Thursday, September 29, 2016

Interesting Development in Efforts to Choke the Oil Glut

Declining oil prices from global over-production have the potential to produce significant financial problems for over-leveraged firms.

Iran's entry into the global market, as a result of normalization of international relations, posed a particular problem because of the country's capacity to produce large amounts of oil at relatively low prices.

It looks as if OPEC is going to pull together to try to limit over-production, with the Saudis potentially absorbing cuts in order to balance overall production:
By Rania El Gamal and Alex Lawler September 28, 2016, OPEC reaches first deal to cut oil output since 2008 - sources. Reuters,

...Saudi Energy Minister Khalid al-Falih said on Tuesday that Iran, Nigeria and Libya would be allowed to produce "at maximum levels that make sense" as part of any output limits which could be set as early as the next OPEC meeting in November.

That represents a strategy shift for Riyadh, which has said it would reduce output to ease a global glut only if every other OPEC and non-OPEC producer followed suit. Iran has argued it should be exempt from such limits as its production recovers after the lifting of EU sanctions earlier this year.

Over the last year I've been covering the financial implications of declining commodity prices, especially oil, resulting from over-production. Here are some relevant headlines and excerpts addressing "souring" energy loans in the context of production practices and norms:

The Wall Street Journal's weekend print edition reported that "More Energy Loans are Turning Sour" (Jan 16-17, 2016, B2).

Tyler Durden, "America's Cash Flow Negative Energy Companies Have $325 Billion In Debt Among Them Submitted ZeroHedge, January 18, 2016, 
Ryan Dezember. 2016, July 22. Oil Pay Plans in Cross Hairs. The Wall Street Journal, C4.
“Moody’s Investors Service said it may begin penalizing oil and gas producers that partake in a widespread industry practice: incentivizing their executives to drill regardless of commodity prices. Most oil-company executives derive part of their annual cash bonuses by hitting production and reserve growth targets. These bonuses, which can amount to millions of dollars, have come under criticism from some shareholders who say the incentives don’t make sense when oil and gas prices are too low for drilling to be profitable”

Sarah McFarlane, Nicole Friedman, and Alison Sider. 2016, July 28. Gasoline Glut Swamps Oil. The Wall Street Journal, C1.
Crude prices fall to a three-month low below $42 a barrel as fuel storage fills up.

Just when it appeared crude oil’s supply problems were easing, a glut of gasoline is drowning the market’s hopes for a recovery. Vast new supplies of gasoline around the world, combined with the overproduction of oil, has sent crude prices sliding.... The result is near-record levels of gasoline put into storage around the world, around 500 million barrels in total, according to Citigroup.

Arthur Berman. 2016, July 28. Oil Industry About To Be Burned Again By Fall In Oil Prices. Zero Hedge

The current oil-price rally is over.

U.S. rig counts have surged as oil prices sink. Capital is driving the oil markets and it enables bad behavior by producers. That is why oil prices will stay low.

The oil-price rally that began in February is over. Prices rose from $26 per barrel to $51 by early June and are now below $42 (Figure 1). If they fall through $40, the next likely support level is at $36 per barrel.
Global energy production is fundamentally irrational when long-term supplies and the environmental costs of extraction and refining are considered. There has to be a better way...


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