How long will low oil prices continue?
The Saudis are going insure that this low oil price drop lasts for quite sometime maybe a year or two. The Saudis are going to attempt to and probably bankrupt many USA shale producers and their investors. USA shale production is the threat that the Saudis are trying to contain.
The USA shale producers rely on leverage, borrowed money from the banks, seed capital from investors and moderate to high oil prices to stay solvent.
The Saudi induced price drop will last long enough to exhaust oil pricing hedges, last long enough to cause banks to tighten credit, last long enough to cause investors to seek greener pastures. The price drop will last until it gets these needed results. This will probably take 6 months to upwards of two years depending marketplace reaction. Most USA shale is hedged 3 to 6 months out dropping steadily to very low levels after 1 year.
Then after oil prices rise again, the banks and investors will likely not fund USA shale producers again because they know if they do, the Saudis will screw them again. It is not a question of if but when.
The Saudis can not absolutely control the long term price of oil but they can inject oil price volatility into the market which impacts the risk analysis and increases the margin of safety demanded by investors to fund new oil exploration anywhere. For instance now some oil futures contracts are selling in the $30 range which would have been unthinkable 1 year ago. This is because the implied long-term oil price volatility has increased. The Saudis are just trying to contain the growing global production of oil as best they can. This growing global production is negatively impacting future Saudi wealth.
This is how business and economics works in the real world. So here we are at the present, a guaranteed glut of oil supply courtesy of the Saudis and OPEC for the near term future. So what is the likely oil price going forward to achieve the required Saudis goals ?
The most important fact is the cost of Saudi production is between $10 and $15 a barrel.
Many USA shale fracking operations have costs approaching $60 to 70 / barrel funded with borrowed money.
Some USA shale fracking operations have costs as low as $40 / barrel.
The likely Saudi price target is likely in the mid 40's for this reason as it will severely curtail most if not all USA shale fracking as well as high cost oil production elsewhere in the world.
These highly leveraged players all around the globe will likely fold in the coming years as investment capital flees and banks do not ante up with loans to fund continuing operations.
This is the sole reason why the Saudis will deliberately leave prices low for a few years to caution future investors in funding new USA shale fracking operations. This is how the capital markets function, they operate on risk, reward and the expected future returns.
The Saudis have let everyone know that they will not tolerate high cost producers in the oil market ever again.
So if oil prices ever trend back up to $100 barrel expect the shale oil producers to be sleeping with one eye open.
Until usa shale production costs come down to a level lower than the Saudis are willing to produce at, the Saudis will remain in control.
On the geopolitical side we have the oil price numbers for each nation for budget breakeven
$80 / barrel for the Saudis
$105 / barrel for the Russians
$125 / barrel for Venezuela
and Iran is in a world of hurt begging at the bargaining table for sanction relief.
As of 1/6/2015 oil is below $50, and the process is accelerating which is great for the USA and the Saudis because the Russians and the Iranians will surrender sooner as opposed to later because they know at this point the Saudis have won. Delay in negotiating with the West will just increase the financial pain without any benefits.
The Saudis have enough fiscal sovereign reserves to play this game for a few years even if oil drops to $20. The Saudis have repeatedly publicly stated this just to assure investors and markets know they are not bluffing. Clarity and certainty of purpose is honored in the marketplace.
More details are found in the enclosed article below.
Sheikhs v shale
This near-40% plunge is thanks partly to the sluggish world economy, which is consuming less oil than markets had anticipated, and partly to OPEC itself, which has produced more than markets expected. But the main culprits are the oilmen of North Dakota and Texas. Over the past four years, as the price hovered around $110 a barrel, they have set about extracting oil from shale formations previously considered unviable. Their manic drilling—they have completed perhaps 20,000 new wells since 2010, more than ten times Saudi Arabia’s tally—has boosted America’s oil production by a third, to nearly 9m barrels a day (b/d). That is just 1m b/d short of Saudi Arabia’s output. The contest between the shalemen and the sheikhs has tipped the world from a shortage of oil to a surplus.
