Crude oil prices are finding some support on the possibility that the oil supply will start to tighten in the future. Not only is the market speculating that we will see OPEC and non-OPEC nations agree to freeze output, but the reality that large oil companies are not replacing their reserves.
The Wall Street Journal is reporting that, “The world’s biggest oil companies are draining their petroleum reserves faster than they are replacing them - a symptom of how a deep oil-price decline is reshaping the energy industry’s priorities.” The Journal reports, “in 2015, the seven biggest publicly traded Western energy companies, including Exxon Mobil Corp (NYSE:XOM). and Royal Dutch Shell (LON:RDSa), replaced just 75% of the oil and natural gas they pumped, on average, according to a Wall Street Journal analysis of company data. It was the biggest combined drop in inventory that companies have reported in at least a decade.” For Exxon, 2015 marked the first time in more than two decades it didn’t fully replace production with new reserves, according to the company. It reported replacing 67% of its 2015 output.”
The Journal story is disturbing because it seems that the movement by big oil to not replace reserves means that we are laying the groundwork for a price spike in the future. When oil companies fail to replace reserves, they almost always over compensate for short term drop in oil prices. What is more, it is beginning to look more likely that in the foreseeable future we will see an even larger drop in oil company’s reserves. The drain game has begun and more than likely it will continue.
USA Today reported that, “the depletion of old oil wells is expected to surpass new sources of supply in 2016, as the ongoing oil price slump puts a long list of oil projects on the shelf. Bloomberg flagged new data from the Norwegian consultancy firm Rystad Energy, which predicts that legacy production will tip the supply balance into the negative in 2016 for the first time in years. “The production from an average conventional oil field typically ramps up in the early years, plateaus and then enters a period of decline. Depletion rates vary wildly from field to field, but a rule of thumb for conventional oil fields – which make up the bulk of total global supply – is that they decline something like 6 percent per year on average. Again, those depletion rates can differ depending on location, levels of investment, etc., but one thing that is clear is that the oil industry needs to bring new oil fields online every year in order to merely keep production flat.”
Energy estimates that the crash in oil prices has cut into upstream investment so severely that natural depletion rates will overwhelm the paltry new sources of supply in 2016. Existing fields will lose about 3.3 million barrels per day (mb/d) in production this year, while new fields brought online will only add 3 mb/d. This does not take into account rising oil demand, which will soak up most of the excess supply by the end of the year.
But the 3 mb/d of new supply in 2016 will mostly come from large offshore projects that were planned years ago, investments that were made before oil prices started crashing. The EIA sees four offshore projects starting up in 2016 – projects from Shell, Noble Energy (NYSE:NBL), Anadarko (NYSE:APC) and Freeport-McMoran (NYSE:FCX) – plus two more in 2017. The industry completed eight projects in the Gulf in 2015. U.S. Gulf of Mexico production will climb from 1.63 mb/d in 2016 to 1.91 mb/d by the end of 2017.
This comes as the U.S. rig count resumes its plunge. Baker Hughes reported that the oil rig count fell 15 to 372 this week the lowest total since the week of November 13, 2009. Oil last week fell after Baker Hughes report that we broke the 13-week of lower rigs. Now the big drop is another sign that U.S. oil output will slow.
Long term there is a seismic change in the future production outlook. Historically this has always led to higher prices down the road. This is the time to put on long-term hedges and lock in what could be close to the lowest prices we may see for decades.