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Big Oil Gears Up For $60 Break-even Price As Profits Sink

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Gaurav SharmaOCT 31, 2015

The latest quarterly results season is receding into the accounting archives, with BP, Royal Dutch Shell, Chevron and the keenly anticipated numbers of Exxon Mobil now with us.

That lower oil prices continue to dent profits at the world’s biggest oil companies is no longer news. Figures on their often unloved downstream operations performing well bring a few smiles and keep detractors of the integrated model quieter than usual.

Take big beast Exxon, which reported quarterly profits of $4.24bn, down 47% on an annualized basis from the same quarter last year. Its profits from refining doubled to about $2bn, but upstream takings fell 79% to $1.4bn. Prior to Exxon, smaller rivals (e.g. – BP, Shell and Chevron) had all posted declines in headline quarterly profits earlier in the week. Yet read between the lines of the profit declines, and a common message on how to cope seems to be emerging.

The big ten International Oil Companies, along with Latin American, African and Middle Eastern National Oil Companies, are preparing for a break-even average oil price of $60 per barrel for the current financial year, 2016-17 and 2017-18, using Brent as a proxy benchmark.

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Listening to analysts calls and direct interactions with policymakers, I get a sense that most big oil finance chiefs are resigned to 2015 being a bad year, but 2016, to quote Exxon chief executive Rex Tillerson would be about maintaining, “a relentless focus on business fundamentals, including cost management, regardless of commodity prices.”

His thoughts are likely, rather certain, to be echoed across the industry given the number of capital expenditure cuts announced by the 20 biggest oil and gas companies by market capitalization. The $60 break-even figure brandished about has not been plucked out of the air. In fact, BP chief executive Bob Dudley is among the few to have openly acknowledged the $60-level in media interviews as a price point the company was gearing up to face over the next three years. Others have tacitly nodded too.

Part of the reason is that while most, including IOC bosses, expect non-OPEC oil production to decline from the present quarter onward, no one expects the decline to be anywhere near enough in terms stretching the price beyond $60 for at least the first three quarters of 2016. Caution for the year ahead also keeps expectations low and for good reasons.

For some, additional Iranian barrels would contribute towards keeping supply levels high, but for me Iraq is the bigger supply-side factor. All the while, demand is not going to fire-up, rather remain marginally above present levels, with only India expected to record meaningful importing volume increments.

That’s not to say China, Japan and South Korea’s demand would fall, rather it will not perk up as much, while the US is delving less and less into the global crude oil supply pool. Put that together, and there will still be enough crude out there to neutralize the geopolitical premium we had become so accustomed to between the second half of 2011 and the first half of 2014.

On balance of probability, taking supply upsides into account – $60 sounds about right for much of 2016. That is the level the Brent is likely to lurk around. I do not see it falling to $20 barring a financial tsunami, but there will not be a paced climb upwards either; rather a creep up towards $70 come the fourth quarter of 2016. The only caveat is, we need to divorce current sentiment from 12 month futures.

Of course the oil price can fall further, but as I noted on Forbes during the third quarter, 2016-17 futures look undervalued as current sentiment is weighing on them.

The oil majors have their pain threshold price of $60 spot on. Regrettably as the results season has indicated – from Total to Eni, Chevron to Shell – jobs losses, process streamlining and capital expenditure cuts are inevitable.

From a human resource perspective, it is obvious the pain would be the highest for BG Group’s workforce, and to an extent Shell’s talent pool, as the mammoth £43 billion ($70 billion at April valuation) takeover of the former by the latter nears completion.

More holistically speaking, this will not be the old 1980s tussle all over again; it’ll be the new 2016 for a sector undergoing a once in generation oil supply-side realignment with few producers willing to give an inch if they can help it, while craving “resilience at current oil prices”.  Just ask OPEC!

Follow the author on Twitter @The_Oilholic

The above commentary is meant to stimulate discussion based on the author’s opinion and analysis. It is not solicitation, recommendation or investment advice to trade oil and gas futures, options or products. Oil and gas markets can be highly volatile and opinions in the sector may change instantaneously and without notice.

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