Shale Producers Will Adapt and Ensure a Lasting Oil Glut

Whilst oil prices might spike higher in the short-term, analysts expect the price to remain lower for longer as a transitioning shale sector keeps global supply 'pumped'.

Oil will spike in the short-term but longer-term it will fall back down to 30 dollars per barrel according to research published by Handelsbanken Capital Markets.

Those hoping that there will be a rebound in the price of oil as shale oil production falls, reducing global supply, will be dissappointed according to Handelsbanken's analysis. 

Instead of shale operators going bankrupt due to the relatively high cost of production using this method, as some analysts believe, Handelsbanken argue many shale producers will actually survive, lower their costs and continue producing.  

“In the longer term (12 month), shale oil continues to lower breakevens and any oil price spike will be met by increased shale oil activity under protection from short paybacks on investments and the ability to sell production on a steep contango forward curve (contango is when forward prices are higher than spot prices).”

“Accordingly, we expect the oil price to land in the low USD 30/bbl range at the end of 2016, and we believe oil will trade lower in 2017 than in 2016.”

Bankruptcy is not the end

Jansson believes the shale market is beginning its final “financial countdown” as the low price of oil precludes the high cost of shale production, which is in the region of 70 dollars per barrel.

However, rather than shale producers going bankrupt and disappearing Jansson thinks they will be ‘saved’ from bankruptcy and become ‘zombies’ just as happened to many banks which were bailed out following the crisis.

Essentially they may continue producing oil even if they cannot meet their debt obligations:

“However, bankruptcies do not mean the days are numbered for production.

“This is particularly true in the US where seeking protection from bankruptcy means debt holders will rid themselves of payments, but the oil market will not eliminate production.”

Bank of America Merrill Lynch have even suggested shale producers are the 'silver lining' for non-OPEC production which now looks set to drop across the board by 2020, regardless of spot or forward prices by their estimates.

"Shale may offer a silver lining, as the investment cycle is shorter than for conventional production," say BofA in a note to clients.

Bank of America are forecasting an upward price trajectory from here and the US rig count should increase again by 2H2016.

As such, the bank sees US shale output falling by 470 thousand b/d in a $40/bbl WTI environment, while growth returns at $50/bbl. Above $60/bbl, growth stands above 400 thousand b/d.

The Oil Glut Will Continue

"Not even bankruptcy will stop the oil glut” Handelsbanken argue. Using examples from mining and coal industries to show that widespread bankruptcies do not automatically lead to a fall in production researchers say:

“Some people think that if a company goes bankrupt, everything just stops, but the recent downturn in the mining industry shows that it is a slow process.”

The Handelsbanken report argues there are many ways shale producers could continue to operate even after bankruptcy proceedings have begun:

“Chapter 11 allows debtors to reorganise their financial affairs.

“The reorganisation process may last months or even years depending on its size and complexity.

“In the meantime, the operator could sustain production without paying debt holders.

“If the company runs out of cash to cover opex, a financially stronger producer could step in and continue to produce from those reserves.”

Indeed, the report even goes on to suggest the industry could benefit from a ‘bankruptcy boost’ as happened in the coal industry where operators were forced to stream-line production and improve processes in the face of impending shut-down.

Supply to Continue Rising

Jansson also sees other sources of currently hidden supply coming online in the future, which will further increase the oil supply, putting pressure on prices, and overall he sees risks tilted to more not less supply in the future:

“The supply risk is rather on the upside given that Libya currently is producing at low levels, Iran is about to ramp up its idled production and Saudi Arabia still has spare capacity.

“It could be a breakneck curve for oil prices once Iran starts to fight for the market share in Europe, which Saudi Arabia and Russia grabbed during the sanctions on Iran.”

The report dismisses as “zero chance” the possibility of OPEC cutting production in 2016.

Projects already Begun

Supply will be further increased by large scale capital intensive projects coming online which have “too many incurred costs” to be halted.

These all share the characteristic that they have very low operating costs and so will potentially further drive down the price of oil:

“opex is surprisingly low, meaning that production will generate positive cash flows.

“Norway’s Johan Sverdrup is one example of such a field, albeit at the extreme, that is scheduled to come on stream in 2019 at a operating cost of about USD 5/bbl.

“Eni´s Goliat in Barents Sea is another example, with first production in 2015.”