“The bottom of the market may still be ahead”

I have become an avid reader of the International Energy Agency Oil Market Report. A”free” synopsis is published mid month with the full report and data tables made public at the end of the month. Here are the bullets from the report summary published on 10th July:

  • Crude oil prices fell to their lowest in nearly three months in early July, pressured by ever rising supply while financial turmoil in Greece and China unsettled world markets. At the time of writing, Brent was around $59/bbl and US WTI at $53.10/bbl.
  • Global oil demand growth is forecast to slow to 1.2 mb/d in 2016, from an average 1.4 mb/d this year, with strong consumption expected in non-OECD Asia. World oil demand growth appears to have peaked in 1Q15 at 1.8 mb/d and will continue to ease throughout the rest of this year and into next as temporary support fades.
  • Global oil supply surged by 550 kb/d in June, on higher output from OPEC and non-OPEC. At 96.6 mb/d, world oil production gained an impressive 3.1 mb/d on 2014, of which OPEC crude and NGLs accounted for 60%. Non-OPEC supply growth is expected to grind to a halt in 2016, as lower oil prices and spending cuts take a toll.

  • OPEC crude supply rose by 340 kb/d in June to 31.7 mb/d, a three-year high, led by record high output from Iraq, Saudi Arabia and the UAE. OPEC output stood 1.5 mb/d above the previous year. The ‘call on OPEC crude and stock change’ for 2016 is forecast to rise by 1 mb/d, to 30.3 mb/d.
  • OECD industry inventories hit a record 2 876 mb in May, up by a steep 38.0 mb. Product holdings led the build and by end-month covered 30.7 days of forward demand. Global supply and demand balances suggest that the rate of global stock builds quickened rapidly to an astonishing 3.3 mb/d during 2Q15.
  • Robust margins spurred stronger-than-expected OECD refinery runs, lifting 2Q15 global throughput estimates to 78.7 mb/d. Global refinery throughputs are forecast to increase by a further 0.7 mb/d in 3Q15, with annual gains shifting to the non-OECD. New capacity start-ups in 2015 and 2016 will put margins under pressure.

The title of this post, “The bottom of the market may still be ahead”, is the last line of the July IEA OMR summary. Those companies and investors hoping for an early end to this low price crisis may be disappointed. Global supply was up again in June by 550,000 bpd. Demand growth looks set to slow. Inventories are at record levels. And not surprisingly prices have once again yielded to the gravity of glut and have fallen below $60 / bbl. To add insult to injury US oil rig count has risen these last two weeks and UK North Sea oil production looks set to rise in the years ahead.

Rig Count

The US oil rig count has fallen every week since December 2014, that is until two weeks ago when it rose for the first time in 7 months a feat repeated last Friday.

The US oil rig count has risen over the last two weeks by a total of 17 units. So what is going on? Why have the shale producers not all gone bankrupt as some industry watchers forecast. An interesting article in Breitbart, posted by Roger Andrews in this week’s Blowout, gives some clues.

The U.S. “fully burdened exploration and production “break-even” cost is now $51 per barrel, and falling fast. Furthermore, with hundreds of American oil companies having already paid the exploration lease acquisition costs to accumulate tens of thousands of drilling sites, the production-only break-even cost for positive cash-flow is about $29 a barrel. After tacking on a 9 percent profit, U.S. domestic oil companies are now incentivized to produce domestic oil any time the price is above $32 a barrel.

The operating cost base for drilling and producing shale oil has followed the oil price down. If these figures from Breitbart are anywhere close to correct then many OPEC members should be extremely concerned. Can they run their social services on $30 per barrel?

UK Oil Production to Increase

Not only do the oil companies and the oil price have to contend with robust US production but there is a prospect of UK oil production increasing for the first time since the year 2000. The forecast scenario below is from Derek Louden who provides a tremendous overview of UK oil production in this presentation.

UK oil production has a historic decline rate of about 9% per annum. It was always the case that when production declined so far that it would become easier to reverse basin decline. For example, when production stood at 2.9 Mbpd, 261,000 bpd new production capacity was required every year to replace declines. Now that production is closer to 0.8 Mbpd, 72,000 bpd new capacity will do the job.

