Production shut-ins amid lower oil prices may be substantial this time

Production shut-ins amid lower oil prices may be substantial this time

BAKU, Azerbaijan, March 28

By Leman Zeynalova - Trend:

Unlike 2015/2016, production shut-ins amid lower oil prices may be substantial this time, Trend reports citing Wood Mackenzie research and consulting company.

“In the short term, companies, governments and other stakeholders are likely to continue producing assets at a loss, as they have in the past, in the hope the price will rebound quickly. But, the current trifecta of oversupply, demand evaporation far greater than the capability to build storage and global behemoths fighting for market share, may require immediate and dramatic action,” the company said in its report.

Just as companies rush to minimise the cash haemorrhage, petro-economies may have to act to avoid steep climbs in budget deficits, said Wood Mackenzie.

“Paradoxically, where a high proportion of an asset’s production costs are fixed – think facilities running costs, materials, rent, compliance and so on – the easiest way to reduce unit operating costs is to increase production, if that is an option. If prices don’t rebound, the taps will inevitably be turned off or strategically choked back in some areas. And unlike 2015/2016, production shut-ins may be substantial this time. Given the difficulties and costs associated with restarting mature production, a proportion of this supply may never return.”

At a Brent price of $35 per barrel, revenue from 4 million b/d (4 percent) of 2020 global liquids supply does not cover production costs and government share. This rises to 10 million b/d (9 percent) if prices fall to $25 per barrel.

“In the last downturn virtually no out-of-the money production was shut in. But in 2015/16, prices only dipped below $45 per barrel for a year, and below $35 per barrel for one quarter,” Fraser McKay, vice president, upstream, said.

“There is no precedent for the scale of potential shut-ins, if there is a prolonged period of low prices, for today’s asset classes. The industry’s ability to keep higher-cost barrels flowing will be severely tested. Longer-term, the impact of a lack of spend on maintaining existing production and capital spend to replace declines will take over as the primary driver of supply.”

Saudi Arabia’s conventional oil has the lowest production costs; with a weighted-average short run marginal costs (SRMC) of just $4 per barrel. Russia is also at the low end of the marginal cost curve. Its production requires just $10 per barrel on the same basis. The US is the world’s largest oil producer. It completes the trio of the major global suppliers and has a wider SMRC range. Its weighted average is similar to Russia’s, at $9 per barrel, but while its lowest cost production is essentially covered by gas revenues, its marginal barrels are more expensive to produce.

McKay said: “Each of these core producers needs to continue drilling wells to maintain production levels. But whereas the Saudi and Russian governments decide their own investment and production levels, the US government does not. Individual company strategies fill that role. Those same companies were challenged financially even before the price fell.

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Follow the author on Twitter: @Lyaman_Zeyn

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