A sharp reduction in spending by oil producers points to a rapid
recovery for oil prices once the economic downturn begins to
alleviate.
Oil prices are showing signs of having hit bottom, trading
recently at $41.83 a barrel, close to where the market stood at the
start of December.
The global economic downturn remains a heavy weight, however.
Demand is still dropping worldwide, a fact that has quickly sapped
energy from budding rallies.
Once demand stabilizes, oil prices could bounce back quickly.
Cash-strapped producers have cut budgets faster and deeper than in
past downturns, according to the oilfield services companies that
are the recipients of much of that spending. The lack of investment
is already speeding up the rate of decline in older fields, and
delaying the start of new production. Service companies see a
possible repeat of the last four years: During this period, prices
rose to record levels as demand grew faster than new supplies, an
imbalance that some in the industry attribute to a lack of
investment during the previous downturn.
"In a world of a deeper recession in the West and sluggish
growth in the emerging economies, it isn't a relevant problem" that
producers are cutting spending so drastically, said Bernard
Duroc-Danner, chief executive of Weatherford International Ltd.
(WFT), a major oilfield services firm, in a conference call. "In
the world of recovery and stronger...growth, this isn't a
sustainable situation."
Duroc-Danner expects that producers will cut oil field spending
outside the U.S. and Canada by up to 12% in 2009, a figure that
would likely grow if oil prices fall below $40 a barrel for an
extended period.
The severity of the spending cuts has remained under the oil
market's radar, as producers have mostly avoided shutting-in wells
or canceling major projects, preferring a subtler approach. In
Russia, for example, producers are reducing the cumulative distance
they drill into the ground by up to 20% in older fields, according
to Schlumberger Ltd. (SLB), the world's largest oilfield services
company by market capitalization.
The effect on production can be similar to that of an outright
shutdown, as producers often have trouble reviving aging wells that
are allowed to run down naturally. The lack of outright cuts
reflects producers' belief that oil prices will quickly rebound,
said Bill Herbert, an analyst with Simmons & Co. in
Houston.
"It all comes down to producer expectations," Herbert said. "If
the expectation is that we'll be mired in sub-$40 oil for a long
time, then you're going to see a lot of shut-in production."
The IEA estimates that in 2008 global oil production fell by
150,000 barrels a day outside the Organization of Petroleum
Exporting Countries, whose members hold output below capacity in an
effort to support prices. Non-OPEC production will average 50
million barrels a day next year, down 700,000 barrels from the
IEA's September forecast.
Anti-Aging Process
Production cuts have so far come under the guise of a natural
decline in older oil reserves. As a field ages, it requires an
increasing amount of drilling as well as chemical and water
injections into existing wells, simply to avoid a rapid, sometimes
irreversible decline. Producers stepped up efforts to reverse the
aging process as global demand surged. By the time oil prices
topped $145 a barrel in July, some companies were undertaking
immense drilling and well-servicing programs that would only be
profitable as long as oil was expensive.
When demand began to decline last year, and oil prices with it,
the need for massive drilling programs and expensive chemical
injections lessened. Oilfield service companies and analysts blame
the financial crisis last fall for speeding up the pace of
producers' cutbacks, especially in expensive, maturing fields such
as Russia's.
"The small Russian companies that depended on credit markets
will probably just not drill," said Schlumberger CEO Andrew
Gould.
Other producers are coping with the financial crisis and low oil
prices by "stretching" their spending over a longer period. They
are generally trying to maintain current production levels, while
putting off exploration work or postponing the start date for new
fields. Saudi Arabia is delaying development of 900,000 barrels a
day of new production at its offshore Manifa oil field, for
example.
The Long Cycle
Analysts see these delays as setting up the next boom-and-bust
cycle in the oil market. Producers cut back when oil prices dipped
to $10 in the late 1990s, and had difficulty ramping up when demand
from developing countries began to rapidly increase a few years
later.
"Delayed and canceled projects on energy infrastructure will
only add to the same supply bottlenecks that gave origin to the
commodity super-cycle of the last seven years," wrote Francisco
Blanch, head of global commodities research at Merrill Lynch.
The rapid response by producers also increases reliance on OPEC.
The group agreed to cut output by 4.2 million barrels a day late
last year, and Saudi Arabia is adding significantly to its
production capacity.
Should demand begin to rise again, OPEC will be called on to
provide additional oil if other producers have cut back, said David
Kirsch, an analyst with the consultancy PFC Energy.
"The issue won't so much be whether or not we have sufficient
supplies in the medium term, but whether or not we're getting them
from OPEC or non-OPEC sources," Kirsch said.
-By Brian Baskin, Dow Jones Newswires; 201-938-2062;
brian.baskin@dowjones.com
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