Short-Term Perils of Lower Oil Prices: DW Monday

At present we are seeing lower oil prices as a function of softer demand growth in both Europe and China combined with recent output increases from OPEC, particularly Libya, together with the ongoing surge in US production, notes Douglas-Westwood in the latest 'DW Monday'.

In the short-term, supply could start to be taken out of the market quite quickly if lower price levels are sustained – we have earlier noted that returns for most E&P companies have been eroded by rapidly-rising costs. This has pushed hurdle rates for new projects higher often to around $80/bbl, indeed many are described by our E&P clients as 'marginal' at $100/bbl, which means that we could start to see a major shift in oil company strategy if prices fall much further. This is likely to manifest itself in terms of pressure on the supply chain to cut costs, delays in project sanctioning and in major modification projects. So below $85 we are likely going to see investment levels materially impacted.

Further supply-side pressure may well be seen in Russia, albeit in the longer term. There are reports that western activity with ‘sanctioned companies’ (includes Rosneft, Lukoil, Surgutneftegaz) will have to stop in the coming weeks which could halt the likes of Exxon working with Rosneft in the Arctic and have wider implications for the oil field service community (e.g. Seadrill’s provision of rigs for Rosneft). However, in reality, Artic joint ventures such as these are long-term in nature and any impact on the oil supply is most likely to be seen over a 2-5 year period.

Without political interference markets eventually self-correct. Much of the additional production capacity added in recent years is high cost US unconventional oil – and these wells peak early and decline rapidly.

So if drilling stops, over-production capacity will quickly evaporate which could bring global oil supply down materially, and as we have stated so often in the past, if investment slows significantly we will be short on oil supply and there will again be upward pressure on oil prices.
 
Source: Douglas-Westwood