Saturday, January 17, 2015

Schlumberger Hints at Global Growth, Oil Pressures in 2015

Schlumberger Limited's (NYSE: SLB) earnings conference call yesterday provided some interesting insight into the global growth potential for 2015 as well as a detailed view of the changing dynamics we are witnessing within the oil industry.  For those not familiar with this global company, Schlumberger provides technology, project management, and information solutions to global oil and gas exploration and production (E&P) corporations.  Their clients operate in over 80 countries, giving them a unique view into the health of the economy both domestic and global.

Despite currency weakening both in Russia and Europe, Schlumberger foresees healthy growth in the global economy, surpassing the growth seen in 2014.  They see demand for oil increasing by about one million barrels per day by 2016.  This is matched by the one million barrels per day increase being supplied by the global oil market.

The dramatic drop in prices that we've seen is primarily being driven by a significant increase in supply coming out of North America and Saudi Arabia.  Globally, Saudi Arabia has shifted their strategy from one in which they sought to protect the price of oil via a manipulation of the supply to one in which they seek to protect their market share via an increase in supply regardless of the impact on price.  It's a fundamental shift in philosophy, and it's one to which the rest of the world has yet to fully react.

The impact of this strategy shift and resulting price drop is already being felt.  Exploration and Production (E&P) are down significantly, and are projected to drop by 25% to 30% in the US next year, coupled with a 10% to 15% drop globally.  Already, some 400 oil rigs have been taken offline, due to profitability issues relative to the new oil price point.

Hydraulic Fracturing technologies in the US and Canada have made a significant contribution to the oversupply of oil coming out of North America.  In the realm of cost, however, this technology is one of the highest - much higher than the cost of traditional oil wells that have both a lower start-up cost and a longer life span per site.  (Production from fraked sites declines 45% per year as compared to 5% per year from traditional wells.)  The Arabian oil companies have the lowest production costs and can therefore ride out this wave of low prices to the detriment of all competitors. The break-even point on some Arabian wells is a mere $10 per barrel.  Average break-even in the Gulf-States is $27 per barrel.  US Shale, on the other hand, has a break-even point optimistically at $50 per barrel, and some of the newer sites are even in the $80 per barrel range.  Clearly, the Saudis have the price advantage and can win the market share game simply by holding prices below $50 per barrel indefinitely. 

The impact is being felt beyond North America.  In the North Sea, both UK and Norwegian oil-rig counts are lower today and are projected to be even lower in 2015.  Those wells are simply not profitable at the current price point.  Not only are rigs being taken offline worldwide, but applications for new wells are down over 50%, and Cap-Ex spend projections for next year are being lowered tremendously.  Financing for new exploration and drilling is expected to be difficult to obtain, again due to profitability.  That will be exacerbated by rising interest rates should that happen.

What this means in the medium to long term is two-fold.  At the moment, Saudi Arabia is antagonizing one of the largest industries in their largest global political ally.  Expect the petroleum lobby to begin to apply political pressure in the White House and in Congress, if that hasn't already started.  This will change the politics between US and Saudi relations, and anytime you have a changing political dynamic in the Middle East, events can become very volatile very fast.

The second outcome will be tightening of supply, which will result in a rise in oil prices.  Nobody is willing to predict when that will occur, but it's definitely on the horizon for sometime in 2015.  Even if it's not an overt action taken by the industry, it will be a de facto result as the more expensive drilling operations either go offline until prices rise, or they go bankrupt in the face of insurmountable losses.  A look at the overall break-even points for the various producers will provide an excellent investment opportunity since they are the ones most able to survive this downturn in price, and they are the companies that will reap the harvest when prices inevitably resume their climb.

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