For North American oil producers, the situation is increasingly dire as oil prices continue their gradual decline. Currently sitting at $35 per barrel — the lowest level in 11 years — there are questions about whether this is the end of the downward trend or merely a temporary pause before further declines.
Major oil exporters like Saudi Arabia and Russia are maintaining high levels of production to put pressure on U.S. shale companies and sustain their market dominance. Concurrently, global oil demand is waning as the economy cools, aggravating the issue.
This combination of sustained high production coupled with diminishing demand has led to a surplus in supply, which in turn has driven prices lower. A shift in this trend is unlikely unless there’s an upswing in demand or a drop in production, neither of which seems imminent.
How low could oil prices realistically go? Reflecting on the late 1990s, prices fell below $20 per barrel. Goldman Sachs speculates that we may see those levels again.
Though oil prices won’t go to zero, this fact offers little comfort to the many companies that have heavily relied on financing from Wall Street to develop fracked wells, which require a price of around $60 per barrel to remain viable.
Declining Hedges
While oil prices can’t drop to zero, the stock values of oil companies may very well approach that mark. In fact, within the next year, we could witness a significant wave of bankruptcies resulting in delisted, worthless shares. Here’s the situation, as covered by Reuters:
“A Reuters analysis of hedging disclosures from the 30 largest oil producers revealed that the sector reduced its hedge positions in the three months leading to September.”
“When oil prices began to plummet from about $100 a barrel in mid-2014 due to a global supply surplus, many U.S. producers had robust hedge books that guaranteed prices around $90 per barrel.”
“Currently, with prices hovering below $36 and fears of increased oversupply, only five drillers among those examined by Reuters expanded their hedging positions in the third quarter, while eight were left fully exposed beyond 2015, without any protection against price fluctuations.”
“The five companies that added oil options, swaps, or other derivative positions managed to secure a price floor for their production, increasing coverage by 13 million barrels to a total of 327 million barrels.”
“Meanwhile, five other firms maintained positions that either expire in 2016 or lack any hedges, while the remaining 20 had their hedges decrease by 72 million barrels from the previous quarter.”
Doom and Gloom for North American Oil Producers
The use of price hedges helped many U.S. oil companies sustain production through 2015. However, as these hedges expire, these companies will be exposed to volatile market prices, potentially intensifying financial strain. In fact, conditions may deteriorate further before any potential improvement emerges.
Halting oil production is not a straightforward process; it complicates matters when companies find themselves producing more oil while their revenues dwindle. Continental Resources experienced this dilemma firsthand. They made the ill-advised decision to sell off their hedges in late 2014 and operated throughout 2015 without those safety nets. The year proved to be exceptionally challenging due to rapidly declining oil prices.
In the third quarter of 2015, Continental increased its output by 25 percent compared to the previous year, yet crude and natural gas revenues plummeted by 46 percent during the same timeframe. Moreover, had they retained the hedges they sold in late 2014, they could have generated $1 billion more in 2015 than they ultimately did.
As of mid-December, 39 North American oil producers have filed for bankruptcy protection, with Magnum Hunter Resources Corporation being the latest. At the time of filing, they reported having only $6.4 million in cash against total liabilities of $1.1 billion, resulting in a staggering debt-to-cash ratio of 17,187 percent.
Without the ability to profitably operate at $35 per barrel oil, any efforts to restructure are unlikely to yield results. Indeed, the outlook for North American oil producers remains bleak.
Sincerely,
MN Gordon
for Economic Prism
Return from Doom and Gloom for North American Oil Producers to Economic Prism
