As
we head into the holidays, there may be a shortage of holiday cheer for
energy companies and their investors. Here’s hoping to a much improved
New Year!
Oil prices saw no relief since last week, with the surprise jump in the active rig count in the United States weighing on the market. Baker Hughes reported an increase of 17 for oil rigs (offset by a decline in the gas rig count), a bearish signal that suggests that some drillers feel they can still make money drilling despite rock bottom oil prices. To be sure, there is a lag time between oil prices and the rig count figures, and the metric is not a perfect measure of market conditions. But the increase caught the markets by surprise, sending oil prices down to 11-year lows, surpassing the low points logged during the depths of the financial crisis in 2009.
There are few reasons to be bullish right now, although most market watchers still target late 2016 as the period in which things start to turn around. "We view the oversupply as continuing well into next year before rebalancing in the fourth quarter 2016," Goldman Sachs said in recent report. "Our base case remains that the global oil stock build will on aggregate remain shy of storage capacity, although the storage buffer has once again narrowed." Mild temperatures continue to suppress demand across the United States for natural gas and liquid fuels, which could ultimately result in a much smaller drawdown during winter heating season than is typical.
Of course, oil prices staying below $40 per barrel is extremely negative for oil and gas producers. With hedges rolling off, 2016 is shaping up to be a very painful year for the entire sector. S&P recently warned that financial stress in the energy industry will likely rise as we head into the New Year. “Hedges represent 8% (1.619 MMboe/d) of total expected oil and gas production in 2016, a marked decline from the 15% hedged last year,” S&P said this month. “The trend continues for speculative-grade companies, which have just 29% (1.437 MMboe/d) of total oil and gas production hedged next year compared with 45% in 2015.”
The economic damage inflicted upon oil-producing countries has also been well documented and closely watched. Nigeria is one such country. The West African OPEC member has seen its budget decimated by low oil prices, and the government has come under increasing pressure to devalue its currency, the naira, because of the weakening economy and shrinking foreign exchange. Nigerian President Muhammadu Buhari has held out, projecting confidence that Nigeria can maintain the peg. However, he recently opened the door to a potential devaluation in January.
Buhari said that the central bank could introduce “some flexibility” that would encourage some capital inflows. Nigeria has suffered from a shortage of dollars, which has made some economic transactions difficult in the country. A devaluation would logically address this problem. “I am aware of the problems many Nigerians currently have in accessing foreign exchange for their various purposes,” the president said. “These are clearly due to the current inadequacies in the supply of foreign exchange. We are carefully assessing our exchange-rate regime, keeping in mind our willingness to attract foreign investors, but at the same time managing and controlling inflation to a level that won’t harm average Nigerians.”
Weakening currencies is a problem throughout the oil-producing world, with significant declines exhibited in South America, Africa, the Middle East and Eurasia. Countries with flexible exchange rates have seen their currencies plunge over the past year while countries with fixed exchange rates are coming under extreme pressure to abandon their pegs and devalue. Nigeria’s naira peg could be next on the firing line, but it surely will not be the last.
Another bearish black swan event looming over the oil markets is latent Libyan oil capacity. Rival factions in Libya have carved up the country and kept the North African oil producer from exporting to its full potential. Libya’s oil output has been down around 400,000 barrels per day for the past year or two, while its Qaddafi-era capacity stood at 1.6 million barrels per day. However, the rival governments in Libya have started the peace process, and signed an UN-brokered accord last week. It is unclear whether the peace deal will hold, but if violence and instability begins to abate, Libya could start to bring some oil production back to international markets. The exact amount is unclear, but if, say, 500,000 barrels were brought back online sometime in 2016, that would be extremely negative for oil prices. That would essentially offset the expected declines from U.S. shale next year.
Oil prices saw no relief since last week, with the surprise jump in the active rig count in the United States weighing on the market. Baker Hughes reported an increase of 17 for oil rigs (offset by a decline in the gas rig count), a bearish signal that suggests that some drillers feel they can still make money drilling despite rock bottom oil prices. To be sure, there is a lag time between oil prices and the rig count figures, and the metric is not a perfect measure of market conditions. But the increase caught the markets by surprise, sending oil prices down to 11-year lows, surpassing the low points logged during the depths of the financial crisis in 2009.
There are few reasons to be bullish right now, although most market watchers still target late 2016 as the period in which things start to turn around. "We view the oversupply as continuing well into next year before rebalancing in the fourth quarter 2016," Goldman Sachs said in recent report. "Our base case remains that the global oil stock build will on aggregate remain shy of storage capacity, although the storage buffer has once again narrowed." Mild temperatures continue to suppress demand across the United States for natural gas and liquid fuels, which could ultimately result in a much smaller drawdown during winter heating season than is typical.
Of course, oil prices staying below $40 per barrel is extremely negative for oil and gas producers. With hedges rolling off, 2016 is shaping up to be a very painful year for the entire sector. S&P recently warned that financial stress in the energy industry will likely rise as we head into the New Year. “Hedges represent 8% (1.619 MMboe/d) of total expected oil and gas production in 2016, a marked decline from the 15% hedged last year,” S&P said this month. “The trend continues for speculative-grade companies, which have just 29% (1.437 MMboe/d) of total oil and gas production hedged next year compared with 45% in 2015.”
The economic damage inflicted upon oil-producing countries has also been well documented and closely watched. Nigeria is one such country. The West African OPEC member has seen its budget decimated by low oil prices, and the government has come under increasing pressure to devalue its currency, the naira, because of the weakening economy and shrinking foreign exchange. Nigerian President Muhammadu Buhari has held out, projecting confidence that Nigeria can maintain the peg. However, he recently opened the door to a potential devaluation in January.
Buhari said that the central bank could introduce “some flexibility” that would encourage some capital inflows. Nigeria has suffered from a shortage of dollars, which has made some economic transactions difficult in the country. A devaluation would logically address this problem. “I am aware of the problems many Nigerians currently have in accessing foreign exchange for their various purposes,” the president said. “These are clearly due to the current inadequacies in the supply of foreign exchange. We are carefully assessing our exchange-rate regime, keeping in mind our willingness to attract foreign investors, but at the same time managing and controlling inflation to a level that won’t harm average Nigerians.”
Weakening currencies is a problem throughout the oil-producing world, with significant declines exhibited in South America, Africa, the Middle East and Eurasia. Countries with flexible exchange rates have seen their currencies plunge over the past year while countries with fixed exchange rates are coming under extreme pressure to abandon their pegs and devalue. Nigeria’s naira peg could be next on the firing line, but it surely will not be the last.
Another bearish black swan event looming over the oil markets is latent Libyan oil capacity. Rival factions in Libya have carved up the country and kept the North African oil producer from exporting to its full potential. Libya’s oil output has been down around 400,000 barrels per day for the past year or two, while its Qaddafi-era capacity stood at 1.6 million barrels per day. However, the rival governments in Libya have started the peace process, and signed an UN-brokered accord last week. It is unclear whether the peace deal will hold, but if violence and instability begins to abate, Libya could start to bring some oil production back to international markets. The exact amount is unclear, but if, say, 500,000 barrels were brought back online sometime in 2016, that would be extremely negative for oil prices. That would essentially offset the expected declines from U.S. shale next year.
