We all knew that there was an oil glut several months ago. US oil production is the highest in three decades. US crude stockpiles climbed 7.27 million barrels in the week ending December 19. This brought the gain to 387.2 million barrels. But the wild card was Saudi Arabia and OPEC. In previous periods of oversupply, OPEC has cut production. This time they dropped a bombshell and said NO to cutting production, that they would pump 30 million barrels per day. OPEC supplies 40% of the world’s oil. This caught the energy market by surprise. Where Brent crude was trading at $111.05 per barrel in June, it plunged more than 50% to $59.45 per barrel in the February futures contract. WTI crude closed at $54.73. The impact on producers and suppliers is creating a crisis of monumental proportions. Producers, oil- rig operators and manufacturers, refineries, and natural gas producers are all getting hit. The US dollar has been trending higher with a close on Friday December 26, of 90.31 for the March futures contract. Commodities usually take a beating with a stronger dollar. Let’s examine the impact of the oil crash on key oil exporting and importing countries.
The Saudis are sitting in the cat- bird’s seat. They have central bank reserves of 905 billion riyals, enough to last for six years. Make no mistake. The Saudis are in no mood to cut production. Finance Minister, Ibrahim Alassaf said: “We have the ability to endure low prices over the medium term. He defined the “medium term” as three to five years. They plan to increase spending for 2015 to $230 billion, up .6%.
Venezuela stands to be the biggest loser in this oil crunch. It does have the largest proven oil resources in the world at 297.47 billion barrels. Chavez nationalized oil production. This shut out most foreign investment. Over the years oil drilling equipment has deteriorated, leaving the industry in shambles. Inflation is running at 60% and the economy has shrunk 5% over the past year.
Russia is the second largest oil producer in the world. The crash in oil prices is plunging the Russian economy into recession. The Russian Ruble has dropped more than 40%. The effect is growing inflation and rising interest costs. Interest rates have jumped to 17% with mortgages above 12%. Big money is fleeing the country, leaving little room for new investment.
Japan is an importer of oil. However, Japan has experienced two consecutive quarters of negative growth and is also facing recession. Oil imports have dropped by 17% in November to 3.08 million barrels per day.
Hardest hit have been the shale oil producers. Pioneer Oil (PYD) is cutting spending by 41%. Continental (CLR), Conoco Phillips and Apache are also cutting spending and moving rigs to more profitable locations. Dividends are being cut and share buy backs are being put on hold. New construction is being delayed.
Oil rig operators are getting slammed. The big players are Transocean (RIG), Noble Corp (NBL), Ensco PL, and Hercules Offshore (HERO) Production of shallow water rigs has fallen off a whopping 84%. These companies are scrapping “floaters”, costing $12,000 a day to run. They are selling off old rigs and taking big write offs. At the Bakken location, 70% of the rigs are not profitable. Borrowing costs have sky rocketed to 10.43%, up from 5.68%
When such a crash occurs, don’t look for a quick turn around. Oil may rebound from these low levels but it is not the time to run in a buy the market. Always remember that the first low will be tested after a rally.