Exuberant drilling: In search of a cure
Three years of bankruptcies and billions in financial losses later, U.S. oil companies remain their own worst enemy.
Oil prices have fallen 20 percent in recent weeks into the $45-a-barrel range, largely because of irrational exuberance. Earlier this year, prices rose above $52 a barrel for West Texas Intermediate, prompting investors to acquire oil assets, inspiring traders to buy futures contracts and leading analysts to declare the 3-year-old bust over.
Apparently, none of them realized that infusing cash into those companies would extend the bust for another year.
Oil companies pump crude. That’s what they do. They took their newfound capital and hired oil field services companies to hydraulically fracture hundreds of uncompleted wells and to drill hundreds of new ones. The Baker Hughes rig count has grown in the Permian Basin from a low of 132 in April 2016 to 369 last week. Nationwide, the rig count has grown from 330 to 769.
All of those rigs will soon add oil to a market still awash in crude. Crude and refined petroleum product inventories remain at near-record levels. Demand over the past four weeks is down 3 percent from last year, according to the U.S. Energy Information Administration.
Prices, therefore, are unlikely to rise until the U.S. rig count goes down or the Organization of the Petroleum Exporting Countries cuts production, according to Tudor, Pickering, Holt & Co., a Houston-based energy investment bank.
“The market wants rig count lower by about 100 rigs to alleviate the fear of a tsunami of U.S. crude oil in 2018,” analysts wrote last week. But the company added that large exploration and
production companies have sufficient funds to keep drilling, leaving some analysts worried that the flood is inevitable.
North American land rigs, though, aren’t the only source of new crude.
Around the world, oil companies are investing in their existing wells to increase output and lower per-barrel costs. With few analysts predicting crude prices above $60 a barrel before 2020, owners of existing wells that break even at $60 a barrel or more are looking for ways to cut operating costs or to increase output. Shutting down production makes little sense because 90 percent of a well’s cost is sunk before the first drop of oil is produced.
BP plans to spend $17 billion a year through 2021 on the company’s very expensive Gulf of Mexico platforms to increase production by 5 percent a year, CEO Bob Dudley told investors recently. Company executives want to slash operating costs by 50 percent.
“Our strategy is to take this investment that we spent so much money building, and keep it full” to the platform’s capacity, Richard Morrison, BP’s regional president for the Gulf of Mexico, told the Reuters news agency.
Oil investors looking to OPEC for help with prices will be disappointed, as I’ve repeatedly pointed out for three years now. The cartel cut production by more than 1 million barrels a day in December, but that was only after members had boosted production by 1 million barrels in 2016. Cutting new barrels is an easy promise to make. Going lower is harder.
OPEC also didn’t apply any quotas to Libya and to Nigeria, where civil unrest had led to involuntary production cuts. Both countries have since ramped up again, adding barrels back to the global market and pushing prices down.
While OPEC ministers will meet later this month to review member adherence to the quotas, cutting more barrels is not on the agenda. With non-OPEC countries boosting production, OPEC is worried about losing global market share.
U.S. oil exports, for example, have doubled since Congress let them begin again in 2015. President Donald Trump has also said he wants the U.S. to export more oil and natural gas to “dominate” global markets.
OPEC members know full well that U.S. oil companies will capitalize on any price increase, and they don’t want to do U.S. exports and profits any favors.
None of this is good news for Houston, which has lost 75,000 jobs from the 2014 oil price collapse. Oil industry workers here design new wells and build equipment to drill them, which means fewer rigs leads to fewer jobs.
So why do U.S. oil companies consistently overproduce? It’s called the free market.
Everyone knows that commodities boom and bust. But the scale and length of the cycle is rarely predictable. Companies that get in early do the best before the associated costs of land and contractors shoot up. Once pumping, the operating costs of the well are minimal compared with the initial capital investment, so most banks and investors require companies to keep wells running, no matter what happens to the price, to recover as much of their investment as possible.
The U.S. also forbids companies from colluding to prop up prices, and no one has the authority to set quotas the way OPEC does. Only investors can limit production by withholding the capital needed to drill.
Eventually, the price of oil will rise again and make a lot of people rich, but not now. What we’ve just witnessed was a false dawn.