Market Currents: Oil capex cuts are under the spotlight

Forty-seven years (!) after Simon and Garfunkel released ‘The Boxer’, and the bulls and the bears are slogging it out again. After trading blows in recent days, the bulls appear to have the upper hand, as technicals trump immediately weak fundamentals. Nonetheless, we are seeing a pullback today. Hark, here are six things to consider in oil markets today:

1) Jumping straight into economic data, we’ve had disappointing retail sales out of the UK before the Eurozone interest rate decision (still stuck at 0.0%, deposit rate still negative at -0.4%). We’ve subsequently had comments from ECB President Draghi that stimulus is working – and that loose monetary policy will persist for as long as it takes. The euro initially rallied, before unwinding again.

2) On to the US, and weekly jobless claims came in at 247k, astoundingly a 42-year low. The Philly Fed was a party pooper, however, with the regional manufacturing index coming in below consensus, showing deteriorating conditions.

jobless claims 42 year low
weekly jobless claims (source: investing.com)

3) There is a fair bit of focus on oil and gas investment levels at the moment, given we are in the redetermination period (aka credit-line reassessments). The IEA’s chief Fatih Birol has chimed in on the topic today, highlighting low oil prices have cut investment by about 40% over the past two years, and how the sharpest falls have been in the US, Canada, Latin America and Russia.

4) A study by Wood Mackenzie (chart  = h/t @WoodMacKenzie) highlights that the trend of lower investment is set to persist. Their study projects $91 billion in capex cuts across 121 upstream companies this year:

upstream capital budget

5) A key takeaway from the above is that Rosneft is just one of two companies boosting their spending compared to last year. Rosneft, who accounts for about a tenth of Russian output, doubled its drilling rate last year. This piece (h/t @jfarchy) highlights how the Russian tax system and the weakness in the Ruble has helped to offset the pain of lower prices – at least compared to its global peers.

Hence, after a 12% increase last year in drilling activity, Russian production finds itself kicking around a post-Soviet record at ~10.9mn bpd:

Russian output

6) Finally, the EIA has analyzed the annual reports of 40 publicly-traded US oil producers, highlighting the significant differences in their financial situations. The group as a whole saw combined losses of $67 billion last year, although these losses varied wildly from company to company.

Eighteen of the forty companies experienced losses in 2015 in excess of 100% of their equity (termed as high loss companies – HGLs). The driving force behind the HLG’s deteriorating financial conditions was leverage; their long-term debt-to-shareholder equity ratio averaged 99%, compared to the non-HLGs whose debt was at at much-lesser level of 58% of shareholder equity.

Not only were the HLGs the most leveraged, but their assets were revised down the most too. Last year the 18 HLGs saw a 21% reduction in proved oil reserves, while the non-HLG group saw a drop of just 6%. The lower reserves for the HLG group caused impairment charges, decreasing the value of their assets. This lower asset value is ultimately reflected in lower credit availability to these companies. 

reserves

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