There are growing signs that the collapse in oil prices is biting deeper in the US oil patch, a key target for Arabian Gulf producers looking to reverse a world oil glut without cutting their own output.
The US sector had seemed to show resilience early on amid the oil price depression, and even last week oil prices dipped as the market focused on a US government report showing oil inventories growing to a record high.
But a deeper look at the sector shows growing vulnerability, one of the clearest signs of which is stress on bank lending.
“Banks and debt investors are a lot more cautious given the oil price outlook,” said Virendra Chauhan, a Singapore-based oil analyst at the consultancy Energy Aspects.
According to a report by Deloitte’s energy consultancy unit last week, 51 oil and gas producers have filed for bankruptcy among the independent North American exploration and production sector since the beginning of last year, but that number could be set to soar. There are 175 companies at “high risk” of failing to meet loan covenants, which means they might be forced to take radical action to stave off bankruptcy, Deloitte reckons.
One reason for the vulnerability is the high level of debt the sector carries in relation to its cash flow, which companies have hitherto protected by selling much of their oil for future delivery at preset prices – hedging.
But as Paul O’Donnell, the principal energy analyst at IHS, has pointed out, the independent sector – which accounts for the bulk of North America’s shale producers, which were responsible for doubling US oil output from 2010 to last year – have become more financially vulnerable this year as their ability to hedge has weakened.
“Companies hedge their production to provide a level of protection against oil and gas price fluctuations, and in 2016 and 2017 we see a significant decline in hedging protections, which means more companies are exposed to the current depressed prices and market conditions,” Mr O’Donnell said.
That in turn means that the level of debt companies are carrying has soared sharply in relation to their cash flow.
Already, companies have cut spending from US$101 billion last year to a projected $78bn this year, but Mr O’Donnell reckons that unless they cut their spending this year by another $24bn, the independent sector will run into further financial difficulties.
Mr Chauhan agrees. “We have looked at metrics for most companies that have reported [financial results] and despite the capex cuts and efficiency gains, shale remains a cash flow negative business as an industry,” he says.
“This explains why we are seeing further cutbacks in spending this year as producers strive for what has so far proven elusive,” he adds.
The Wall Street Journal last week reported that "several major banks are reducing their exposure to the energy sector by attempting to sell off souring loans, declining to renew them or clamping down on the ability of oil and gas companies to tap credit lines for cash".
This fundamentally weak scenario for the North American oil sector was somewhat overshadowed by last week’s report from the Energy Information Agency showing inventories rising to a record 535 million barrels.
However, the increase may partly have been because of a backlog of shipments waiting to offload in Houston.
Meanwhile, domestic production figures – at about 9 million barrels per day – reaffirmed a consistent trend of lower production since last summer’s peak around 9.6 million bpd. Also, imports of crude in the past four weeks averaged well above 8 million bpd.
This will be good news for Arabian Gulf producers, especially Saudi Arabia, which is leading the effort to get major exporters to hold steady to allow the world market to come back into equilibrium.
Saudi Arabia’s oil minister and some of his counterparts from Russia and other producers are scheduled to meet in Doha in three weeks to try to reach a deal to “freeze” their current levels of output.
While such a deal is seen as being largely symbolic – especially as it would exclude Iran, and likely Iraq too, which are the two major contributors to expected Opec output growth – its effect will be strengthened by signs that the Saudi-led policy of the past 18 months is working.
The results have been less clear outside of North America, with North Sea output, for example, growing last year and projected to grow this year, while other provenances such as Brazil’s offshore are feeling the bite of lower capital spending.
“On a global basis, the lagged response in supplies to lower investment is very apparent now,” says Mr Chauhan. “We have seen year-on-year declines in crude stocks for three consecutive months now, and with large upstream maintenance planned we expect this trend to continue.”
Oil prices are up more than 40 per cent from their lows earlier this year, but the market’s fragility was seen last week as the major benchmarks dipped back below $40 a barrel on the US inventories news.
A steady drumbeat that lower investment is bearing fruit should support prices in the face of short-term setbacks.
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