Oil mood falters as market mood takes a gloomy turn

Oil prices look vulnerable again on mounting evidence that improvements in the world oil market have stalled, at least temporarily.

World benchmark North Sea Brent crude futures on Friday dropped to their lowest level since May, with a decline of 51 US cents to $45.69 a barrel, bringing the total decline from this year’s early-June high to more than 13 per cent.

There had been a sustained recovery from early January through early June as high-cost supplies from places such as North America and the North Sea had gone into decline, which ate into the huge stockpiles that had built up during a long period of overproduction.

But the latest data to worry oil traders was the widely watched rig count from Baker Hughes, an oil services firm, that showed the fourth week in a row where oil rigs in use in the US increased.

Though the count of active oil rigs was up by 14 at 371, it was still way below the 659 rigs in use a year before.

The market’s current dilemma was well-illustrated on Wednesday when the chief executive of Halliburton explained his more positive outlook for the market, even though his firm and his clients are still under substantial financial pressure.

David Lesar brushed off Halliburton’s second-quarter loss, noting that “conventional wisdom coming out of the first quarter was that the rig count would continue to drop, [but] we said we saw North America differently and were the first to call a bottom for the rig count. This is precisely what happened … Today our customers are thinking about growing their business again rather than being focused on survival.”

A report last week from the energy research firm Wood Mackenzie noted how break-even costs for North American producers had dropped substantially over the past year, to a large extent because firms such as Mr Lesar’s have had to drop the rents they charge for their rigs.

Also on Wednesday, the US government’s energy information agency (EIA) noted that the rate of decline of US production had slowed, partly because of higher productivity from larger fields as well as the incentive of higher prices.

That’s the rub: the rising prices through the first half of the year slowed the decline in high-cost production, but the declining prices may have the opposite effect.

The EIA is forecasting declining production in the US through first quarter next year, levelling off in the second quarter assuming prices for West Texas Intermediate crude average $47 a barrel in the third quarter this year and $50 in the second quarter next year.

“The price forecast is highly uncertain, and any significant divergence of actual prices from the projected path could change the pace of new-well drilling, which would in turn affect the production forecast,” the EIA says.

The International Energy Agency last week made a similar point. As most forecasters have recognised, the market upheaval of the past two years is requiring a drawn-out period of structural change in the market.

As Mr Lesar explained, this means much uncertainty as companies adjust to the new reality. Though the industry has become leaner and more able to deal with lower prices, he warned of the medium-term risk of a supply shortage because of under-investment.

“The last 2 years has been a period of significant under investment, where global [capital expenditure] has been reduced by nearly $400 billion,” he told investors on a conference call.

“As a result, the industry will have to find a lot of new barrels in the next five years. Now, you can choose your own energy supply expert and there are many of them out there, but most agree we will need between 18 and 22 million barrels per day of new production by 2021, meaning we have to find nearly two Saudi Arabias worth of production in the next five years.

“To achieve this production goal, we believe there will need to be structural changes that have to happen,” he concluded. “It clearly starts with a supportive commodity price and we’re not there yet today. The prices will have to get there soon or the supply challenges will be even greater.”​


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