As Global Demand For Oil Drops, Worries Rise for Debt-Heavy Oil Companies

By Nick Cunningham,

Weak global oil demand is keeping a lid on prices, according to a new report from the International Energy Agency (IEA), and that’s bad news for companies carrying a lot of debt.

Oil demand for 2014 will be lower than previously expected, prompting the IEA to downgrade its forecast by 180,000 barrels per day (bpd) for the year. In the second quarter, global demand only increased at an annualized rate of 700,000 barrels per day, the slowest pace in over two years.

Flagging demand is helping to keep oil prices from spiking, which is fortunate, considering that violence in oil producing countries around the world is keeping a substantial portion of oil supplies offline. All told, around 4 percent of global oil supplies are offline because of conflict.

But, according to the IEA, “Oil prices seem almost eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world.”

Libya has been in a state of political crisis for over a year, which has kept most of its 1.6 million barrel-per-day capacity offline since the summer of 2013. Nigeria has experienced sabotage to key pipeline infrastructure, knocking some of its production offline. Iran has been under western sanctions since 2012, which have capped Iranian oil exports at 1 million bpd – about 1.5 million bpd lower than pre-2012. And Iraq, despite continuing crisis and chaos, has remarkably kept its output fairly steady.

The fact that prices have remained unusually stable over this period of global unrest is a result of weak global demand. Demand growth in the U.S. and Europe has been much softer than expected. OECD economies – a collection of 34 industrialized nations – saw oil demand shrink by more than 400,000 barrels per day in the second quarter.

But the real surprise is slow demand growth coming from China, where the economy is cooling.

China has been the main driver in rising oil demand for years, so a slowing rate of consumption there could upend predictions about where global demand is going.

For oil companies, this is a troubling development. As oil becomes harder to find and more expensive to extract, oil drillers need prices to rise to continue to make a profit. The industry has steadily increased its spending over the last five years or so to fund drilling in more remote and expensive locations. As an example, The Wall Street Journal recently wrote about the lengths to which Anadarko is going to produce natural gas in Mozambique.

But the problem for the industry is that prices have stopped climbing even as costs continue to rise. At a Houston conference earlier this year, oil executives agonized over ballooning costs. “All of us are facing new realities and pressures,” John Watson, CEO of Chevron said. “Labor and capital costs have doubled over the last decade.” He added that many companies don’t make money unless oil prices are in the triple digits.

Until recently, higher production costs could be tolerated because prices were climbing. But with demand flat, prices have hovered around $100 per barrel, and there is plenty of oil sloshing around.

And that means higher debt across the industry. Unless oil prices rise significantly, there will likely be a shakeout. The most indebted firms will be forced out of the business, and others will have to cut back on drilling. At that point, supplies will tighten – forcing prices to resume their ascent upwards.

Of course, the fortunes of the oil industry could turn out much rosier than this scenario, if global demand starts to rise faster. And that is certainly possible: the IEA projected annual growth in oil consumption to increase to 1.3 million bpd in 2015 as the global economy expands. But considering the latest downgrade by the IEA, there’s no guarantee that will happen. By Nick Cunningham,

It always starts with a toxic mix. Read…. Where Money Goes to Die: How Fracking Blows Up Balance Sheets of Oil and Gas Companies

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  4 comments for “As Global Demand For Oil Drops, Worries Rise for Debt-Heavy Oil Companies

  1. Borpree says:

    It is wise to look at consumption of Oil/Electricity when it comes to China. It will give you a more truthful view of what is going on in the economy rather then looking at the GDP figures.

  2. Orlando says:

    The reason oil is slumping is that money printing is ending. The same thing occurs historically, from 1973, 1982, 1996, 2008. A price chart comparing oil and most other leveraged ‘assets’ to the fed’s balance sheet (or, gasp, M2) is a better predictor of price than any geo political play. Try it, I believe a regression analysis will show an almost 99% fit.

  3. Adverse converging trends = Triangle of Doom.

    High fuel prices adversely affect credit provision as vulnerable firms are compromised. Due to high prices, the marginal debtor hesitates to borrow or is unable to repay; creditors are unwilling to lend outside of self-driven finance market pyramid schemes. Reduced credit provision leads to declining bid for petroleum supplies; drillers lack the credit to meet their own costs, fuel supplies are constrained which leads to higher real fuel prices. Debtors and drillers chase their tails; wash, rinse and repeat in a self-amplifying cycle that ends when credit runs out.

    The answer to the question, “how high is too high?” is, “it’s a lot lower than you think!” When the prices decline, the ability to meet them declines faster. In our haste to consume, our success has created a perverse and poisonous meta-environment where every outcome — to consume or not consume — is fatal. The entire fuel waste infrastructure of the United States and its imitators has been built assuming sub- $20/barrel crude oil into perpetuity: the freeways, tract houses, shopping malls, our massive tower-cities and a billion automobiles. Within this context, $105/barrel oil strands just about everything we own. Meanwhile, ‘use’ of the fuel does not pay for the fuel, nor does it pay for the junk that uses it; our fuel is simply wasted for entertainment purposes only. What must pay is debt and lots of it: since World War Two hundreds of trillions of dollars worth.

    The dynamic is ‘energy deflation’, it is very similar to Irving Fisher’s ‘debt deflation’, there is the same positive feedback mechanism. With debt deflation, the more the borrowers repay, the more in real terms they owe because repayment removes funds from circulation. The vanishing supply of circulating money continually becomes more expensive, a ‘scarcity premium’ appends itself to the marketplace cost of funds. If the borrowers do not repay, then the assets become liabilities that the lenders themselves must retire … which they are unable to do for the same reason as the borrowers.

    With energy deflation, when the customer conserves — whether by accident or on purpose, it makes no difference — the remaining petroleum becomes more costly to extract in real terms. A scarcity premium attaches itself to the real cost of extraction for each new barrel of oil; the result is fewer available barrels as the scarcity premium per-barrel increases. At some point even a large decrease in nominal price is exceeded by the scarcity premium. Energy deflation undermines a pillar of conventional reasoning: that at some price oil supply is always available.

  4. Lee says:

    All you have to do is look at the Tapis oil price and you can judge demand from China.

    Tapis is about US$108 a barrel. It trades at a premium to WTI of about US$13 per barrel.

    So for now there is still plenty of demand from China and other Asian countries.

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