Oil costs Apr15

I don’t take the view that they (OPEC) are in any way trying to threaten other suppliers. I think they’re really kind of on a classic price-discovery exercise, which is important for all of us as investors to know.”

This was the analysis of ExxonMobil CEO, Rex Tillerson, in Houston last week.   And he went on to add:

“I think it’s going to be very useful to the industry to have a clearer understanding of the resilience of these resources, how robust these resources are, and how they are able to withstand different price environments.”

Tillerson didn’t discuss why a price discovery exercise has become necessary, or the evidence that US Federal Reserve’s monetary policies have been a major cause.  Instead he focused on the equally critical issue of operating costs in the world’s major oil producing countries.

These are highlighted in the above IMF chart, produced with Rystad Energy.  It shows operating costs on the left (blue column), and production on the right (red dot).  And contrary to popular belief, it confirms:

  • Almost all countries can operate at prices of $15/bbl
  • Only Canada/Australia with costs of $20/bbl; Brazil at $30/bbl; and the UK at $40/bbl need higher prices

And just to emphasise the point, the IMF adds:

Lower oil prices are expected to have a smaller impact on production of shale oil in the United States than on deepwater and oil sand production, especially in Brazil, Canada, and the United Kingdom”.

ExxonMobil are the largest US shale operator, and Tillerson went on to argue there will be no quick rebound to higher prices.  Instead, he suggested:

My expectation is this is going to be with us for a while.  We’ll have some false signals, we’ll have some false responses, where we get a little bump this way or that, but I do think people need to settle down for us to be in a different price environment for at least the next couple of years, and then we’ll see how things respond.

”Understanding how the resource really behaves in a reduced level of investment is something I think we will all learn in this downturn. Clearly a significant decline in rig activity did not diminish the continued growth of natural gas capacity even in a very difficult price environment. Is that analagous to the tight oil? I think that’s what we’re all going to learn.”

Wise words indeed, especially given the way certain hedge funds have used the Fed’s cheap money to drive up Brent prices in recent weeks.  As the Financial Times reports:

“Hedge funds have placed one of their largest ever bets on a rally in oil prices, just as evidence mounts that energy companies are hunkering down for a delayed recovery.  Exchange data show hedge funds and other large speculators have accumulated a record-breaking number of North Sea Brent futures and options contracts equal to almost 265m barrels of oil — the equivalent of almost three days of global oil demand.”

But the funds have overlooked one key point in their rush to be contrarian. US shale producers are expected to see their costs fall by 45% this year, and by up to 70% by the end of next year. Hess, for example, has announced it has already “driven down drilling costs by 50%, and we can see another 30% ahead.”

Plus, of course, the hedge funds’ buying means shale producers can now hedge their H2 production in the futures market at today’s much higher prices.

The previous record for futures contracts was set in June last year, just before prices began their collapse.  Past performance is not always a good guide to the future, but it is usually reliable.

And last night’s US oil inventory report showed stocks rising for the 16th straight week to a new record high of 485mb.