The record high price of recent years has led to record levels of investment that are only now working through the system with several major new field developments due to come on line in the next couple of years. Derek Louden lists all new developments on pages 42 and 43 of his report. The big ones are: Schiehallion redevelopment, Clair phase 2, Kraken and Mariner. If all goes according to plan then UK production will rise before falling again before the end of the decade.

Oil Stocks

One of the big surprises of the IEA OMR is the record crude oil and products inventory levels that they do not fully understand. In the past I have never managed to make much sense of inventory changes and it is hence a variable that I have not followed. It is perhaps time to put that right. The chart shows the development of stock levels in the USA based on EIA data.

In a recent comment Jim suggested that the flood of LTO may produce a flood of propane and NGL that currently has no where to go but storage. In the USA this does seem to be a part of but not the whole story. It is a rise in crude oil stocks that underpins the recent surge in US inventory.

Concluding Thoughts

The oil companies and service companies have already made deep spending cuts with substantial redundancies. Nevertheless, the momentum built in the last 5 years continues to feed through to higher production levels. Many companies will have been hoping for signs of a robust recovery in price by now, hanging tough to retain staff for when the upturn comes. I suspect that over the next 6 months we will see a second wave of cuts. Things are indeed already austere here in Aberdeen.

One thing we seem to have heard little about so far is austerity within OPEC. There seemed to be solidarity for the current strategy at their June meeting. I wonder how much longer this will last?

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22 Responses to “The bottom of the market may still be ahead”

  1. artberman says:


    Breitbart provides no data to support their preposterous claim that US tight oil break-even price is $51/barrel.

    If that is true, why are tight oil companies losing 3 times as much money in Q1 2015 as they were in Q4 2014 based on their US SEC filings?

    Breitbart has either drank far too much kool-aid or is an industry shill or both.


    • Euan Mearns says:

      Art, the Breitbart numbers are of course wide open to challenge and there will be a wide range in break even costs / prices. What in your very well informed opinion is the break even price range for LTO?

      And do you have an explanation for the rig count rising. For example meeting lease obligations? It can of course simply be a temporary blip.

      Thanks for the article from The Economist. They hit a couple of important points which you have made in the past. 1) many companies are still living of hedges, most of which will expire by year end, 2) they are living off Wall Street 3) they have massive debts that will have to be restructured.

      So I guess the Economist reads your work 😉 It remains totally surprising to me that production has continued to climb. The Saudis clearly saw all this coming. But whereas the US shale industry has the means to reduce its costs, OPEC members do not have the same choice other than to slash their welfare spending.

      I expected rig count to carry on down and for US and global production to be tanking by now. But its not happened yet. What is tanking is the oil price.

  2. Javier says:

    Well, obviously the US rig number is not going to drop to zero. It has to find support somewhere after losing 60% of its numbers.

    Yet to maintain that production is going to continue unaffected requires to conclude that 60% of rig capacity was not being used before June 2014. This is difficult to believe. A more likely explanation is that momentum, backlogs and measures to increase output more efficiently have temporarily kept production levels, but a decline in production has already been compromised for the future once momentum is lost and economic realities set down on companies that are not making money.

    I have no idea how long the delay in the oil industry can be between a price drop in the product and the company being taken down by financial problems, but a year or two does not sound as too much. I am not surprised that after 9 months of low prices we don’t see much change in production. Give it time. It will come.

    • Euan Mearns says:

      Well, obviously the US rig number is not going to drop to zero. It has to find support somewhere after losing 60% of its numbers.


      Yet to maintain that production is going to continue unaffected requires to conclude that 60% of rig capacity was not being used before June 2014.

      The 1600 rigs that were drilling did 3 things 1) provided production to combat high decline rates 2) provided new production capacity and production growth and 3) provided wells that were drilled but not completed – thousands of them.

      Drilling efficiency has improved and companies will probably be focussing on sweet spots, hence I believe its possible that 600+ rigs + completing the backlog of wells already drilled may be sufficient to keep US production stable, or at least to prevent it from tanking. US production tanking was the main mechanism by which many envisaged the oil price bouncing back to $100.

