Are we seeing oil industry capitulation?

What is the sound of one hand clapping? How about the sound of another shoe dropping? As of Friday’s close, oil prices have dropped by nearly 21% since the end of 2015. In two weeks, oil prices have declined by $7.62 per barrel — a stunning amount.

The sharp oil price drop is forcing the oil industry to consider further budget and activity cuts – not good news for the oilfield service industry. These new cuts are effecting 2016 budget plans only recently put to bed by companies, although everyone knew they had to consider all budgets as merely “works in progress.”

The sound of another shoe dropping are really the cries of anguish from employees losing their jobs. It was very interesting that during the first week of January, BP, probably the most aggressive major integrated oil company in confronting the changes necessary to deal with the oil price collapse that began in late 2014, announced it was cutting another 4,000 employees from its work rolls.

Significantly, these layoffs are concentrated within BP’s exploration and production operations and most likely target exploration efforts more than production operations. These targeted cuts are good news for the oil industry’s long-term outlook as less exploration means fewer barrels of new oil and gas reserves being added to the industry’s inventory over the next few years, helping to speed the inevitable oil price rebound. In the near-term, however, it is a depressing and emotionally disturbing step.

Since OPEC/Saudi Arabia decided to turn over oil pricing to the marketplace rather than cutting their output to support prices in November 2014, the oil industry has struggled to right-size operations for this lower oil price environment, not knowing how low prices might go. The normal response to lower oil prices is to cut employees in lockstep with falling activity. Early in 2015, the oil and oilfield service sectors aggressively cut employees and capital spending. In the summer, following the failed spring oil price rally, decisions were made to cut even more employees and further reduce spending with the result that the number of working rigs continued to fall. Unfortunately, oil prices declined throughout the fall and early winter. Oil industry budgets, originally projected to fall by about 9% early last year, are estimated to have actually fallen by 23% for all of 2015.

Spending estimates for 2016 are 15% lower than last year, although, if current oil prices prevail for much longer, the spending reduction might be closer to 20%. Cuts of this magnitude mean further activity reductions – currently underway – and fewer workers. Low oil prices are straining the financial health of the oil and oilfield service industries, which could lead to a surge in bankruptcies meaning more permanent pain.

Baring a dramatic rebound in oil prices – something not likely to happen given the additional 500,000 bbls. of Iranian oil hitting the market soon – 2016’s oilfield activity will be sharply lower than last year. The devastating industry outlook that was suggested last year is likely to become reality this year. Darkness will descend on the industry. The next several months will be among the worst to hit this industry since the depths of the 2008-2009 downturn and the mid-1980s. The oil and oilfield service industry will look different by next December — what we don’t know is just what it will look like.

About the author

G. Allen Brooks

G. Allen Brooks is a 40-year veteran of the energy and investment industries, serving as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a board member of several oilfield service companies. He is the author of the highly regarded energy newsletter “Musings From the Oil Patch” that interprets trends within all sectors of the energy business.

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