Oil is poised for wreckage

Even if optimistic predictions of an oil price recovery prove correct, the industry will suffer considerable damage before then.

Oil prices may return to $US80 a barrel by the end of the year, they may go much higher, but even if that optimistic view proves to be right there will be considerable ­industry wreckage before then.

Not only has the new Saudi monarch, King Salman, made it clear his country will not (at least, not yet) reduce production, but there is the prospect an oil surplus will overhang the market even after the Saudis begin turning off the taps.

Opinions vary. Bear Bob Janjuah of Nomura Securities generated headlines after commenting on a US business channel that oil could go as low as $US30 a barrel — a long way from the $US147 a barrel oil price reached just two months before the GFC hit in 2008.

One of Saudi Arabia’s top ­investors, Prince Al-Waleed bin Talal of Kingdom Holdings, has gone on record with his view that oil will never again see $US100 a barrel. No, just a moment, it could go to $US200 a barrel, according to Claudio Descalzi, chief executive of Italian oil giant ENI. His ­argument is that the recent price crash to about $US45 a barrel is giving the industry a good kicking and will lead to investment cuts that may store up trouble for the ­future.

That $US80 a barrel figure as an end of 2015 prediction comes from Peter Strachan, noted Perth oil watcher at StockAnalysis. But he expects considerable damage before then.

He figures a price of $US77 a barrel is required if your average US shale producer is going to stay in business. He expects US shale oil production to decline by 1.4 million barrels a day by mid-2016 -- news that will be music to the ears in Riyadh -- but high-cost heavy oil producers to be driven from the market by 2015. Longer term, Strachan is on the same page as ENI: the supply story will be ­significantly disrupted by a hiatus in exploration and development, resulting in much higher prices post-2016.

There is also a possibility of a repeat of 2009 when oil prices plunged during the GFC; then more than 70 million barrels of oil were stored in tankers, the owners waiting for higher prices.

“The same dynamic is now building, with many millions of barrels likely to overhang the market, keeping prices weak for longer than might otherwise be the case,” says Strachan. He expects development drilling at US shale fields will slow dramatically over the coming four months, as indicated by falling number of rigs in action, with exploration drilling to come almost to a halt.

Julian Jessop and Hussain Mehdi at London-based Capital Economics say there are signs of oil prices stabilising as US rig counts fall and global investment plans are abandoned or postponed. Their timetable is similar to Strachan’s: the big fall in US output will come later in the year.

Not everyone is hurting. In an update on its Capitola project near Sweetwater, Texas, where two producing formations overlie a large shale structure that has been attracting attention, Pryme ­Energy (PYM) says its estimated cash costs for producing oil are a maximum $US12 a barrel, the drilling and development cost is $US18 a barrel, and the project is expected to be cashflow positive at present oil prices. Nevertheless, the falling oil price has led to cuts in capital spending. But PYM indicates it is comfortable, having $8.4m in the bank.

In other developments in this sector over the week, Red Sky ­Energy (ROG) is, due to the present downturn in oil prices, looking for opportunities in brownfield oil and gas projects that are “on the margin but still at break-even in the current environment”. The plan is to pick up something being sold off at “a fraction” of the historical cost of acquiring these types of assets. This acquisition-on-weakness is seen as putting the junior in the box seat when the oil price recovers.

The strategy is to find something that will supplement ROG’s Cache oilfield in Colorado, the proposal to take a 50 per cent share now being in the due diligence stage. The field produced from wells drilled through the 1960s, most of which are now closed.

Elixir Petroleum (EXR) also shows no sign of slowing down. It also has a 50 per cent stake in a Colorado project and is working to get its licence renewed for the Moselle oil project in France, near the German border, where it has a potentially large oil and gas resource. But EXR has also hired a US consultant, seeing itself as well placed to capitalise on the situation with distressed companies looking to reduce debt through the sale of non-core assets. The consultant is on the sniff for any cheap buys.

Gold stocks rise

Gold's resilience is, as noted last week, working through to the performance of junior share prices.

On Monday Southern Gold (SAU) reported its Cannon project near Kalgoorlie now has a free cashflow forecast of $18.5m, (a 50 per cent gain on previous calculations) doing its figures on an Australian gold price of $1500 an ounce. The shares rose from 1.1c to 1.5c on the news.

Then, on Friday, and calculating on what was by then a prevailing Australian price of $1620/oz, RNI (RNI) said its Grosvenor project in Western Australia had, since the last calculation, achieved a 95 per cent rise in free cashflow to $172m. That sent the shares from 7.3c to 8c.

ANZ put out a second bullish-for-gold report within a week, reporting that “a scent of change is in the air”. After being unfriendly towards gold for the past 18 months, investors had begun accumulating physical gold once more. Holdings of gold in exchange-traded funds rose by 40 tonnes last week. But this is a culmination of a trend now evident in hindsight: in 2013 ETFs sold 870 tonnes, but in 2014 liquidations were down to 165 tonnes.

“The stabilisation over 2014 and sharp increase in exposure so far this year suggests a marked shift in sentiment is under way,” said the co-authors of the note, ANZ analyst Victor Thianpiriya and the bank’s chief economist Warren Hogan.


No investment advice is implied and investors should seek professional guidance. The writer does not own shares in any company mentioned.

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