Chauhan: GoM to remain a key market for producers

The Gulf of Mexico remains a key production hub for operators, offering high margin barrels. The region has benefitted from a large number of projects coming on-stream over 2014 and the first half of 2015, and new projects ramping up will continue to support growth through the first half of 2015, according to Virendra Chauhan, oil analyst at London-based consultancy Energy Aspects.

Credit: morkeman

Low oil prices are expected to have “minimal direct impact” on crude oil production in the Gulf of Mexico through 2016, according to the US Energy Information Administration (EIA).

What is more, EIA forecasts production in the Gulf of Mexico to reach 1.52 million barrels per day (bbl/d) in 2015 and 1.61 million bbl/d in the following year, amounting respectively to 16% and 17% of total U.S. crude oil production. In December 2014, according to EIA, the production of crude oil amounted to 1.46 million bbl/d.

However, these overall positive forecasts for the Gulf of Mexico cannot be isolated by a scenario characterized by growing uncertainty, in the US and on a global level.

For what concerns the US, Baker Hughes’s Rig Count released on the 10th of April saw a decline of exploration and production rigs, which reached 988, against a peak of 2,031 in 2008.

Upstream Intelligence interviewed Virendra Chauhan, oil analyst at Energy Aspects Ltd - an independent research consultancy founded in 2012 - with the goal of understanding current market trends and their implications, both in the GoM and globally.

Where does the Gulf of Mexico (GoM) market sit against the global sector?

The Gulf of Mexico remains a key market for producers offering high margin barrels. The Gulf of Mexico has benefitted from a large number of projects coming on-stream over 2014 and the first half of 2015, which has further supported overall US production which rose by 1.2 million b/d last year.

Of this, 0.14 million b/d of growth came from the GoM, reversing a four year period in which output registered year-on-year (y/y) declines between 2010 and 2013. A low first half 2014 and new projects ramping up will continue to support growth through the first half of 2015.

What are the trends for other regions (non-GoM)?

The other key growth sector last year and in the year to date has been Brazil, where pre-salt wells in the Campos and Santos basin have ramped up to record levels, allowing production to reverse a two year trend of y/y declines in 2012 and 2013.

Across 2014 crude output rose by 0.23 million b/d, the highest rate of growth that the country has registered since our records date back to 2000.

This was fuelled by record high investment and efficiency gains bearing fruit after Petrobras embarked on two years of heavy maintenance investment in 2012 and 2013 as well as excellent productivity from pre-salt wells, which were flowing at rates as high as 30,000 b/d.

Similarly, in Angola where the majority of production stems from offshore wells, production was boosted by the 0.16 million b/d CLOV project coming online.

Has there been any change in global/regional regulation, or any government schemes, to ensure that production is enhanced?

This is going to vary depending on where producers sit. Clearly, in the US, high oil prices allowed shale produces to develop the technology to produce from onshore tight oil basins at break neck pace, whilst Brazil has raised production despite government measures making it increasingly difficult to attract foreign investment.

Regarding China - where market focus is often on demand - it is easy to forget that the country is one of the largest producers of oil, with output pegged at 4.2 million b/d.

Domestic production could fall by 0.2 million b/d this year - even though official claims are for a near 0.6 million b/d y/y fall - with sharp Capex cutbacks and a focus on natural gas weighing on crude production and future development / exploration.

What do you see as the main challenges for the industry?

A low oil price environment has forced producers to re-think their strategies and keep spending within cash-flows leading to a sharp pullback in Capex.

Whilst we are in a period of over-supply at present, under investment can come-back to bite hard particularly as low oil prices will stimulate demand from growing countries in the non-OECD.

As the industry looks to develop harder to reach resources from greater water depths and from more complex geological structures - Pliocene/Miocene and Lower Tertiary plays - demand from the service sector has and will continue to increase.

Innovations in technology and engineering will be required, at a time when operators will have to comply with ever stricter safety regulations, in a post-Macondo world.

What were the main factors driving the recent fall in prices?

