American Shale Oil Stocks Under the Hammer

Big capital expenditure cuts put oil companies on the back foot!

The energy industry has been soaking up punishing blows as the price of oil continues to trade around the $50 per barrel level. The challenge for many of the oil giants is how to balance exploration and investment costs, preserve cash flow and maintain profitability. Oil inventories in the U.S. are piling up, and this is placing tremendous pressure on shale oil producers to reduce their supply and cut costs accordingly. In early February 2015, oil rallied for several days and gained as much as 19%, prompting analysts to announce that the market had finally bottomed out. Those gains were subsequently erased, and the oil industry continues its descent after 8 consecutive months of oversupply and weak demand. The oil stocks selloffs came hot on the heels of a stronger U.S. dollar.

Global oil glut confirms fundamental weakness

Energy fund managers are generally of the opinion that, unless the fundamentals in the oil sector are changed vis-a-vis oversupply, we are going to see continuing oil price weakness in the markets. As many as 2 million additional barrels of oil per day need to be used up to bring equilibrium back to the market and raise prices. According to recently released data from the EIA, U.S. crude oil stocks now stand at over 413 million barrels – the highest they have been in over 33 years. Forecasts for crude oil inventories undershot the actual figure by almost 3 million barrels for the week ending January 30, 2015. By the end of the first week of February, WTI crude oil was trading at $50.48 per barrel and Brent crude oil was trading at $56.57 per barrel. Not surprisingly, the early February spike in the price of oil comes amid announcements by the US shale oil industry of a sharp decline in U.S. oil rig licensing, and exploratory investments for 2015 and beyond. Industry analysts were hopeful that this would restore a modicum of normalcy to the oil markets to balance out supply and demand concerns. Instead, what we are seeing is continuing weakness in the oil price as a result of OPEC's decision to maintain supply.

How oil companies are dealing with $50 prices

Oil companies have deep pockets, but the costs of maintaining operations, explorations and investments are placing heavy pressure on the industry. The fact of the matter is that companies have based their profits on an average price of around $80 per barrel. Now that this figure has been blown out of the water, the industry has been shaken to its core. British Petroleum (BP, Financial) for example has made sweeping cost cuts to accommodate this new reality. Already announcements of over 30,000 layoffs have been made and reductions in production volume are set to follow. The company's capital expenditure budget has been sitting at approximately $35 billion per annum, but its annual growth rate is anaemic. The chief executive officer of British Petroleum, Robert Dudley, alluded to need to reset the entire cost base of the company. BP has already reduced its capital expenditure for the year by $5 billion and almost 1,000 workers have been laid off in the U.S. alone. BP stocks have been declining since late 2007, when the price per share was over $73. Today BP shares are trading at $41.13 each.

Oil production in Texas continues unabated, as it does in other oil-rich states across the U.S. While many rigs are facing closure, and layoffs are widespread, production volumes at existing wells continue to grow. Already, the Department of Energy expects U.S. oil production to hit a 40-year high this year. The Texas Railroad Commission (TRC) announced that 2.3 million barrels of oil were produced per day throughout November 2014. The oil glut is surprising given oil price weakness. Banc De Binary commodities brokers believe there are many forces at play between OPEC and American oil producers. Both sides are intent on maintaining maximum market share, regardless of how much high levels of production are crippling the oil industry. For top OPEC member states, oil wells can withstand a prolonged period of low prices. US shale oil wells have higher cost structures owing to the difficulty of oil exploration, brutal winters and the high costs of peripatetic labor that are required. Nonetheless, production continues in earnest and consumers are benefiting from this in the short term.

Will U.S. shale oil producers fold?

The picture is less rosy when it comes to employment opportunities in the energy industry in the U.S. The number of active rigs in the U.S. dropped to 1,223 (3-year low) according to Baker Hughes. Tens of thousands of jobs have been slashed across Texas, North Dakota and other oil-rich states. Budgets across the board are being trimmed as layoffs and exploration expenditures are factored into the equation. Technological improvements at U.S. oil wells have made it possible to drill wells in double-quick time. Well productivity is increasing and more oil is being pumped out of wells than ever before. The sophistication of shale oil wells allows the drilling operations to tap into the vast resources of oil deep underground. The initial drilling operation is vertical and then it moves sideways for thousands of feet. According to those in the know, the current oil price allows for a break-even scenario so drilling continues in earnest. Once the price drops beneath $45 per barrel, oil producers are going to be in the red. This will accelerate layoffs, divestments, deep budget cuts and production decreases. Producers weigh the costs of ceasing production entirely against maintaining production at low or negligible margins. For many producers, the show must simply go on.

The Saudi Arabians may well be hoping to squeeze the U.S. oil producers out of the market entirely by forcing prices so low that U.S. rigs simply have to shut down. If this is their strategic objective, it's already working but not without serious repercussions for poorer OPEC member countries, too. The effects of low oil prices are not immediately being felt by oil producers in the U.S. Since the price of oil was trading at around $100 per barrel for at least half of 2014, the U.S. industry will only be feeling the pinch in coming months. However, the negative effects of low prices cannot be kept at bay for too much longer and by Q2 or Q3 2015, the US oil market is going to come under severe strain, ceterus paribus. The Energy Information Administration expects the U.S. to be drilling more oil in 2015 than it did in 2014. This is based on the proviso that oil prices will increase after Q2 2015. The U.S. government is expecting the U.S. to pump 9.5 million barrels per day come 2016, but that figure may not have any rational basis if current geopolitical and economic uncertainty continues.