could push crude into the mid-$70 per barrel range, boosting oil revenue by more than $30 million a day.

For now, that scenario is only an incremental risk, so don’t expect significant price rises anytime soon.

“We still have to work off very high inventories before the market reaches a balance in the second half of 2016, once they start to drop,” she forecast.

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RBC Capital Markets managing director and chief commodities strategist Helima Croft

Note: This report first appeared in the Winter 2015 edition of Canadian Real Estate.

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