U.S. Shale Production Costs Are Finally Falling
After years of rising production costs amid post-pandemic inflation, the U.S. Shale Patch can finally breathe a sigh of relief after the cost trajectory hit a turning point. Production costs fell 1% year-on-year in the second quarter, marking the first time they have shrunk in three years. Drill pipe prices have halved this year, daily rig rates are down by more than 10% and the costs of steel and diesel are also trending lower. According to Goldman Sachs via Bloomberg, Drill pipe prices have fallen by 50% this year; daily rig rates are down by more than 10%, while the costs of diesel and steel have been gradually declining. Only labor has been defying this trend as wages continue rising. Whereas a decline of a single percentage point might not make much of a difference on the bottom line, Goldman says costs will be 10% lower in 2024, enough to boost profits and cash flows significantly. Easing price pressures are most welcome: after two years of bummer earnings and copious cash flows, the U.S. oil and gas sector is set to record a decline on both metrics in the current year. According to Moody’s research report, industry earnings will stabilize overall in 2023, but remain below levels reached by recent peaks. The analysts note that commodity prices have declined from very high levels earlier in 2022, but predicted that prices are likely to remain cyclically strong through 2023. This, combined with modest growth in volumes, will support strong cash flow generation for oil and gas producers. Moody’s estimates that the U.S. energy sector’s EBITDA for 2023 will fall to $585B in 2023 from $$623B in 2022. The analysts say that low capex, rising uncertainty about the expansion of future supplies and high geopolitical risk premium will, however, continue to support cyclically high oil prices. But the decline in earnings could come in worse than expected if current forecasts are any indication. U.S. oil and gas major ExxonMobil (NYSE:XOM) revealed in an SEC filing on Wednesday that it expects to book sharply lower Q2 2023 earnings mainly due to low natural gas prices and lower refining margins. Exxon booked record earnings to the tune of $11.4 billion in Q1 2023, double from the $5.48 billion for Q1 2022. Earnings per share clocked in at $2.79 for the first quarter, beating the Wall Street consensus of $2.60. Exxon has predicted Q2 2023 earnings will clock in at ~$7.8 billion, a sharp drop from $11.4 billion for Q1 2023, with the company blaming $2.2 billion lower earnings in the upstream division due to lower natural gas prices, as well as another $2.2 billion decline in the energy products division, due to lower industry margins. Mixed Oil Price Outlook For the second consecutive month, the leading OPEC producer, Saudi Arabia, has extended its voluntary 1M bbl/day oil production cut for another month, this time till August. The reduction will take the country’s production to ~9M bbl/day, the lowest level in several years. Saudi has been single-handedly sacrificing sales volume in a bid to goose weak oil prices, but has so far reaped little reward. The bears remain unconvinced, with Marwan Younes, chief investment officer of hedge fund Massar Capital Management, saying oil price gains are likely to be short-lived. “The problem is when you cut production in an already weak environment, the impact is limited. It looks like we could be here for a while,” Ole Hansen, head of commodity strategy at Saxo Bank, has told the Wall Street Journal. On Tuesday, Morgan Stanley lowered its oil price forecast and predicted an oil surplus during the first half of 2024 thanks to non-OPEC supply growing faster than demand. MS has lowered its Brent price outlook for Q3 2023 to $75 from $77.50 per barrel and cut Q4 2023 forecast to $70 from $75. The Wall Street bank has also cut its oil price forecast for 2024 by $5, and now sees prices at $70 in Q1 2024; $72.50 in Q2 2024, $75 in Q3 2024 and $80 for the final quarter. “Despite low investment, non-OPEC+ supply has been growing robustly and supply from Iran and Venezuela has been creeping higher. We still model stock draws in Q3, but expect oil price softness to continue as the market’s focus shifts to H1 2024 when balances look in surplus,” the bank said in a note. But the bulls are still holding the fort: on Tuesday, TD Securities said that oil prices can still rally over the next 6 months regardless of ongoing demand fears as well as growing supply from the likes of Venezuela, Iran, and even Russia. “We do expect crude to rebound in the second half of the year. We think approaching $90 is probably not unreasonable in the next six months or so as the worst of the fears about a recession moderate. When we look at demand growth for 2023, we’re still looking north of two million barrels per day, and we continue to expect OPEC plus to be fairly well-disciplined on the supply side,” Bart Melek, Global Head of Commodity Strategy at TD Securities stated in a recent investor note. Last month, Goldman Sachs’ oil ultrabull Jeff Currie once again cut his Brent forecast for December, this time to $86 a barrel from $95 and $100 before that. Currie cited increasing supply from Russia, Iran, and Venezuela; growing recession fears, and persistent headwinds to higher prices from higher interest rates for his growing bearishness. His forecast is still good for nearly 20% upside. Oil prices kicked off the second half of the year, trading around the $71 per barrel level and have steadily traded below their 100-day moving average since the end of April. Oil prices have declined nearly 12% in the year-to-date.
