Oil prices are plummeting out of control and fears have been voiced that this oil crisis will be deeper than the one we experienced back in the 1980’s. With a glut of oil stored in the Middle East, how can it be that there will be a shortage of the black stuff at the gas tanks?
Economists predict that crude is expected to continue to drop before it levels off at around $50 a barrel, half the price it was just a year ago. The problem is that the overstock of oil is causing oil companies around the world to curb their production and their total spending is predicted to be slashed by $180billion. The immediate effect is to cut back on new projects and existing operations, setting off a domino effect on other sectors of the economy.
One analyst at Jeffries, an investment bank, said that after the latest round of spending cuts international oil companies lowered their break-even points by $10 a barrel. But this is nowhere near the price of $82 a barrel needed in 2016 in order to cover spending and dividends which have attracted most investors for the last few decades.
“In order to cover the shortfall, the sector will increase its borrowing,” Jeffries said. “While leverage remains manageable within the sector, this is not a practice that can continue in perpetuity.”
Crude can reach as $60.60 by the end of 2015 and as high as $69 by 2017. The International Energy Agency has already predicted that a price of $73 will not take place until 2020.
Shell joins BP Plc and Chevron Corp, two of the world’s biggest oil producers in dealing with the 50 per cent slump in crude prices this year by reducing jobs, rescheduling projects and selling off assets to strengthen their balance sheets and maintain dividend payouts.
$90 by 2018?
A representative at Royal Dutch Shell Plc foresees the current downturn in oil prices lasting for several years, this in contradiction to last April’s forecast that it would return to $90 by 2018.
Shell is eliminating 6,500 jobs this year and has announced plans to reduce capital investment by $7 billion over the next two years. Following this announcement, shares of Royal Dutch Shell was up more than it had been in the past seven months.
Chevron said this week that it is eliminating 1,500 jobs to curb spending by about $1 billion. And ConocoPhillips is continuing to make layoffs while it, too, attempts to slash $1 billion in spending over the next two years.
BC Group
BG Group, the UK-listed oil and gas company that is in the process of being acquired by Royal Dutch Shell for $55billion, also came in with lower profits in the second quarter on lower oil prices but these were offset by higher volumes in oil production and exploration as well as its record high shipping and markets segments. BG is one of the world’s largest shippers of clean-burning LNG (liquefied natural gas) and has large supply contracts with fast-growing Asian economies.
Expenditures by both Royal Dutch Shell and the other major oil companies are expected to be reduced by an additional 5 per cent to 15 per cent next year. Up until now, they have increased their gas and oil output and milked existing investments for revenue as much as possible. These measures have only acted to aggravate the current oversupply, however. These top oil firms are ready now to make harsher decisions in order to deal with the problem.
According to Rystad Energy, an Oslo-based consultancy company, part of the problem for these major oil conglomerates is that they and other oil and shale producers have thought little over the years about consumer demand and have continued to increase their share of global production for years. Now, the situation seems to be out of their hands as investments in the sector have risen exponentially with the increase in oil supplies.
Worse than 1986
Looking back historically, the last time oil prices dropped so significantly was back in late 1985 when they slumped overnight from $30 to $10 when OPEC increased its oil output following an increase by non-OPEC production. The immediate response was to cut spending by nearly 25 per cent and slicing its workforce by a third. Over the next decade, international demand rose and prices slowly recovered.
Morgan Stanley believes that today’s over supply of oil could last much longer than the one in 1986. And one analyst at Rystad pointed out that the $180billion in cuts this year represents only a 20% decrease from 2014. In the meantime, the oil companies have postponed close to $200billion worth of other projects, several of which hold huge resources such as the Canadian oil sands, where oil drilling is now six months behind schedule and several gas projects are lagging by close to 10 years.
For the time being, it looks like most of the major oil companies will be able to hold their own by borrowing more than 15% of their market value. Smaller exploration and production companies, however, will find it more difficult going forward and have already abandoned dividend distribution for this year.
