First oil

“We’ve seen crude oil prices at $10/bbl and at $140/bbl, but we’ve never faltered in our pursuit of E&P projects.”—Sudhir Mathur, CFO, Cairn India.

It may be bravado on Mr. Mathur’s part to keep operating in a low-price environment, but it does make economic sense on large, multi-year E&P projects to not react to every price gyration. Oil and gas being commodities, we have to keep reminding ourselves that price cycles are a fact of life, and neither high nor low prices are likely to remain constant for too long. By maintaining focus on the big prize, Cairn was able to increase its crude oil production in India from about 3,000 bpd in 1996 to nearly 218,000 bpd in 2014. Cairn’s discoveries in the Rajasthan desert have a gross ultimate oil recovery of over 2.2 Bboe. Cairn should serve as an example to the majors, independents and national oil companies, who have the financial wherewithal, to stay in the game over the long haul.

Is $50s/bbl the new normal? At the end of 2014, Brent fell $1.14/bbl to $56.74, its lowest level since May 2009. West Texas Intermediate fell to $52.70, also a 5½-year low. This represents a 46% drop-off in oil prices during 2014. Even the loss of 1 MMbopd from Libya in December, due to militias fighting and closing off export terminals, failed to halt the downward trend. In early January, Brent dropped below $55/bbl.

Buyer’s bonanza. For the long-suffering oil consuming nations, such as China, India and Japan, the decline in oil prices has brought a welcome relief to their balance-of-payments. China is acquiring as many Very Large Crude Carrier (VLCC) cargoes as it possibly can on the spot markets, to build up its crude oil inventory. According to Bloomberg News, as many as 83 VLCCs were heading toward Chinese ports in mid-December. On the other hand, China is running its refining sector at virtually full capacity, to export gasoline to nearby Southeast Asian nations.

Producing regardless of price. Countries that are almost entirely dependent on oil revenues—Venezuela, Iran, Iraq and Russia—to name just a few, must continue to produce, regardless of the price, because of the lack of alternative sources of revenue. In fact, oil supplies from Iraq and Russia have surged to their highest levels in decades. Russia’s oil production reached a post-Soviet record of 10.667 MMbopd, and Iraq exported 2.94 MMbopd in December, the most since the 1980s. Russia receives half of its revenues from oil and gas taxes. Despite the continuing sectarian strife within Iraq, oil exports will continue to increase in the aftermath of an agreement between the Iraqi and Kurdish governments on exports through Turkey.

Break-even price vs. lifting cost. While lifting costs for Saudi Arabia are as low as $10/bbl, the break-even cost for the Kingdom is as much as $30/bbl because of budgetary requirements and to maintain social order. For other OPEC members, the break-even prices vary considerably. For instance, Venezuela requires a crude oil price of more than $150/bbl to balance its budget. Of course, that is no longer possible, but the country has a strong incentive to increase production, to obtain as much revenue as it possibly can.

Balancing supply and demand. Under the low-price scenario, the world economy should get a boost. Global oil consumption could increase by 6% to 8% each year. But long before demand puts pressure on oil prices, the supply should start heading south. Since OPEC and Saudi Arabia are still refusing to cut production, it is probable that Western countries in general, and U.S. shale producers in particular, will have to assume the role of a swing producer from Saudi Arabia by curbing output from certain fields and plays, where break-even cost exceeds the wellhead price. Through an emphasis on prudent cost-cutting and cost efficiencies achieved by advanced technologies, the operators should continue to fund multi-year projects that will pay off in the long run.