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The Four Real Reasons Oil Prices Are Slipping

by | published August 4th, 2015

As I write, I am flying from Kansas to Baltimore. I’ll be visiting Money Map Press headquarters to discuss some exciting developments we’ll tell you about shortly.

But today’s Oil & Energy Investor is all about where I have just been…

Years ago, a legendary wildcatter told me you have to smell the crude and get it under your fingernails before anybody should call you a genuine oilman.

Well, yesterday I was addressing a convention hall full of them.

I’ve been at the annual meeting of the Kansas Independent Oil and Gas Association (KIOGA). More than 800 industry insiders were in attendance for my keynote address in downtown Wichita.

I always look forward to spending time with the “little guys” in oil exploration and production (E&P). These are the fellows who have comprised the bedrock of American domestic production for over a hundred years – the very small, very local companies. Many are running some of the smallest operations around. The average KIOGA member company has just more than three employees!

And in my address, I shared with them the four real reasons oil prices are declining.

Here’s what I discussed in my briefing…

Why Small Oil Operators Are Hurting

Throughout the decades, small E&P outfits have endured market downswings, vicious weather, profit constrictions (or outright profit disappearances), and virtually every conceivable problem with oil field service, equipment/supply prices, and the cost of running debt.

This year, all of these crises – and more – have hit at once.

There were those in the audience who knew they would not make it to January. But this is also a resilient bunch. The collective history sitting in front of me was flat-out extraordinary.

However, they face difficult times.

As crude settles in below $50 a barrel for WTI (West Texas Intermediate, the benchmark used in New York for futures contracts), operators at the wellhead are making about 15% below that figure. To survive, they need to be lean and selective in drilling.

The plunge has hit hardest those companies developing deep drilling operations in shale and tight formations, those requiring horizontal drilling and fracking. Without a price for oil of around $65 a barrel, there is no likelihood that forward investment commitments can be sustained. Here is where the main cuts in new projects have been taking place.

The Best Strategy for Survival

It just so happens that the best strategy to use in such times is an approach the folks in Kansas know well. It has allowed them to weather storms before, and it will do so again.

Yes, as I have often said, a rising tide does not lift all boats. Yet it is also true that a declining water line does not scuttle all boats, either. In a low price environment that nonetheless has strong demand, a specific positioning in known and prolific, completed infrastructure, along with attention to managing forward capital expense, is essential.

Most of the folks in the audience already knew that, but not all of them are able to move on it. Vulnerability is intensifying.

Deliverance from the current malaise is not going to be across the board. In fact, that was part of one of the four primary points I wanted to make in my address.

The Four Reasons Behind the Decline in Oil Prices

I began by laying out the current dynamics attending the price decline: supply gluts, the value of the dollar, excessive short positions on crude, OPEC-related sovereign wealth funds undercutting the price of their own production, and the widening spread between “paper” barrels (futures contracts) and “wet” barrels (the actual consignments of oil in trade).

All of these we have discussed here in Oil & Energy Investor.

The current price for crude oil in New York (WTI) is some $11 below where it should be based on straight market factors. Meanwhile, Dated Brent (the benchmark set daily in London) is closer to $15 below “fair market value.” The differential is the result of elements having very little to do with either supply or demand dictating price.

The next two factors I have also considered at length in Oil & Energy Investor: the changing nature of the oil balance and the acute crisis in energy debt.

The balance considers sources of supply and expanding end use markets. Supply is now coming from places quite different than only a few years ago, as the “call on shale” has begun to replace the more traditional “call on OPEC.”

Meanwhile, the debt issue involves the increasingly too expensive interest that must be paid when high yield (i.e., “junk”) bonds are issued. The ability to roll over debt, a staple of cash poor operators in the U.S., is vanishing, as is any genuine option of hedging current prices against future prospects.

The Coming Wave of Consolidation

This sets the stage for my fourth and final main point in Wichita. We are moving again into a major period for mergers and acquisitions (M&A). Some companies will simply go belly up. On the other hand, others having choice leases and well operations (but becoming exceptionally weak in capital) will become primary targets for takeovers.

However, there is an additional wrinkle emerging. A widening number of companies are prepared to sell select wells and leases for the immediate funds needed to stay afloat until the broader market stabilizes.

In these situations, whole companies are neither going under nor being acquired. The focus here is on selective assets.

Remember this. Because it is the key to a major initiative we are about to open up. And I’ll be there, monitoring the situation, every step of the way.

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. Robert
    August 4th, 2015 at 14:04 | #1

    Hi Kent,

    Another well informed article, thanks for keeping us up to date.

    Like everyone I’m keen to know how you see price action playing out in the short-medium term for WTI. Do you think things will get worse ($40) before they get better?

    Thanks,
    Robert

  2. Brian Casey
    August 4th, 2015 at 15:14 | #2

    Hi Kent, I see that the Bakken producers are really held hostage on prices because of the lack of pipelines to be able to export their oil from a port on the West Coast USA.

  3. Dennis Wilson
    August 4th, 2015 at 22:24 | #3

    Dr. Moors, Sir:

    First, Thank You for all of the information and insight you present to us about the Energy Sector and for all the labor you put into finding it. I read many reports and have begun to see a trend where others (the Back Benchers we will call them) have begun to parrot your reports two or three days after you post up. Added to their reports, the Back Benchers tend to speculate how low oil will run (some as low as $10/barrel WTI) or that this isn’t real and the upward climb will resume any day now. And of course, the media is just so much incoherent noise making and quacking.

    That said, what is your perspective on all of this? What do you anticipate for a low price and really, how much capacity do we have in reserve before the supply/demand curve turns prices around? When approximately, given nothing new-drastic is added to the equation do you predict bottoming of prices and then after that an upturn?

    Best Regards;
    D. Wilson

  4. Lamar
    August 5th, 2015 at 19:43 | #4

    Dr Moors, do you know much about Standard Oil in West Virginia? They’re an independently owned oil company buying up other companies leveraged too far. Would you recommend buying into their stock-it would seem they are positioning to go public fairly soon.

  5. terry shead
    August 6th, 2015 at 04:25 | #5

    oil is gold, its not for just running your car there is no other commodity that can compare with it.

  6. naveen
    August 6th, 2015 at 07:43 | #6

    the situation in oil futures market is pathetic. How can small oil producers survive if their break even price $50? A month ago wallstreet bank g sachs reported that crude will touch $35 or so by october. how do they know this? It simply means the big traders like jpm chase, g Sachs, m stanely to name a few are shorting. But the fact is they also own oil storage/wharehouses. This situation is un nerving for the global middle class people. Because there will job losses as many oil countries will lose funds -venezuela, russia iran for example. this will have a negative repercussions in even oil producing countries like india and japan. for example collapse of euro
    versus dollar has cost many indian IT and pharma companies forex losses.
    And we common people have not benefited by falling crude -here Gas prices are still the same as it was when crude was ruling $105/barrel in December 2014. something must be done -all wrong doers i.e. commodity traders must be exposed and punished.

  7. naveen
    August 6th, 2015 at 07:56 | #7

    small correction -India and japan are oil importing countries. not oil producing. regret the typo

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