As at 20 February 2016, the spot
price for Brent oil closed at $ 31.09 while WTI crude oil closed at $
29.05. Year to date, the Brent fell 15.1% while WTI crude fell 21.8%.
HIGHLIGHTS
- US shale oil revolution plans
- OPEC unlikely to find an agreement for a deal
ANALYSIS
Data source (Excel format): U.S. Energy Information AgencyUnited States to become a net supplier of crude oil from shale oil revolution
US is one of the top oil consumers in the
world. On average, US has been demanding 23.24% of the world’s total
oil consumption in 2000-2014. In 2000, US began researching into shale
oil production.
Referring to the chart above, US’s net
imports of crude oil has been falling since 2005, 3 years before the
shale oil revolution began in 2008. The US dependence on foreign oil
producers have fallen more than 70% following the shale oil boom. US oil production grew 37.6% within 4 years, outpacing the world’s oil production of 7.8%!
With US still being a net importer of crude oil, it is possible that
the growth of shale oil has yet to reach its full potential.
Unfortunately, under intense competitions
from OPEC, US producers are are unable to generate funds to grow as
quickly as anticipated. To improve operational efficiency, shale oil
producers cuts the number of active oil rigs, while increasing the
production capacity per rig. In April 2015, producers managed
approximately 11.75 thousand barrels per day per rig compared to 5.86
thousand barrels per day per rig in January 2014. US producers have
doubled their output yields per oil rig.
Operational cost of US shale oil
production is estimated to be $ 14.80 per barrel. This means that at
current price levels, US should still be able to maintain its output
levels. While the oil price war would not be able to stop the growth of
shale oil indefinitely, it can slow down US growth drastically. At crude
spot price of $ 31.09, earnings should be $ 16.29 ($ 31.09 – $ 14.80).
This means that earnings is $ 0.04463 per day, hence it would take about
1 year and 117 days to generate enough internal funds to fund $ 21.50
of capex for expansion.
To summarize, US is still bound to
produce enough supply to meet its domestic demands as long as oil prices
remain above $ 14.80. Oil price is unlikely to fall below $ 14.80, as
world production would not be enough to support demand at that price
levels. Hence, the OPEC’s decision to knock out shale oil will be
a failure, although it can slow down the growth rate of the US outputs.
US is expected to grow by 27.6% by the time it becomes a net exporter of
oil. By then, US would dominate the 20% of global market share, solely based on its domestic demands only. As a side note, US currently owns about 15.5% market share.
OPEC deal to freeze output unlikely to succeed
On 11 Feb 2016, Venezuela proposes OPEC, non-OPEC producers to freeze oil supply. Below are some of the general terms and conditions of the deal:
- Saudi Arabia requires that Iran restrict plans to restore market share.
- OPEC to maintain market share of 40% of global output.
Based on the analysis on US markets, it
would be absurd if US producers would freeze their output levels when
they have bright prospects for growth. Hence, other producers, notably
the OPEC group have to agree on output levels to stabilize oil prices.
Meanwhile, consider the case below:
- Iran, a member of the OPEC, has lost a significant amount of market share from the Iran sanctions imposed by United Nations Security Council back in 2006. Iran lost 1.5% global market share from 2006-2015, equivalent to an annual revenue of $ 8.0 billion at Iran’s previous market share levels.
- If Iran is able to raise exports at prices above $ 25.80, then Iran is better off raising its exports.
- But if Iran raises output and oil prices fall below $ 25.80, then Brazil and United Kingdom will suffer as production costs will exceed its selling price drastically. Brazil and UK will be forced to lower outputs and forgo its market share, while stabilizing the oil prices. Either way, Iran has a sure win situation if they raise their output levels.
From the case above, Iran should decline
the deal, which automatically terminates the deal to freeze output.
Currently, Iran is showing lack of interest in the deal, which I
believe is the right decision.
VALUATION
The US shale has contributed
significantly towards the supply glut. With so much room for output
growth in US, the glut will persist unless external parties acts to
stabilize the prices. On the other hand, Iran is deciding its own output
levels and offering discounts to raise exports, which further
complicates the situation.
According to assumptions from CNBC;
(i) the time taken to transport oil via oil tanker from Middle East to
US is about 30 days, and 60 days from Middle East to Asia (ii)
2 million barrels per VLCC (iii) cost of hiring oil tanker at $ 80,000,
according to Bloomberg chart above.
Estimated transport costs per barrel from Middle East to US: $ 1.20
Estimated transport costs per barrel from Middle East to Asia: $ 2.40
With minimal transport costs to mitigate the effects of Iran raising exports, it seems that the upside for oil prices is limited and there is more downside pressure. Nevertheless, I estimate that the bottoming of crude oil at $20 – 25 per barrel.
Thank you.
Shaun Loong
https://megamicrocaps.wordpress.com/2016/02/21/an-attempt-at-valuing-oil/
Crude Oil - An Attempt to Value Oil
