The head of Russian oil group, Rosneft reckons global oil prices will drop under $US60 a barrel in early 2015 – the way prices are going it could happen before the end of this year – but there will be an awful lot of nervous oil company boards, managements and shareholders hoping that doesn’t happen – especially in the buoyant US shale oil sector.
And no company will be as anxious as BHP Billiton, which is facing an assault on its finances on two fronts – the plunge in iron ore prices, and now the rout in oil.
In effect Saudi Arabia is taking on the US shale oil sector, especially its vulnerable high cost producers, with the unspoken aim of driving many of them out of business.
It is similar to what BHP Billiton and Rio Tinto in particular are trying to do in iron ore, helped by vale of Brazil and the smaller Fortescue Metals group in Australia.
Both are high stakes plays – but none more so than for BHP – as directors cut costs and husband resources, it is now facing enormous pressures on revenues and cash flows from its two biggest businesses – iron ore and oil and gas.
The chances of the company reporting lower earnings than previously though for the current six months and for 2014-15 as a whole, is going.
And watch for the rising pressure on the company to impair some of its margin oil and gas assets in the US – as it did several years ago, at much higher prices.
BHP is exposed as few other global resource companies are from the two worst performing commodities in 2014. BHP shares fell 1.6% on Thursday to $32.
This morning they fell nearly 4% in early trading, while Woodside shares were off more than 5. Santos shares fell by just on 10% at one stage and Oil Search shares fell close on 8% in early dealings.
Clearly reality has finally hit the oil and gas sector, and its about time.
And financial cost to BHP and other companies in the oil and gas sector (Santos, which showed this week it had been taken by surprise by the rapid fall in prices, Woodside, Oil Search and service companies such as WorleyParsons) will be as a result of what is a ‘price’ war in oil.
Driving that price war is Saudi Arabia, the world’s biggest oil producer – and its taking on the US, the biggest consumer and the second biggest producer, and possibly the biggest if current production trends continue into 2015.
The question though for US shale oil groups, including the likes of BHP, is whether they can ride out a price war (especially when it is battling an iron ore price war). No one is deliberately cutting prices, just using rising production to force prices lower at a time of weak or stagnant demand.
But the US shale sector is squarely in the sights of the Saudis and other gulf producers, such as Kuwait.
The likes of high cost natural oil producers such as Venezuela, Iran, Nigeria, Libya and others are already known to be facing rising budgetary pressures from the current level of prices of around $US68 for US WTI type crudes and around $US72 for the global market crude type, Brent.
But they are sovereign countries and for a while can create money to balance budgets, cut spending – take all the actions open to a government to survive.
Companies are different – they live on revenues and cash flows – especially if they are high cost operators, as most US shale producers are.
So when revenue falls and costs exceed the money coming in, companies have to slash and burn to survive – as we are seeing in coal and iron ore at the moment.
But when those companies have high levels of high cost (even by current low interest rates) debt, the pressures are doubled, trebled.
That’s why there are an increasingly large group of bankers, investors and company boards worried about oil prices at current levels, let alone going lower.
And these companies will follow their more established giants such as BP, Shell and ExxonMobil, and companies in other commodities, such as BHP, Rio Tinto, Peabody Energy and more, in cutting costs, closing down margin projects, slashing exploration spending to rein in costs to match falling revenues and cash flows.
Crude prices are now down close on 40% since June and should they fall under $US60 a barrel, as Igor Sechin, head of Russia’s state oil group Rosneft, predicted overnight, the pips will start squeaking, especially in the US shale areas of the Eagle Ford in Texas (and the associated Permian basin, an established group of mega natural oil and gas fields) and the Bakken oil area in North Dakota which is the source of much of the extra US production.
By resisting calls for a cut, Saudi Arabia, Opec’s largest producer, seems to to be preparing for what is in effect a price war – a lengthy period of low prices, aimed squarely at US shale operators with the ambition of driving out the highest-cost producers.
“I wouldn’t call it a price war, but it’s a very aggressive test for US shale,” said Jamie Webster, oil analyst at IHS Energy, a consultancy. “It’s a new gambit for Opec to try,” The Financial Times reported.
It’s in fact a big test for all oil companies – look at the way the prices of oil companies and big services companies fell overnight. Shell’s shares lost 4.1% in Europe, BP lost 2.7% (both are already down more than 14% in the past month or so), Total shares lost more than 4% as well in France.
Shares in Seadrill, the world’s biggest drilling rig company, lost 7% – that was a day after the company announced a sharp profit fall and abandoned its dividend – a move which caused the shares to plunged 23% – so the shares are down 30% in the last two days alone.
Seadrill will stop paying dividends to conserve cash and capital for the coming months as it sees oil prices falling and business falling away.
And look at Transocean, the world’s biggest offshore drilling company – earlier this month it saw the light and wrote down the value of its assets, especially many of its rigs by a total of $US2.8 billion because it could see revenues falling as companies deferred exploration campaigns of forced cost cuts on suppliers like Transocean.
Transocean shares fell 8% in the US on Wednesday and are down 22% in November – they will come under future pressure when trading resumed tomorrow. It is now tipped to follow Seadrill in abandoning dividends to preserve cash.
They won’t be alone.
