As oil falls to $45 US, Citi says another round of cost-cutting would be ‘even more painful’
CALGARY — Debt-laden oil producers have long been comforted by a simple belief: That eventually, given a long enough timeline, prices will rebound. But a steep price slide in recent weeks has dampened even that far-off silver lining.
While members of the Organization of the Petroleum Exporting Countries (OPEC) and even Big Oil have embedded higher prices in their long term forecast, Citigroup analysts believe it is a flawed strategy.
“It is an underestimation of shale and a failure to see that the rapid growth in shale is simply displacing investment decisions that are higher up the cost-curve,” Citibank analysts said in a report.
As U.S. crude dipped below $46 US per barrel on Tuesday, Citibank says the “market is too complacent on price recovery.”
Citi expects prices for West Texas Intermediate to average $55 US in 2017 and $57 US in 2018. GMP First-Energy analysts in Calgary expect prices to average US$56 in 2017 and $65 US in 2018. Barclays estimates crude prices will average just $55 US in 2018.
It’s a darker picture than the one imagined until recently, when producers and analysts alike where predicting a slow but steady price rebound.
But technological improvements in U.S. shale plays has shattered that illusion as nimble American companies to pump out record levels of crude at increasingly lower break-even prices.
Citi analysts argue that the overarching expectation in recent years that prices would soon top $60 US per barrel may have given producers a false sense of security.
“The advantage in OPEC and companies believing that a future fix will come from higher prices is that they don’t have to contemplate too heavily the other side of the profitability equation, their own cost-base,” the analysts wrote.
The Wall Street bank said major oil companies have reduced costs by as much as 30 per cent since prices began to tumble in 2014, partly through widespread layoffs. However, those reductions were achieved under the expectation that prices will eventually recover to the mid-$60 US to $70 US range.
But if rapid production growth in U.S. shale fields keeps prices in the $50 US to $60 US range, producers will need to reduce costs by another 20 to 25 per cent, the analysts estimate.
“That will be even more painful,” Citi said.
To be sure, higher-cost producers have benefited from OPEC’s supply cut. The Citi report points to Canadian heavy oil producers in particular, who benefitted from OPEC’s strategy.
But the oilsands remain at the higher end of the cost curve despite recent improvements in steamassisted gravity drainage (SAGD) technology and a low Canadian dollar. Recent acquisitions by Canadian Natural Resources Ltd. and Cenovus Energy Inc., which announced multibillion-dollar deals in the oilsands in recent months are also seen as big bets on higher long-term prices.
“In an inflationary oil scenario these acquisitions will likely prove highly accretive; not so if oil remains sub-$50,” the Citi analysts said.
Meanwhile, OPEC kingpin Saudi Arabia has been sending positive signals to the market in a bid to prop up prices, in the run up to a meeting on May 23 to extend the output cuts they had first been orchestrated at the start of the year.
On Monday Saudi Energy Minister Khalid al-Falih said producers would do “whatever it takes” to rebalance oil markets, adding that he expects OPEC and non- OPEC members to extend a deal to cut supply through 2017.
“Our analysis of supply and demand shows that if OPEC continues at more or less the same rate of compliance—setting aside increases in Libya and Nigeria— the market does tighten up in the second half of the year,” said Ann-Louise Hittle, a vice-president of research at Wood Mackenzie.
But a price recovery may have to wait, despite OPEC’s best efforts. The U.S. Energy Information Administration said it expects American crude production to rise by more than expected in 2017 to 9.31 million barrels per day from 8.87 million barrels per day in 2016, a 440,000 barrel-per-day increase.
“Higher oil production from the United States, along with rising oil output from Canada and Brazil, is expected to curb upward pressure on global oil prices through the end of 2018,” Howard Gruenspecht, acting administration at the EIA said in a statement Tuesday.