The Energy Report 06/05/2020

Come Together

If OPEC Plus can iron out their differences, maybe there is hope for the rest of us. After some dancing around and some veiled threats from Saudi Arabia and Russia, OPEC cheaters promised to get their oil production under control and has set the stage for a weekend meeting.

Opec and the wider Opec+ group will both hold their ministerial meetings tomorrow via video conference at 7:00 am central time, and Opec+ will hold its meeting immediately after that at 9:00 central time. Saudi Arabia and Russia reportedly want to extend output cuts of 9.7 million barrels per day (bpd) into July and possibly until the end of the year. If OPEC fails to agree this weekend, the deal would revert back to 7.7 million barrels a day. That would add at least 2 million barrels a day of production and probably more because Saudi Arabia could stop over complying that would be like an increase of over 3 million barrels of oil a day. Yet because the meeting is scheduled, it is unlikely that the deal will fall apart. Let’s face it, the oil production cut that was engineered in large part by President Trump has been very successful and has helped the global energy industry stabilize.

How successful has the oil cut been? Well, according to John Kemp at Reuters, the dated Brent crude oil five-week calendar spread drew close to level yesterday, signaling physical crude traders expect the tightest market since the original OPEC+ agreement broke down. So despite a lot of fear that the cut would do no good because of the coronavirus demand destruction, demand recovery in China, Europe, and the U.S. along with the cut, market forces are helping the market heal. If demand continues to recover and OPEC plus stick to their guns, the most significant coordinated production cut in history will soon be viewed as a smashing success.

Of course, it did not come without some real pain in the energy industry. And while we are seeing a recovery, the damage caused by the coronavirus shut-ins may have set the stage for oil shortages in the future. The pullback in investment will have ramifications for years to come. How bad? Well, according to the U.S. Energy Information Administration (EIA), global expenditures related to oil and natural gas exploration and development (E&D) increased $42 billion (13%) for 102 publicly traded oil companies in 2019, totaling $361 billion. As a result of significant crude oil price declines in 2020, however, global proved reserves will likely be revised downward, and oil and gas exploration and development (E&D) expenditures will also likely decline. Several companies have already announced large budget reductions.

EIA says it based its analysis and its recently published 2019 Financial Review primarily on the published financial reports of 102 publicly traded companies, so the conclusions do not necessarily represent the sector as a whole because the analysis does not include private companies that do not publish financial reports. “According to their financial statements, these 102 companies produced 22.2 billion barrels of oil equivalent (BOE), a measure that reflects their combined production of crude oil and natural gas, and spent $361 billion in E&D. Dividing these companies’ E&D expenditures by their combined production volumes provides a ratio of $16/BOE in 2019, or about one-quarter of the average Brent crude oil price of $64/barrel (b).

In its May Short-Term Energy Outlook, EIA forecasts Brent crude oil prices will average $34/b in 2020. If this crude oil price forecast is realized, E&D expenditures per BOE could fall to less than $10/BOE in 2020 if E&D expenditures remain at about one-quarter of the Brent crude oil price. Proved reserves are estimated quantities of oil and natural gas that analysis of geological and engineering data demonstrates with reasonable certainty are recoverable under existing economic and operating conditions. Because crude oil prices directly affect the profitability of E&D projects, changes in the prices companies use to develop their calculation of reserves can significantly affect their proved reserves levels and the volume of reserves they can claim as additions.

The U.S. Securities and Exchange Commission requires companies listed on U.S. stock exchanges to value proved reserves at the end of a year based on the average crude oil prices from the first trading day of each month during that year. On the first trading day of the first six months of 2020, the front-month Brent futures closing price averaged $44/b, or 30% lower than the 2019 full-year average of $63/b. When crude oil prices decline, oil companies can take impairment charges for assets that fall in value to less than the cost of developing them. Impairment charges represent the decrease in value of assets a company owns, typically its amount of proved reserves. The current low price environment suggests that the 102 companies EIA analyzed will likely post large negative revisions to their proved reserves in 2020.

Traders will be on storm watch with tropical depression Cristobal. Accuweather reports that Tropical Storm Cristobal unloaded flooding rainfall and made landfall in southern Mexico on Wednesday. Accuweather meteorologists are busy looking ahead to where the storm may go after meandering across southern Mexico. The system, now a tropical depression, is expected to take a northward turn, and it could gain strength over the Gulf of Mexico before reaching the southern United States coastline. The track will go over the bulk of Gulf production and is headed to the heart of the refinery row. While it is not expected to do significant damage, the slow-moving nature of the storm will still mess things up.

Rumors are the U.S. Transportation Department plans to issue a revised order likely to allow some Chinese passenger airline flights to continue. The order will be sometime in the coming days. That may give the beleaguered jet fuel market a boost along with plans by American Airlines to resume many flights.

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