Oil Futures Market Finally Signals Supply Tightening
The oil futures market has strengthened this week, signaling that a market tightening could be on the way. Following the latest announcements of fresh supply cuts from OPEC+ leaders Saudi Arabia and Russia, key spreads in the oil derivatives markets have started to show strength, according to Bloomberg’s estimates. Prompt spreads in the futures market have returned to backwardation, from contango. Contango is the state of the market in which prices for delivery at later dates are higher than front-month prices—a market situation signaling oversupply. The opposite market situation—backwardation—typically occurs at times of market deficit, and in it, prices for front-month contracts are higher than the ones further out in time. Last week, the six-month spread in Brent flipped to contango for the first time since December 2022, after being in backwardation for months. The U.S. benchmark, WTI Crude, also dropped into contango on June 27, for the first time since March. But in recent days, prompt spreads have strengthened, swaps contracts linked with physical supply have surged, and in options markets, the premium of bearish puts over bullish calls has narrowed. On Monday, Saudi Arabia and Russia announced nearly at the same time fresh cuts to global oil supply. Saudi Arabia said it would extend its unilateral oil production cut of 1 million bpd into August. Saudi Arabia will be producing around 9 million bpd in both July and August after extending the voluntary cut into next month. “This additional voluntary cut comes to reinforce the precautionary efforts made by OPEC Plus countries with the aim of supporting the stability and balance of oil market,” Saudi Arabia said. Minutes after the Saudi announcement, Russia’s Deputy Prime Minister Alexander Novak said that Russia would cut its crude oil exports by 500,000 bpd in August in a bid to ensure a balanced market.
Saudi Aramco exploring investment opportunities in India, CEO says
Saudi Aramco, the world’s largest oil-exporting company, is looking for investment opportunities in India amid a surge in crude demand in the South Asian country, its president and chief executive has said. In terms of crude imports, both China and India – two large oil-consuming countries – have surpassed pre-pandemic levels, Amin Nasser said during the Opec International Seminar in Vienna on Wednesday. China’s crude imports hit a record16 million barrels per day in March as its economy recovers following the lifting of Covid-19 restrictions earlier this year, the International Energy Agency said in its April oil market report. China was the largest importer of oil from Saudi Arabia last year, buying about 1.75 million barrels per day. In March, an Aramco unit acquired a 10 per cent stake in Shenzhen-listed Rongsheng Petrochemical in a deal valued at $3.6 billion to expand its refining operations in China. In December, Aramco and China Petroleum and Chemical Corporation signed an initial agreement to build a refinery and a petrochemicals plant in China. The 320,000-bpd refinery and 1.5 million tonnes-per-year petrochemical cracker complex will be operational by the end of 2025. Mr Nasser said that rising crude demand from China and India would lead to an “imbalance” in the oil market amid underinvestment in new oil and gas projects. “Their priority is raising the [living] standards for their people and sustainability comes next. In Asia alone, there are 150 million people with no electricity,” Mr Nasser said. While policies such as the Inflation Reduction Act in the US and similar initiatives in the EU will support energy transition in those countries, such incentives will not work for developing economies, Mr Nasser said. It is expected to spur about $3 trillion of investment in renewable energy technology, according to Goldman Sachs. The International Energy Agency and Opec expect the oil market to tighten in the second half of the year, supported by a rebound in crude demand in Asia and Opec+ production cuts. However, Brent, the benchmark for two thirds of the world’s oil, has lost nearly 11 per cent of its value since the beginning of the year on economic slowdown concerns and resilient Russian crude supply.