      Continued growth in oil supply and weakening demand is bad news for the industry.

      • Javier says:

        Because if the US number of rigs falls to zero that means that no new production capacity and no new production growth would be brought on line. It means that the US oil industry has no future and therefore would not be able to get credit beyond extracting what has already been drilled. It would have entered terminal decline state. I know of no significant oil producing country that has had zero rigs.

        By reducing the number of rigs, oil companies are exchanging future production for present reduction of costs. When we get to that future we will lack that production. Present production is just not representative, due to backlogs, sweet spots and hedges that momentarily are allowing companies to keep a high level of production at a reduced cost. Once backlogs are worked through, sweet spots are exploited and hedges expire we will see what all those rigs were needed for, and production will decline.

        I am in no position to say when will that happen. Perhaps 2016. Already shares of many oil companies are tanking, so I guess many investors are not buying that bullshit that oil production is not going to be affected and that producers are now able to produce at $20-30/b.

        I agree that continued growth and weakening demand is bad news. It is not sustainable and therefore if demand doesn’t pick eventually, a decrease in production is inevitable. Economic laws dictate that the most inefficient producers will bear the burden of a decrease in production.

  3. It seems to be generally accepted that current oil prices are depressed, as indeed they are relative to the 2005-2014 Brent Crude average ($92.81/bbl in constant 2014 dollars). But they’re a good bit higher than the 1984-2004 average ($35.40/bbl) and about the same as the 1984-2014 average ($53.92/bbl). So are they really depressed, or have they just returned to normal?

    • Javier says:

      I wholeheartedly agree. The pre-2005 price of $35/b was the correct one for economic development. $60/b is already too expensive for many world economies that have not recovered from the 2008 crisis and are in a much worse shape than in 2005.

      According to CPI calculators $35 of 2005 are $42.62 of 2015. When it gets to that price we will be in pre-crisis oil input price. Ah, the good old days.

  4. Jimmy says:

    I read an unsubstantiated claim that shake oil was profitable at $10 a barrel. Must be true. An expert said it. Lol what a load of garbage you just posted.

    • Euan Mearns says:

      Much of Sheik oil is profitable at around the $10 mark. Its just that many OPEC countries run extremely generous social welfare systems off their oil revenues and require between $100 and $150 / bbl for fiscal breakeven. It has also surprised me that we have not heard more about spreading pain and social unrest in certain OPEC countries, in particular Algeria and Venezuela.

      Lol what a load of garbage you just posted.

      Can you be more specific about which parts of this are inaccurate. PS this comment falls way below the standard for this site and I have put you straight to comment moderation.

  5. Rob says:

    Will the North Sea see a return of investment levels seen in the last few years
    or are the Oil Service companies terminal decline. Unfortunately companies not hanging
    tough and have released contractors now shedding staff.

    Can any prediction be made for medium and long term future

    I used to work in Aberdeen last year just wondered are the boom to time
    over for good

    • Euan Mearns says:

      The recent boom in Aberdeen was kind of crazy. New offices, hotels and roads everywhere. The bust so far has been pretty cruel. The city is eerily quiet.

      I don’t think the investment levels of recent years will ever return. Amongst other things we haven’t made any new discoveries for years. Unless someone comes up with a new play concept then the cupboard is bare. Most expensive and difficult discoveries are now under development.

      When recovery comes Aberdeen will do OK as a service centre for the international industry. But I think Aberdeen is now post-peak.

  6. Jeff Edzier says:

    Thanks for this wonderfully informative site. My question is, if fracking has been sustained for months by hedges, the losses to the payor counter parties must be massive. Does anybody here know who has been caught with these losses, i.e. banks, hedge funds etc.?

  7. Jeff Edzier says:

    Austerity within OPEC?

