On Monday 9th March 2020, the oil price saw its biggest fall in 30 years. Here’s our analysts’ rapid response to the oil price crash. Look out for more detailed analysis in the days and weeks to come.
Coronavirus is the most severe shock to hit the world economy since 2008’s financial crisis. Containment measures to limit the spread of the outbreak have shut down factories, schools and events around the world, and travel restrictions both voluntary and mandatory have cut passenger and freight transport by land, sea and air.
The result has been a plunge in oil demand. Wood Mackenzie estimates that in the first quarter oil consumption will be 2.7 million barrels per day lower than in the same period of 2019. The OPEC+ group of countries has compounded the problems facing oil producers by failing to agree a cut in output, with Saudi Arabia and Russia leaving an acrimonious meeting in Vienna vowing to increase production. As a result, Brent crude has plummeted to about $37 a barrel, with West Texas Intermediate (WTI) at about $33 a barrel.
Find out more in this report from the macro oils team, "OPEC agreement collapses and takes oil price with it"
What could this mean for oil and gas companies and the global markets of which they form a critical part? Our analysts got together to share their initial findings.
1. US$380 billion of upstream cash flow could vanish from our 2020 forecasts
Fraser McKay, head of upstream analysis, used Wood Mackenzie’s Lens platform to calculate that up to US$380 billion of upstream cash flow would vanish from forecasts if Brent prices average US$35/bbl for the remainder of the year. This represents an 80% drop relative to a continuation of the US$60/bbl it has averaged year-to-date.
Sustained crude prices below US$40/bbl would trigger a new wave of brutal cost-cutting. Discretionary spend would be slashed, including buybacks and exploration. Unsanctioned conventional projects will also be delayed, and in-fill, maintenance and other spend categories scaled back.
Oilfield service companies and other players in the supply chain could struggle to recover. Even short-term downward pressure on prices tends to lower the ceiling on activity levels and rig counts in the long term.
2. This isn’t a rerun of recent price crashes
This is not the first time we’ve seen a price war – the last was as recently as 2014-16. But this time, oil demand is also weak as the coronavirus outbreak depresses global economic growth. The macro-economic backdrop is uncharted waters for oil and gas companies.
The oil and gas industry’s financials are in much better shape than in 2014, thanks to the capital discipline brought in following the last price collapse. At current activity levels, we estimate that our Corporate Service coverage group needs an average Brent price of US$53/bbl to break even in 2020, including dividends at expected current levels and announced buybacks.
The price collapse could trigger a new phase of deep industry restructuring – one that rivals the changes seen in the late-1990s. Indebted Lower 48 producers could be forced to act sooner rather than later.
Some Majors, however, may not have an appetite for large-scale oil and gas acquisitions in light of their recent commitments to decarbonisation. With a higher risk and a rising cost of capital, higher hurdle rates will be attached to oil and gas projects in the future. For some companies, this might be the catalyst for strategic repositioning.
Unfortunately, a return to higher prices or another radical change in the cost base will be needed to provide sufficient capital to take that leap.
3. The slowdown in US tight oil will be immediate and aggressive
Before coronavirus and the oil price crash, capital discipline was the big story, with E&Ps under pressure from investors to improve cash flow and capital efficiency. A 25% drop in rig count from 2019 and double-digit price deflation among oilfield services left suppliers bidding competitively for low-cost jobs while operators continued to cut back. Across all basins, rig day rates and the cost of pressure pumping and casing fell significantly.
At today’s spot price, none of that matters. Because there’s no fat left to trim in 2020, the cuts to development activity are necessarily fast and brutal, made possible by tight oil’s unique flexibility. The response from explorers and producers in the Lower 48 has been dramatic. Some reduced rig counts even before Monday’s markets opened.
In late 2019, $45/bbl (WTI) was floated as the minimum price required to keep capital plans in place. How long the price stays below that level will influence how long and how much shale shrinks. How low can production go? Rigs can’t drop to zero, no matter the price outlook. Contracts prevent it, and heavily indebted shale oil E&Ps are bound by debt covenants to keep production above a certain level.
