Oil Industry Cutting Again, But It Still Might Not Be Enough

Chevron announced on Dec. 10 its decision to slash capital expenditures even further for 2016, cutting spending down to $26.6 billion, or 24% below 2015 levels.

“Our capital budget will enable us to complete and ramp-up projects under construction, fund high return, short-cycle investments, preserve options for viable long-cycle projects, and ensure safe, reliable operations,” Chevron Chairman and CEO John Watson said in a statement. “Given the near-term price outlook, we are exercising discretion in pacing projects that have not reached final investment decision.”

That follows an October announcement in which the company said it would cut 10% of its workforce.

ConocoPhillips announced on Dec. 10 similar plans for 2016, with cuts to spending of about 25%. Its capital budget will reach only $7.7 billion, which is 55% below 2014 levels. ConocoPhillips will also sell $2.3 billion in assets to raise cash.

The company will focus the core of its spending on U.S. shale, particularly in the Bakken, Eagle Ford and the Permian Basin, the latter of which is one of the last remaining shale basins that drillers can still pull oil from the ground at a decent profit.

Globally, spending on exploration and production could fall by $70 billion in 2016, according to Rystad Energy. But that could be a conservative estimate. Cowens & Co. sees a much deeper cut of $115 billion next year.

The oil industry has had to repeatedly revise their spending plans downwards, narrowing their ambitions as depressed oil prices have persisted. The cuts may not yet be over – the oil glut continues. After OPEC’s decision to remove its production target, crude took yet another dive. Both WTI and Brent have broken fresh multiyear lows, and Brent is even below $40, a once unthinkable threshold.

While relief can be expected eventually, the near-term still looks pretty depressing. OPEC reported that it produced the most oil in three years for the month of November, pumping 31.7 MMbpd. That result was reached in part because of major gains in Iraq. The war-torn country continues to defy expectations and achieve production gains. It increased output by 247,000 bpd in November, although some of that was gained because of an outage in October. Still modest gains came from Angola and Kuwait, each ratcheting up output by 25,000 bpd.

The high levels of production from OPEC illustrate the problem that the group had when trying to agree on a production target. Nobody has room to cut – the glut has crashed oil prices, but OPEC members each need to make up for lost revenue by stepping up volumes.

Cutting back could indeed boost prices, but no one actually wants to take on the burden of being the one to do the cutting. And since collectively the group is producing well above its stated target, and has been for some time, they decided to shed the pretense of a production target.

Moreover, Iran could add 500,000 barrels per day early next year, which could take OPEC’s collective output above 32 MMbpd. As such, the 30 MMbpd target was an untenable façade, so it was tossed out.

Private oil companies will be the ones to force a cut back in production, as a result. The EIA expects U.S. oil production to average 8.8 MMbpd in 2016, a fall from the 9.3 MMbpd average for this year. While a 0.5 MMbpd decline is significant, the way things are going right now in the oil markets, the EIA’s estimate could be a bit optimistic.

Oil prices are hitting new lows, and while oil companies have cut spending, payrolls, and drilling expenses significantly, they haven’t really had to deal with sub-$40 oil so far. If oil prices stay this low for an extended period of time, exploration companies will have to cut deeper into the bone. Rig counts are already in freefall once again, after a pause over the summer.

Down from a peak of just over 1,600 rigs in October 2014, the oil rig count leveled off in July and August 2015 after prices rebounded to $60 per barrel in the late spring. But the shale patch has lost more than 100 rigs since just September. With a lag effect, the loss of drilling activity won’t show up for a few more months.

By the late first quarter or second quarter of 2016, the sharp contraction in the rig count will start to be reflected in earnest in the production numbers.

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