Doom and Gloom for North American Oil Producers

To the dismay of U.S. shale producers, oil prices continue their long slow slide into the abyss.  Perhaps the current price of $35 per barrel – an 11 year low – is the final destination.  More than likely, however, it’s a brief reprieve before the next descent.

Oil exporters, including Saudi Arabia and Russia, have maintained high production rates.  Their goal is to bankrupt U.S. shale companies and preserve market share.  At the same time, oil demand is tapering as the global economy cools.

The combination of high production and declining demand has resulted in excess supply, and lower prices.  The trend of lower prices won’t change until either demand increases or production decreases.  At the moment, it doesn’t appear that either of these factors will change any time soon.

So how low can oil prices go?  If you recall, in the late-1990s, oil prices dropped below $20 per barrel.  Goldman Sachs thinks we’ll see $20 per barrel oil again.

Obviously, oil prices can’t go to zero.  However, this offers little consolation for the many oil companies that borrowed gobs of money from Wall Street to leverage development of fracked wells that require $60 per barrel oil to pencil out.

Declining Hedges

So while it isn’t possible for oil prices to go to zero.  It is possible for the stock prices of oil companies to go to zero.  In fact, over the next 12 months there could be a rash of bankruptcy’s that results in delisted, worthless shares.  Here’s why, as reported by Reuters

“A Reuters analysis of hedging disclosures from the 30 largest oil producers showed the sector as a whole reduced its hedge books in the three months to September.

“When oil started falling from around $100 a barrel in mid-2014 due to a global supply glut, many U.S. producers had strong hedge books guaranteeing prices around $90 a barrel.

“Now, with prices below $36 and flirting with 11-year lows on renewed oversupply fears, only five drillers among those reviewed by Reuters expanded their hedges in the third quarter and eight had no protection beyond 2015, leaving them fully exposed to price swings.

“The five companies that increased outstanding oil options, swaps or other derivative hedging positions to secure a price floor for their production, added 13 million barrels in the third quarter to 327 million barrels covered, data show.

“Five other firms did not expand their books, with positions that either expire in 2016 or no hedges altogether.

“The remaining 20 companies had hedges decline by 72 million barrels from the previous quarter.”

Doom and Gloom for North American Oil Producers

Suspended animation, in the form of price hedges, allowed many U.S. oil companies to maintain production in 2015.  Yet now that those hedges are expiring, and sales will be settled at daily market prices, these companies will get squeezed.  In fact, it may get worse before it gets better.

Turning off oil production is not as simple is flipping off a light switch.  Unfortunately, a twisted scenario can come about where output increases but revenues fall.  In other words, companies can find themselves producing and selling more oil while earning less.

That’s what happened to Continental Resources.  They foolishly sold their hedges in late 2014 and operated in 2015 without hedges.  Given oil’s rapid price decline, it has been a brutal year.

During the third quarter 2015, Continental Resources increased output by 25 percent from the year before.  However, crude and natural gas revenues fell 46 percent over this same period.  What’s more, had Continental Resources merely held on to the hedges they sold in late 2014, they would have made $1 billion more in 2015 than they did.

As of mid-December, there have been 39 North American oil producers that have filed for bankruptcy protection.  The latest being Texas driller, Magnum Hunter Resources Corporation.  At the time of their bankruptcy filing, they had $6.4 million in cash and $1.1 billion in total liabilities.  That represents a debt to cash ratio of 17,187 percent.

Unless they can figure out how to turn a profit on $35 per barrel oil, restructuring is futile.  Indeed, it’s doom and gloom for North American oil producers.

Sincerely,

MN Gordon
for Economic Prism

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