Oil hit again by rising supply

U.S. oil marked its steepest five-day plunge of the year Wednesday after government data showed that light, sweet crude is still pouring into domestic storage tanks in defiance of market expectations that the global price bust would break the domestic oil production boom.

For the second week in a row, crude storage tanks in Oklahoma and elsewhere filled up higher even though refineries were churning out huge amounts of gasoline to accommodate summer road trippers. It broke an eight-week streak of shrinking crude stocks.

For oil traders, the data defied the comfortable narrative that low oil prices would pinch U.S. shale plays to the point they would put out far less oil. That idea had gained traction as oil companies side-

lined hundreds of drilling rigs this year, but analysts say markets now are realizing that crude prices had been kept elevated for two months in large part because of a pervasive fallacy.

“What’s going to be one of the biggest surprises of the year is the decline in the rig count is not going to translate into the decline in production that the market expects,” said Andy Lipow, president of Lipow Oil Associates in Houston.

The U.S. crude benchmark edged down 68 cents Wednesday to $51.65 on the New York Mercantile Exchange, down from $59.47 on June 30. A rebound in prices would likely benefit Houston’s economy, which has shown signs of slowing down during the oil slump that began last summer.

Brent, the international standard, increased 20 cents Wednesday to $57.05 on the ICE Futures Europe.

On Wednesday, potential financial crises in China and Greece loomed over the oil market, as did Iran’s potential nuclear deal with six Western powers, which could unleash Iranian crude into the market. Those three international developments have weighed heavily on crude prices this week, but analysts noted the U.S. price initially dropped by more than $1 a barrel when the U.S. government released its crude storage data early Wednesday.

Recovery in question

If barrels of crude continue to trade for $50 or less, the U.S. petroleum industry can forget about an anticipated modest drilling recovery in the second half of the year, Goldman Sachs analysts said this week. When oil was still hovering around $60 a barrel, the market had expected 100 to 150 drilling rigs to return to work this year. Now, Goldman believes only 20 to 50 rigs will be called back into the field in the remaining half of the year.

The oil job market won’t recover nearly as much as expected, as each rig employs scores of workers, directly and indirectly. And more companies may be willing to shed more jobs or sell themselves to avoid going broke, because “the psychology at $50 is much different than at $60,” said R.T. Dukes, an analyst at research firm Wood Mackenzie in Houston.

“A lot of companies have tried to hold on tight for a recovery, but if you stay at $50 very long, it becomes much harder to do that,” Dukes said.

The Goldman Sachs analysts also predicted U.S. oil could sink to $45 a barrel by October, around the time banks will reassess how much money oil companies should be able to borrow. It isn’t inconceivable, Lipow said, that the oil market will “test the lows” it had seen earlier this year, meaning its possible prices could sink again to its annual low of less than $44 a barrel.

Mergers more likely

This fall, which may herald the threat of a liquidity crunch for oil companies if banks show less mercy than they did in the spring, is widely considered a make-or-break season for the industry.

Fifty-dollar oil, analysts say, could be a psychological threshold for producers that had teetered on the edge of having to sell themselves or going broke.

“Our fundamental view is that oil prices have gone under sustainable levels,” said Guy Baber, an analyst at Simmons & Company International in Houston. “The longer prices remain below those levels, the more likely mergers and acquisitions become.”

The oil industry was able to avoid a wave of corporate consolidations this year because capital markets and banks were generous with cash the companies needed.

But now those investors seem to be holding back. Bloomberg reported Wednesday that Houston oil producer Swift Energy is struggling to raise funds for a $640 million loan because investors are demanding better terms for the debt, and analysts say other companies have had trouble getting deals done.

“There’s nothing magical about $50 oil — the bigger issue is that at current prices, across the spectrum, oil producers do not generate sufficient cash flow and can’t invest in a sustainable way,” said Pavel Molchanov, an analyst at Raymond James in Houston.

U.S. crude stocks climbed by 384,000 barrels the week ended July 3, up to 465.7 million barrels all told. Investors see the rise in crude stocks as a sign that lower drilling activity, for some reason, isn’t curbing the nation’s oil production. Analysts had expected inventories to shrink by 489,000 barrels, according to Bloomberg.

Jim Burkhard, head of global oil market research at research firm IHS, said that because shale rock is so different in the various states where it is found, some formations produce a lot more oil than others. In 2014, he said, 70 percent of U.S. wells produced 16 percent of the nation’s shale oil. That means oil companies can idle hundreds of rigs without making a big dent in U.S. output.

Dukes, the Wood Mackenzie analyst, said some regions within the major Texas, North Dakota and mid-continental shale plays require oil to be $90 or $100 a barrel in order for companies to break even on the drilling investment; in others areas, the break-even figure is $60 a barrel.

The shale boom has been able to withstand the oil market collapse because the areas that cost less also produce three times more than the more expensive regions, which generally are tougher to drill, have less subterranean pressure lifting oil up and house fewer hydrocarbons.

And drilling costs have come down as oil field service companies have given the producers a break on daily rig rates and tool prices, so oil companies are producing more oil for less money. For example, Houston-based Noble Energy is using 40 percent fewer rigs in the DJ Basin in Colorado to do 70 percent more drilling, Dukes said.

After 29 weeks of shutting rigs down, oil companies last week added a dozen oil rigs to their active roster, according to Baker Hughes. That was evidence, Goldman said, that producers can increase drilling activity at $60 oil, as oil-field service costs coming down 30 percent.

Now, Dukes said, “there aren’t many places making much money at $50 oil.

“What’s at risk right now is the longer you stay at $50, any growth that might have happened in 2016 might not happen. They’re going to struggle to ramp up investment.”