The last barrel

To freeze, or not to freeze—that is the question. With an air of dramatic flair that would make even the most flamboyant playwright proud, the world’s major producers are, once again, talking about an oil production freeze. An informal meeting between OPEC member countries and Russia will take place on the sidelines of the 15th International Energy Forum (IEF), which will be held in Algiers toward the end of this month.

News of the talks emerged on Aug. 8, as Dr. Mohammed Bin Saleh Al-Sada, Qatar’s Minister of Energy and Industry, and the new president of OPEC, said that oil’s recent decline was “only temporary.” In a statement posted on the Vienna-based group’s website, Al-Sada said, “This expectation of higher crude oil demand in the third and fourth quarters of 2016, coupled with decrease in availability, is leading the analysts to conclude that the current bear market is only temporary, and oil price would increase during [the] later part of 2016.”

The announcement, and other well-timed comments by various stakeholders, proved to be remarkably effective, and oil soon resumed its upward trajectory before floundering toward the end of the month, amid doubts over the viability of any freeze. However, amid the cacophony of headlines, we would be well-served to remember that a similar round of much-hyped talks fell apart earlier this year.

Despite all of the rhetoric, the challenges facing any new oil freeze are far from inconsequential. Russia and Saudi Arabia, the world’s two largest producers, are already pumping flat-out, and at different times have questioned the need for a freeze. In the meantime, despite making a commitment to stabilize oil markets at the G20 summit, one has to wonder about the longevity of an agreement between two nations that have so often found themselves at odds. In addition, Libya and Nigeria, two member nations whose production has been curtailed by domestic strife, aren’t likely to be content with freezing output at current levels. And let’s not forget Iran, which remains something of a wildcard. Gaining a consensus among the individual nations could be challenging, to say the least.

The ever-changing reports on the proposed talks render any analysis of the positions of the individual countries almost immediately outdated. But one fact remains: freezing production at what are essentially elevated levels—without any actual cuts—isn’t that big a deal and should be taken for what it really is: talk.

Meanwhile, while the North American upstream industry has been hit disproportionately by the downturn, it’s worth noting that OPEC member nations have not escaped unscathed. According to  the U.S. Energy Information Administration, OPEC member nations earned $404 billion in net oil export revenue in 2015, which represents a 46% decline from their 2014 earnings of $753 billion. This year, revenue is projected to fall even more—to $341 billion—before recovering to $427 billion next year.

OPEC, and its de-factor leader, Saudi Arabia, may be, temporarily, winning the war on shale, but it is paying a very heavy price. However, any uptick in prices arising from a future (probably illusory) production freeze, would also risk providing a small measure of relief to shale producers.  

Pricing, pricing, pricing. As Patrick Schorn, president of operations at Schlumberger, pointed out during a recent presentation, OPEC’s spare capacity has declined to some of the lowest levels seen in eight years. While the mere specter of spare capacity is enough to send shivers down many an oil man’s spine, he does raise an interesting point, in that some kind of unforeseen geopolitical event could lead to an unexpected price shock.

And while warning that near-term oil prices will be held in check by the “continuing, but slowing” increase in stockpiles of crude and refined products, the world’s largest service provider is maintaining a more upbeat longer-term view.

“With demand holding steady, markets are moving closer to balance by the end of 2016, supporting what we have called a medium-for-longer oil price environment,” Schorn said while speaking during the Simmons 2016 European Energy Conference in Gleneagles, Scotland.

According to Schorn, “There have been positive developments in well design and costs that are improving drilling and completion efficiency. Some of these cost reductions are structural and, therefore, sustainable, while others are not.”

By way of example, the cost for an average, unconventional onshore well in the U.S. has fallen 40% since 2014. And while some of these savings can be attributed to technical and operational improvements, “one of the largest contributions has come from the service industry’s acceptance of lower pricing,” Schorn said, adding that this has now reached “a point that parts of the business are financially unviable.”

“With the price of oil having nearly doubled since the start of this year, the service industry must now seek to increase price to restore the financial viability it requires to develop and deploy technology, maintain its geographical footprint, and preserve its technical expertise,” the executive added.

The upstream food chain—whether we like it or not—is pretty well established. The operator is king, and when times are hard and commodity prices are low, it’s only natural for operators to seek concessions from service companies. In turn, service companies seek cheaper pricing from their suppliers, and the effect ripples throughout the industry and its associated supply chains.

However, going forward, we, as an industry, need to find a new equilibrium. Very few people expect oil to reach $100/bbl in the foreseeable future, so service companies will be limited in their ability to simply increase prices. Instead, we need to establish new, more mutually beneficial ways of working. Service companies must have prices that allow them to develop technologies, which will, in turn, enable operators to thrive in the new oil price environment.