    Saudi ‘to borrow to finance soaring deficit’, says report


    • Euan Mearns says:

      Interesting to note that the Saudi deficit is larger than planned suggesting that this has not gone according to their plan. Last time I recall Saudi having to borrow was in 1999 and feeling then that this must surely herald the end of the crisis. If Saudi are in pain then the weaker countries like Algeria, Nigeria, Iraq and Angola must be in a whole world of hurt.

  8. Heinrich Leopold says:


    Many shale companies have significantly lost value (EOX, GDP, ssn, HK, QEP,…. down 99% and more). So it is nonsense to say that the shale industry is not affected by low oil prices. People have lost already fortunes. So far companies could produce on spending equity, yet this is about to fade out.

    • Euan Mearns says:

      It wasn’t my intention to say that shale companies were unaffected. My main point comes down to the surge in production this year. I’m not aware of anyone forecasting that, including me. The consequence is going to be a deeper and longer lasting crisis for the industry. I, along with many others believed in a big bounce back 2016 as supply fell naturally and not by OPEC cutting. Now I’m not so sure about a big bounce, especially if companies adapt to lower prices. It looks increasingly likely to me that OPEC may blink first.

      • Heinrich Leopold says:


        In my view shale is now the victim of its success. Oil prices came up so fast as the US economy had a high current account deficit due to high oil imports, which increased even further when the oil price rose. As US oil production rose, the current account deficit shrank, which made the US dollar stronger. Yet it is exactly the higher dollar, which prevents a higher oil price as the world economy needs a weaker dollar for faster growth. US production must fall at least 2 mill barrels per day until the oil price can move higher. The reason why OPEC will not blink first is that OPEC oil production relies on high fixed costs (high upfront costs and lower follow through costs), which is in stark contrast to shale, whch has basically high variable costs only. It is much more difficult for high fixed costs producers to reduce production as the most of expenses have been spent anyway and it is very expensive not to produce. There is the basic rule that the last barrel is the cheapest. This is why high fixed producers produce at the highest production rate even if prices are low.

  9. Euan Mearns says:

    I see Iran has done a deal that will see about 600,000 more bbls per day coming to market:


    And WTI is flirting with $50. The Saudis are going to be thrilled about this 🙁

  10. 624weeks says:

    The rig count has most definitely lead to shale oil production falling according to what I’m reading.

    This article http://www.reuters.com/article/2015/07/14/us-oil-shale-predictions-idUSKCN0PN2G720150714 says that the EIA expect US shale production in August 2015 to be 91,000 lower than July. If that is accurate then we can expect to see US shale oil production down by about 1 million barrels per day in the next 12 months (although sanctions ending in Iran can easily make up for this).

    And if the Breitbart article stating that the break even costs of shale oil is $51 and $29 is needed for a positive cash flow is accurate then drilling at today’s prices can only continue in the short to medium term. With the costs already sunk they can (and will) keep producing at today’s prices, but oil companies are unlikely to be able to replace these assets unless WTI stays consistently above $60-$65 per barrel.

    If I had to guess I would say that the current slump in oil prices will last about 3 to 4 years and that the price can easily go lower in the short term. I expect that in 3 years time US production will be about 2 million barrels per day lower than it is at the moment and that world demand will about about 3.5 million barrels a day higher. Iraq, Iran and Saudi Arabia will be able to make up for those additional 5.5 million barrels but after that I expect that supply will start getting tighter again. This is my guess, and only a guess as that’s all forecasts ever are.

    • Euan Mearns says:


      Here’s the EIA report, not one I’ve followed before, there’s a great spread sheet in there, I’ll have a post tomorrow. This data clearly shows US shale production going into decline. One of the problems I’ve had following US production is that the EIA have revised upwards US total production by 300,000 bpd two times in recent in recent months. And their reporting is months in arrears. That really clouds the underlying picture.

      If I had to guess I would say that the current slump in oil prices will last about 3 to 4 years and that the price can easily go lower in the short term.

      I’m tending to agree with this. Previously I thought prices would rebound strongly in 2016, now I’m not so sure. Word on the street here in Aberdeen is that the industry is gearing up for a second round of cuts.

      • Rob says:

        When you say cuts do you mean another 10% cut in contractor pay for engineering services
        or new projects.

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