Monday, September 28, 2015

NYT: "Shell Exits Arctic as Oil Slump Forces Industry to Retrench"

Royal Dutch Shell ended its expensive and fruitless nine-year effort to explore for oil in the Alaskan Arctic on Monday in another sign that the entire industry is trimming its ambitions in the wake of collapsing oil prices. ... At a time when global markets are glutted with oil, it also confirmed major oil companies’ increasing willingness to turn their backs on the most expensive new drilling prospects in the Gulf of Mexico and suspended plans for new projects in Canada’s oil sands. Shell spent more than $7 billion on its Alaska venture.

When oil was selling for $100 per barrel, drilling in the Arctic likely made sense. Since oil has hovered around $45 per barrel -- West Texas Intermediate crude closed today at $44.47 on the NYMEX -- it is not viable.

What this decision by Shell tells me is that economists inside Shell -- and likely inside other oil majors -- now believe that crude oil is likely to stay under $50/bbl for a long time, perhaps several years. If they believed that in 2016 WTI crude would be $90 or $100/bbl or more, they would be willing to drill for oil in remote places today, even with the price much lower. It is the fact that they don't believe oil is going up in price in the next year or two that is causing them to stop drilling in marginal locations.

The industry has cut its investments by 20 percent this year and laid off at least 200,000 workers worldwide, roughly 5 percent of the total work force. At the same time, companies have retreated from less profitable fields in places like the North Sea, West Africa, and some shale prospects in Louisiana and North Dakota.

What's interesting about the oil bust is how it negatively effects certain oil-reliant economies and that in turn depresses demand for other market goods and thus harms global growth. I had never contemplated that until this bust. What I was well aware of is that, when the global economy is going strong and demand for oil outpaces supply and oil prices rise dramatically, the result is harm to ongoing growth, even enough to cause a recession. The money that would otherwise be going into more consumption, housing, savings and investment ends up going to pay for higher priced oil, gasoline, airplane fuel, diesel, etc.

In between -- I am not sure the exact number -- there must be a healthy price of oil, where it is high enough for the producing regions to profit and spend, yet low enough that it is not draining the income of the consumption regions of the world. At $45/bbl, the price is too low and the effect is harmful to demand. 

And a low oil price is likewise a sign that demand is generally weak for all products. At established levels of production, consumers just cannot buy up as much oil as is being produced. So the price will fall until producers stop drawing so much crude from the ground.

United States oil companies have decommissioned more than half of their drilling rigs over the last year, and production is beginning to drop in the United States. Even exports from Saudi Arabia are beginning to ebb because of a glut in its Asian markets. “The decision by Shell to abandon its Arctic drilling program for now primarily reflects the realities of lower global oil prices,” said Michael C. Lynch, president of Strategic Energy and Economic Research, who advises oil companies and investment banks.  “When prices go down the oil industry shortens their list of projects in development by removing the most expensive ones.” This year, industry executives expressed hopes that the oil price, which has fallen more than 50 percent to below $50 a barrel since last summer, would recover before too long. But in recent weeks, a growing number of executives have warned that the downturn could last well into 2016 and perhaps beyond, especially if the Iran nuclear deal leads to a flood of new oil on world markets. With demand dwindling, the current 94 million barrel a day oil market has roughly 2 million barrels in surplus supply.

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