‘Oil Industry is headed for tough times if current trends continue’
Paal Kibsgaard, Schlumberger CEO, in a management call at the release of the company’s 2017 second quarter results, recently said the industry is headed for tough times if current trends continue.
Shale production
Kibsgaard laid out a worrying trend that has received little attention but has dire consequences for global oil market. All too often, there is excitement over US shale production and the impact on OPEC production, but little attention is paid to the overall impact on long-term profitability.
The Schlumberger top boss believes that the rapid decline in breakeven prices for shale has led to a wave of irrational exuberance from equity investors that have led to unsustainable growth.
He argues that the production level from the US land E&P companies which currently represent around 8 percent of global oil supply is largely driven by the US equity investors who are encouraging, enabling and rewarding short term production growth in spite of marginal project economics.
Hence, these fast barrels from US land are facilitated by a factory approach to both drilling and production and supported by a rapidly scalable supplier industry with a low barrier to entry. So in this market, the pursuit of equity appreciation now outweighs the lack of free cash flow, net income and return on capital employed for both E&P companies and the service industry.
He said that although the fast barrels from US land have already cooled the oil price sentiments as well as the evaluation of the equity investments themselves, this has yet to limit the investment appetite for additional production growth.
The points are valid. In 2014 independent US oil & gas producers took on huge debts to fuel double digit production growth each quarter, but this backfired as oil prices fell from $110 a barrel to just $26 a barrel in January last year.
However shale drillers have become more adept and have become so prolific such that even at $50 barrel, they are turning profits. However, they are also spending more to develop these formations making their operations unsustainable in the long-term.
On OPEC production
American shale producers may have forced down the reality that OPEC producers do not have the final word on oil markets. Kibsgaard is concerned that other producers who make up over half of current global supply have drastically cut back on exploration and development spending.
He said these companies are now focused on meeting the cash return expectations of their shareholders either equity investors or government in case of national oil companies. To do this, they are keeping production flat by producing their existing outlets past their normal and by limiting investments to what provide short term contributions to production at the expense of increasing depletion rates.
The Norwegian chief executive said that with a low rate of new projects being sanctioned since 2014, this tailwind will taper off in the coming years. This harvesting approach is not uncommon for conventional oilfields that are in their last years of life prior to being shut in. However, this investment in stewardship model is unsustainable for a vast resource space that is both expected and required to provide a substantial part of global oil production for decades to come.
Kibsgaard concluded that the longer the current underinvestment carries on, the more severe the cliff like decline trend will likely be when the producers run out of short term options to maintain production. Given the size of the production base, it would be difficult for the rest of the global producers to compensate for this pending supply challenge.
ISAAC ANYAOGU