The oil price collapse that started in October 2014 seems to have run its course and it is clear that it will be seen as a historic event once the rout is over.

The drop in 2008/09 was arguably more catastrophic, but was led by factors outside the oil market. That collapse was a result of an epic banking crisis and a sharp contraction in economic growth, which took down both oil demand and liquidity.

The drop in 2014 is different and not just because of the relative scale of price moves. It is different because the sell-off originated in the oil market, firstly from rising inventories as demand weakened and unplanned outages eased, and secondly when OPEC - effectively Saudi Arabia - decided not to intervene, leaving oil price dynamics in the hands of market forces.

What do you think drove such decisions from key OPEC producers? 

Arguably, one of the reasons for Saudi Arabia to forgo its role as a swing producer this time is precisely because of this difference.

In 2008, external factors caused the drop in demand, which OPEC then took measures to balance. In 2014, the problems came from within the oil market.

Cuts by Saudi Arabia to shore up prices would therefore only result in the Kingdom losing market share, given the inability and unwillingness of other OPEC and non-OPEC countries to reduce output. This is because of various reasons such as high decline rates, lack of revenues, high social spending.

The oil price collapse has been so sharp it has dragged other asset classes down and threatens to destabilise countries such as Russia and Venezuela - oil producing nations already struggling with their fiscal balances.

While Saudi Arabia’s decision to not reduce output has revived old debates about its relevance in the market, especially in light of the growth in US tight oil, many may have missed a simple point. The decision not to intervene is also a decision, and a brave one at that, given it signals a departure from what economic theory would suggest an oil producer should focus on - revenues.

Indeed, Saudi Arabia is giving up billions of dollars of revenues in the short-term, which could potentially extend for a year or two, running a $38 billion budget deficit in 2015. Instead of cutting production, it is focussing on market share in the expectation that a period of lower prices, which it can withstand given plentiful foreign exchange reserves, will shake out some high cost producers.

The decision to focus on market share was clear when OPEC decided to roll over the existing 30 million b/d quota, but the Kingdom did not stop there.

What do you think will be the implications of such decisions for the global oil industry?

According to our cost curve analysis, over a third of global oil production is uneconomic - although they won’t necessarily be shut in - at today’s prices, and over 2 million b/d of new projects are at risk.

The market impact of prices at $60 is significant, and so the marginal benefit of a further drop in oil prices, say by another $10, which would cost Saudi Arabia over $2 billion dollars in daily revenues - based on current exports of 7 million b/d - is unclear, even if the thinking is based on short-term pain for long term gain.

However irrational it may seem when judged from a producer’s perspective, Saudi Arabia has effectively declared ‘game on’ to the other producers for now.

For the industry, not only has the recent collapse broken a long cycle of high and stable oil prices, it has been a huge wake up call.

The general assumption since the 2008-09 crisis, when OPEC cut supplies by 3 million b/d led by Saudi Arabia and signalled a clear floor, was that Saudi Arabia would ensure prices stay within its desired range, which eventually settled at $90-$110.

That complacency meant tight oil producers went on a tear, racking up debt and increasing Capex, and oil majors focussed on ever more challenging locations - also due to the fact easy oil has largely been extracted - resulting in soaring costs.

Even though returns for a lot of oil companies faltered as costs escalated, capital discipline was almost non-existent as prices were expected to stay at $100 per barrel.

After all, the thinking was Saudi Arabia would cut output if prices fell too sharply, since it also needed a high price to fund social spending. We believe no board room discussion at an oil company will be the same again.

Pursuing projects at any cost, which was already being questioned by investors, will now be more closely scrutinised by management, if Saudi Arabia is no longer the price stabiliser. Moreover, amid high capital costs, violent price swings will do little to encourage companies to go ahead with these projects.

And if costly projects, which form the majority of today’s non-OPEC supplies, are not undertaken, the steady growth in non-OPEC supply will slow.

Years of 1.5 million b/d of supply growth will be few and far between; the steady state may be 0.5 million b/d at best and 2015 may well be the year to position for that upturn.