Fuel injection
Cheaper oil should act like a shot of adrenalin to global growth. A $40 price cut shifts some $1.3 trillion from producers to consumers. The typical American motorist, who spent $3,000 in 2013 at the pumps, might be $800 a year better off—equivalent to a 2% pay rise. Big importing countries such as the euro area, India, Japan and Turkey are enjoying especially big windfalls. Since this money is likely to be spent rather than stashed in a sovereign-wealth fund, global GDP should rise. The falling oil price will reduce already-low inflation still further, and so may encourage central bankers towards looser monetary policy. The Federal Reserve will put off raising interest rates for longer; the European Central Bank will act more boldly to ward off deflation by buying sovereign bonds.
There will, of course, be losers (see article). Oil-producing countries whose budgets depend on high prices are in particular trouble. The rouble tumbled this week as Russia’s prospects darkened further. Nigeria has been forced to raise interest rates and devalue the naira. Venezuela looks ever closer to defaulting on its debt. The spectre of defaults and the speed and scale of the price plunge have unnerved financial markets. But the overall economic effect of cheaper oil is clearly positive.
Just how positive will depend on how long the price stays low. That is the subject of a continuing tussle between OPEC and the shale-drillers. Several members of the cartel want it to cut its output, in the hope of pushing the price back up again. But Saudi Arabia, in particular, seems mindful of the experience of the 1970s, when a big leap in the price prompted huge investments in new fields, leading to a decade-long glut. Instead, the Saudis seem to be pushing a different tactic: let the price fall and put high-cost producers out of business. That should soon crimp supply, causing prices to rise.
There are signs that such a shake-out is already under way. The share prices of firms that specialise in shale oil have been swooning. Many of them are up to their derricks in debt. Even before the oil price started falling, most were investing more in new wells than they were making from their existing ones. With their revenues now dropping fast, they will find themselves overstretched.
A rash of bankruptcies is likely. That, in turn, would bespatter shale oil’s reputation among investors. Even survivors may find the markets closed for some time, forcing them to rein in their expenditure to match the cash they generate from selling oil. Since shale-oil wells are short-lived (output can fall by 60-70% in the first year), any slowdown in investment will quickly translate into falling production.
This shake-out will be painful. But in the long run the shale industry’s future seems assured. Fracking, in which a mixture of water, sand and chemicals is injected into shale formations to release oil, is a relatively young technology, and it is still making big gains in efficiency. IHS, a research firm, reckons the cost of a typical project has fallen from $70 per barrel produced to $57 in the past year, as oilmen have learned how to drill wells faster and to extract more oil from each one.
The firms that weather the current storm will have masses more shale to exploit. Drilling is just beginning (and may now be cut back) in the Niobrara formation in Colorado, for example, and the Mississippian Lime along the border between Oklahoma and Kansas. Nor need shale oil be a uniquely American phenomenon: there is similar geology all around the world, from China to the Czech Republic. Although no other country has quite the same combination of eager investors, experienced oilmen and pliable bureaucrats, the riches on offer must eventually induce shale-oil exploration elsewhere.
Most important of all, investments in shale oil come in conveniently small increments.
The big conventional oilfields that have not yet been tapped tend to be in inaccessible spots, deep below the ocean, high in the Arctic, or both. America’s Exxon Mobil and Russia’s Rosneft recently spent two months and $700m drilling a single well in the Kara Sea, north of Siberia. Although they found oil, developing it will take years and cost billions. By contrast, a shale-oil well can be drilled in as little as a week, at a cost of $1.5m. The shale firms know where the shale deposits are and it is pretty easy to hire new rigs; the only question is how many wells to drill. The whole business becomes a bit more like manufacturing drinks: whenever the world is thirsty, you crank up the bottling plant.
Sheikh out
So the economics of oil have changed. The market will still be subject to political shocks: war in the Middle East or the overdue implosion of Vladimir Putin’s kleptocracy would send the price soaring. But, absent such an event, the oil price should be less vulnerable to shocks or manipulation. Even if the 3m extra b/d that the United States now pumps out is a tiny fraction of the 90m the world consumes, America’s shale is a genuine rival to Saudi Arabia as the world’s marginal producer. That should reduce the volatility not just of the oil price but also of the world economy. Oil and finance have proved themselves the only two industries able to tip the world into recession. At least one of them should in future be a bit more stable.
Source:
http://qr.ae/63Hw9