Oil Weekly: Energy Prices Are Too Low to Encourage Investment

Summary

• Activity within the oil and gas sector in Texas stalled in Q2.
• Energy prices are currently too low to encourage investment. Meanwhile, costs continue to rise.
• A Russian insurrection is unlikely to impact oil production because the site of most production, Siberia, is far from Moscow.

Low Energy Prices Hurt Production Growth Prospects

The Dallas Fed Energy Survey showed low oil prices are impacting production growth:

• Overall activity in the oil and gas sector was unchanged in the second quarter.
• Oil and natural gas production increased more slowly than the prior quarter. Natural gas production was most impacted, with the production index falling to 2.1 from 7.4 in Q1, whereas the oil production index fell to 8 from 10.5 (Chart 1).
• Energy firms continue to face rapidly rising costs, although the rate of increases slowed. The project cost index for E&P firms fell to 14.9 from 46.8 (the largest quarter-on-quarter decline on record) as they benefited from a fall in the price of rolled iron. Meanwhile, input costs for energy services firms fell to 41.2 from the extremely elevated level of 61.6 (Chart 2).
• Capex growth has almost come to a standstill with the E&P capex index falling to 9.9 from 11.7, while the capex index for Energy Services fell to 5.9. from 27 (Chart 3).

Notably, it is typically smaller and private energy firms that tend to alter their capex plans based on a fluctuating energy price. Larger firms, such as Exxon and Chevron, pre-agree capex spend in advance, which they then announce to shareholders with only minor adjustments over time. This has been especially the case in recent history as investors focus more on capital discipline and return on capital employed, rather than production growth.

Each quarter, the Dallas Fed also asks respondents several special questions to get further details about certain topics.

Three questions stood out to us this quarter. The first asked respondents about their views on how credit conditions have changed since February. 54% of executives stated that tighter credit conditions have had no effect, 28% reported a slight impact, and 18% reported a significant impact.

The second asked how energy executives see credit conditions evolving over the course of this year. Here, the results were more mixed. 41% of respondents stated that they expect tighter credit conditions to slightly impact their businesses, 38% expect no impact, and 21% expect a significant impact.

Lastly, the survey asked respondents how oil demand has compared so far this year versus expectations, particularly pertaining to China’s reopening. Here, more than 40% of respondents felt that oil demand had slightly underperformed relative to expectations, while 30% felt that demand had met expectations (Chart 5).

Here are some of the comments from the survey which stood out to us:

Exploration and Production (E&P) Firms

• ‘It is a tough time to be an E&P, as product pricing is in no-man’s land. It is hard to be bullish on natural gas prices (especially considering rigs aren’t dropping fast enough), and it’s concerning that most in our industry seem to be bullish on oil prices. We would think crude in the low $50s again would be the pain trade.’
• ‘Artificial intelligence will replace workers in some areas, such as accounting, and increase the need for others ( i.e., reservoir engineering).’
• ‘Natural gas prices are unsustainable, and if they stay at this level for the better part of 2023, it is going to do great damage to our ability to provide natural gas in the future. If we lose the low-producing wells, they aren’t coming back.’
• ‘Saudi Arabia needs $81 per barrel for oil to keep growing its economy. Tier 1 shale acreage is drilled. Drilling outcomes are changing in the shale plays. More natural gas production due to bubble points is appearing, which is not good for oil recovery.’

Oil and Gas Support Services Firms

• ‘Labor availability is a big issue in blue-collar areas. It is hard to find employees, and wage rate requirements continue to increase.’
• ‘As an infrastructure service company (pipelines mainly), [our] business is fairly steady. We continue to see our customers reducing their vendor base. We are fortunate to be in sound fiscal shape, so we are retaining not only our long-time customers, but are also picking up new customers. That being said, there is still a lot of uncertainty throughout our industry with no significant relief in sight unless there is an administration change. Meanwhile, we will rock along and try to stay under the radar so as not to draw attention from lawmakers and regulators.’

In sum, it is clear that oil and in particular natural gas prices are too low to encourage further investment from smaller and private E&P producers. Therefore, US oil production is likely to disappoint later this year.

How Could Insurrection Impact Russian Oil?

Given the heightened risk of insurrection in Russia, we examine the location of Russia’s key oil production infrastructure.

First off, the weekend saw no disruptions to either Russian oil or gas production. We see Russian pipeline delivery of Russian gas via TurkStream operating as normal, as are flows via Ukraine at Sudzha.

Most Russian oil production happens in Siberia, with West Siberia the key site for producing Russian Bitumen (asphalt). The Arctic Ocean is also home to large production sites, particularly within the Brents Sea, Kara Sea, and the Laptev Sea. Other notable production sites include Tatarstan and Orenburg. 

We think a future insurrection would have little impact on Russian production for two reasons. First is the large distance between Siberia and Moscow (flying from Moscow to Siberia takes over five hours). Second is the importance of oil revenues to any future leader.

Viresh Kanabar has worked in the UK financial services industry for over 8 years including in Consulting and Investment Risk. Most recently he launched The Macro Journal Substack where he puts out regular in-depth reports covering all areas of global macro.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)