Crude oil prices have risen to within a hair’s breadth of $50 a barrel, a level previously thought unattainable before the second half of this year or 2017. The past four months have seen oil prices essentially go straight up since the low of $26.19 a barrel on Feb. 11. The 85% price rise is beginning to fuel optimism that the worst of this downturn is now in our rearview mirror.
Of course, a realist would point out that today’s oil price is merely back to the level we were at in late October and early November of last year before the market’s collapse.
The rise in oil prices has been fueled by solid industry data showing a decline in domestic output in response to a lack of new well drilling. On the other hand, industry data is also showing that oil demand is growing, especially for gasoline as Americans drive more. Shrinking supply and growing demand are the recipe for falling inventories and ultimately higher oil prices. A higher oil price is the medicine the industry needs before ramping up activity.
Just when producers will start going back to work depends on several questions. How high do prices need to go and for how long before producers’ confidence about the future is restored and they resume drilling?
In an interview with CNBC on May 20, Tom Ward, CEO of Tapstone Energy and a co-founder of Chesapeake Energy and Sandridge Energy, was not encouraged about a quick industry recovery. In contrast to other producers who have stated that when oil prices reached $50 bbl. they would reactivate drilling rigs, Ward said the industry needed to get back to $75 bbl. before there would be a production response.
Oil production is falling because the industry has effectively shut down. U.S. oil and gas companies deferred $380 billion in capital projects through the end of last year due to low oil prices, according to energy consultant Wood Mackenzie. As Ward pointed out, “Whenever you make a decision to stop drilling, it takes a number of months or years in order for that decision to actually impact the market.” Likewise, once the market rebalances and oil prices rise to a level sufficient to justify investing in new projects, it will take some time before drilling starts and even longer before new production arrives.
The key point Ward made to CNBC was this: “In our business, the dirty little secret is you can’t really spend within cash flow and grow production.”
Translation: Only when the industry can return to spending more than it takes in can we reverse the oil output decline. It is possible that we return to the industry environment we were operating in before this downturn, but it may be that the future will be different and overspending will not be tolerated. If this comes to pass, it is likely that we will experience much higher oil prices for a lot longer than many currently anticipate.
The views and opinions expressed in this blog are the author’s and not necessarily those of WorkBoat.