Global crude oil prices have rebounded somewhat from the twelve-year lows recorded earlier in the year; however, they are still quite removed from two-year-ago levels. Burdened by the lingering low-price regime, many of the higher-cost producers have either scaled-down their operations or gone completely offline, with quite a few filing for bankruptcy. According to the law firm Haynes and Boone LLP, about 85 North American oil and gas companies have gone bankrupt since the beginning of 2015. There has been a spike in defaults for U.S high-yield bonds. Speculative-grade U.S. defaults rose from 4.4% to 5.1% of total outstanding between Q1 and Q2, according to a recent Moody’s Investor Service bulletin.

That price rebound stirred some ― even if limited ― production activity, particularly among the more nimble shale operators. Oil-focused rotary rig count, for example, rose six of the past seven weeks in the United States, according to Baker Hughes data. While many analysts and stakeholders in the industry have projected a market rebalancing in the near term, certain near-term and longer-term issues are noteworthy.

Oil Imbalance

The protracted low-price regime was driven in the main, by oversupply of oil, which inevitably conduced to high inventory levels. In the United States, the Department of Energy reports that stock levels were well above the five-year range at the end of May; and though stocks dropped 2.3 million barrels the week ending July 15, they stood at a historical high for the period. At the end of May also, there were almost 94 million barrels of oil in floating storage globally, according to the International Energy Agency, IEA; and December saw a five-year record for floating storage tankers, as data for ocean tankers show. In addition, forward days of demand rose in Organization for Economic Cooperation and Development (OECD) countries from just under 58 in 1Q 2014 to more than 67 in 1Q 2016.

Global crude oil imbalance ― excess of supply over demand ― which rose steadily from less than half a million barrels per day (bpd) in 1Q 2014 to more than two million bpd in 2Q 2015, has since been on a downward trend.

While global crude oil demand has been on the increase, that downward trend in imbalance may have been accentuated by the recent supply outages in major producing countries such as Nigeria, Canada and Brazil among others. It is noteworthy that imbalance increased steadily between 2Q 2014 and 2Q 2015 even as demand was growing. Given the reversal of those supply disruptions as well as a faltering demand ― largely from U.S. refiners, having built up bloated gasoline and other product stocks from the low price regime ― an oil price rebound would most likely be sluggish.

That heralded spike, early last month, in the prices of international benchmarks Brent and West Texas Intermediate (WTI) to just over US$50/bbl, saw a sudden retreat. Brent and WTI stand at US$46.20/bbl and US$44.75/bbl respectively.

Investment

Many producing companies availed themselves of that price spike to hedge their operations, in anticipation of lower oil prices; and the current low-price regime has had a telling impact on reserves as well as capital expenditure (capex). Oil and gas reserves of the 50 largest U.S. producers for example, declined 12% and 21% respectively in 2015, according to a report by Ernst & Young LLP; and global upstream development outlay for the period 2015 through 2020 declined by US$1 trillion.

It is noteworthy that the Middle East is least affected by that investment decline, with Saudi Arabia recording none for the 2016-2017 period. When this is considered in the light of declining non-OPEC supply (especially in the U.S.), concerns about the rising dependence on Middle East oil supply become relevant.

Outlook

A recent report by consulting firm Wood Mackenzie indicates that about 70% (9 million bpd) of all crude oil development projects to be delivered over the next decade would be commercially viable at a Brent price of US$60/bbl, with most of them coming from U.S. tight oil plays. The balance of supply (4 million bpd) would come at US$85/bbl.

Uncertainties concerning the rebound of oil prices have led to the delay or cancellation of a significant number of development projects; and even some current production areas are barely breaking even. In the United Kingdom for example, the average production cost is US$44.33/bbl according to Rystad Energy, while the current price for the Brent grade is just under US$47/bbl.

Aging oilfields are even worse off. Such fields are already in their declining productivity phase and the rather expensive technical applications necessary for wringing out extra oil may be uneconomic in a low oil price regime; the often-high decommissioning costs, when factored in, could compound issues.

The consulting firm’s report also adds that in addition to the 13 million bpd set to be delivered over the next decade, about 10 million bpd of crude oil would be needed to meet demand projections. In the event that available supply capacities fail to meet that shortfall in a timely manner, the global oil market may suffer a major price shock.