Recovery still distant as oil industry contracts

FORT COLLINS — Recovery in the oil market could easily be 18 months out, and the prolonged downturn may trigger a rash of mergers and acquisitions in the industry, analysts say.

But cuts to capital spending, decreased production and increased consumer demand for U.S. gasoline may help stem further price declines, according to the analysts.

Recovery will occur after producers curtail production at smaller, less productive wells while maintaining production in larger, more productive wells, said Stephen Trammel, research director and energy advisor for Englewood-based analyst IHS. Additionally, he said, producers that have drilled wells will wait to complete them until oil prices rebound.

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Oil prices have fallen below $50 per barrel this year, with the price of West Texas Intermediate crude settling at $49.90 earlier this month, declining from highs exceeding $100 last summer. The oil downturn comes amid a supply glut and turmoil in the Middle East and Europe, as well as slowing demand in China, a shift in Europe to renewable energy, nuclear power in Japan and new production in Mexico. In 2014, U.S. production topped 8 million barrels per day, the highest level since 1986. Colorado set a record of 64.1 million barrels of oil produced in 2013.

Oil companies have responded by cutting their capital spending. Noble Energy Inc. (NYSE: NBL), among the top producers in Weld County, cut its 2015 capital budget by 40 percent to $2.9 billion from more than $4 billion last year. Anadarko Petroleum Corp. (NYSE: APC), another top oil producer, plans to cut its capital budget by 33 percent to $5.8 billion.

When traders see the production decline following capital spending reductions, oil will begin to command higher prices, Trammel said, something that isn’t likely to occur until the last half of 2016.

“They’re not going to $100, necessarily,” he said. “They’re going to be in the $65, $70 range.”

Worldwide, gasoline demand has tapered, especially in China. But higher gasoline demand by U.S. consumers could help temper the market’s fall in the short term, according to oil analysts.

“You’ve got this economic stimulus happening with low-energy prices,” Trammel said. “That could help bring demand back up.”

David Beard, managing director of Energy Equity Research for Iberia Capital Partners in New Orleans, agrees that a recovery will begin in the second half of next year. However, one scenario points to a “new normal” where the U.S. has no power to price its oil, instead remaining at the mercy of OPEC pricing schemes.

Just how much oil prices rise will depend on levels of worldwide demand, Beard said.

“If you have a weaker global demand outlook for the next two years, it’s possible that OPEC – Saudi (Arabia), Iraq, others – can meet modest growth, and prices might hover around $50 to 60 per barrel, as U.S. production is not needed to meet demand in this scenario,” he said. “A stronger demand outlook might require $60 to $70 oil in order to modestly grow U.S. production in 2016 and 2017.”

That doesn’t bode well for 2015. Late last year, less than a third, or 29 percent, of oil and gas chief executives were confident of revenue growth within the year, according to a survey conducted by PricewaterhouseCoopers LLP during the third quarter.

The downturn may lead to mergers and acquisitions in the industry, said Rowena Cipriano-Reyes, a Denver-based partner with PwC’s energy practice. Companies can only go so far in attempting to lower their costs, so they are doing additional research on partnerships to find greater efficiencies. Around half of oil and gas CEOs expect to enter into a new strategic alliance or joint venture over the next year, according to the PwC survey.

“Companies will look at potential strategic partnerships, either to drive down costs, to find efficient ways to operate and to make it profitable within $50 oil,” she said. When the first quarter ends, “It will be interesting to see how M&A is reacting to this low price environment.”

Oil prices may not have hit bottom this year as production has yet to decline enough for West Texas Intermediate oil prices to improve, said Tony Starkey, manager of Denver-based analyst Bentek Energy’s oil team.

The Denver-Julesburg Basin, which includes territory in Northern Colorado, will feel the squeeze perhaps more than other basins nationwide, he said. Many industry representatives have said that the basin remains one of the more economical oil plays, but Starkey said the basin’s distance from larger demand markets may increase its vulnerability.

The Denver-Julesburg Basin already has seen a decline in activity. The number of rigs exploring for oil and natural gas in the D-J Basin totaled 39 at the end of February, 16 fewer from 55 rigs same time a year ago, according to Baker Hughes Inc. (NYSE: BHI). Rigs in the region can support as many as 125 direct and indirect jobs.

“It’s pretty far from the main refining centers in the Midwest and the Gulf Coast,” said Starkey, adding that the basin produces a lighter crude oil while U.S. facilities refine mostly heavier crude oil. “Our refineries are already struggling to continue to consume the lighter crudes.”

Complicating matters is the restriction on U.S. crude oil exports, restricted by Congress in the 1970s in response to Arab oil embargoes. So even as international oil prices recover, domestic prices may remain low because of oil oversupply.

“That oversupply really has nowhere to go, except into storage,” Starkey said.

Steve Lynn can be reached at 970-232-3147, 303-630-1968 or slynn@bizwestmedia.com. Follow him on Twitter at @SteveLynnBW.