Perspective: Violent Swings in Prices Reflecting Market Uncertainties
Global financial markets have been gripped by fear in recent weeks, causing record volatility for oil prices. While a measure of calm has returned to these markets, many of the underlying negative fundamentals are still in place. As a result, the downside risks for most commodity prices are likely to persist for some time. China remains the linchpin of global oil demand growth, and uncertainty spurred by the rout in equity markets and the devaluation of the yuan has driven the contagion to oil in the last month. In terms of the fundamentals in physical oil markets, weakening Chinese economic indicators have led to a small reduction in our Chinese oil demand growth forecast this year with a larger reduction in 2016. Growth patterns will likely react to any new policy approach proposed by Beijing to deal with the current slowdown, and in our view, the growth acceleration seen in 2015 is unlikely to be repeated in 2016.
The second uncertainty impacting oil markets is the timing and magnitude of the supply adjustment, particularly in the US tight oil. While IHS has maintained careful attention on the reactivity of US crude production, our focus on this topic has intensified during August. We believe that three issues are of particular importance in understanding the current situation:
- Accelerating decline rate of shale plays, and the need to feed the "maintenance mountain". Our recent work examines how a slowdown in drilling during 2015 lowers decline rates in 2016, and explains the amount of new drilling required to keep US production flat.
- Hedging protection is set to plunge in 2016 for the North American E&Ps. North American E&Ps remain largely exposed to low prices in 2016, with just 11% of total production hedged for the year. At the core of our forecast for oil supply is our detailed analysis of capital spending which shows that capital spending for the group will drop significantly in second-half 2015 compared with first-half 2015.
- Impairment charges have reached record levels for North American E&Ps. Our preliminary second-quarter 2015 data shows the North American E&P peer group (Large, Midsized, and Small) took a total of $31.2 billion in impairment charges during the quarter. This propels the first-half 2015 total to nearly $60 billion, far exceeding the high of $48.5 billion in 2008 and the 10-year annual average of $18.1 billion. A high level of impairment will change the structure of the US industry and slow the reactivity of the system when prices rebound.
We also looked at how low prices impact access to existing resources and reserves. In Brazil, low oil prices are exacerbating a series of challenges to timely development of deepwater crude oil production-- well below potential through 2030. In our view, Petrobras's cash flow constraints are pushing it to divest in-country assets, creating an opening in Brazil that was not possible in a high oil price environment. We also assessed the future for field growth in existing undeveloped discoveries and also future discoveries. Global trends showed that during 2000-14, more new resources came from growth in reserves from discovered fields than from new discoveries. In the second part of this study we take a more granular look at field growth.
Finally, we took a close look at the impact of the rising refined products trade over the next decade, increasing global opportunities but also intensifying global competition for refiners and other segments of the supply chain. These competitive pressures will fuel well-positioned and successful refineries-but also lead to refinery closures in certain regions.
3 September 2015 by Roger Diwan, Vice President, IHS Financial Services
This is an excerpt from IHS Energy's monthly Oil Research Digest.
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