OilVoice Edition 48 - March 2016

Edition Forty Eight — March 2016

Dark predictions about North Sea oil look all too believable How Saudi Arabia's grip on oil prices could bring Russia to its knees These Numbers Show How High Oil Must Go-and Fast

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U.S. Shale Oil Resilience; What OPEC Didn't Expect?

Written by Alahdal A. Hussein from Society of Petroleum Engineers (SPE)

It is over a year now since OPEC declared its market-share cold war against shale oil producers back in 2014, yet the cartel still can't declare 'mission accomplished' and claim its victory.

Following its decision not to cut oil production, OPEC expected oil prices to drop to $70 a barrel, which they thought would be enough to squeeze many shale oil producers out of the market.

The reality proved otherwise, shale oil producers were able to react quickly in order to reduce their costs through various cost-cutting measures to weather the storm of low oil prices. And many of them managed to survive at those prices.

For OPEC, that meant only one thing; oil prices have to slump further, therefore OPEC's members pursued their market-share strategy and kept pumping.

In January 2015, oil prices were down at levels around $45-$55. During that time, OPEC's Secretary-General was calling the bottom in oil prices. He offered a bullish statements during his speech in London on Jan. 26 by saying 'Now the prices are around $45-$55, and I think maybe they have reached the bottom and we will see some rebound very soon.'

It was not too long after that, oil prices fell further making the remark of OPEC's SecretaryGeneral another layer of noise. Things didn't go as OPEC expected and oil prices are still falling till today to levels not OPEC nor anyone else has expected at that time.

Today, oil prices are slightly above $30 a barrel down from over $100 a barrel in 2014. U.S. average rig counts is 541, down 1068 from their recent peak of 1,609 on Oct. 10, 2014. More than 40 U.S. oil and gas companies have filed for bankruptcy protection, and other companies are aggressively reducing their budgets aimed surviving the current downturn. And yet, U.S. oil production is only inching downwards.

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Despite falling oil prices and rig counts declines, production cutbacks are relatively minor.

According to EIA, in the U.S. alone, oil production has only declined 384,000 barrel a day from its peak in July 2015 of 9,598,000 barrel a day. In general, U.S. shale oil is showing a great resilience regardless of the current bearish sentiments.

A point worth mentioning here is the fact that U.S. oil production dropped to its lowest point during this downturn which was 9,096,000 barrel a day on September 2015. This can be seen as a normal reaction for the crashing prices. However, the following months production started increasing till it reached 9,227,000 barrel a day last month.

Economically, low oil prices means an inevitable decline in supply and historically, low rig count leads to declining oil production. But the current downturn has proved that this is not always the case. Something changed, and a new shift in the oil industry is taking place.

Technological Advancement is Beating Rig Count

Rig count is considered as a direct measure of the health of oil industry and oil production. Falling rig count lead to a decline in oil production, but why this is not the case in this downturn? Why shale oil producers are able to maintain production?

The answer to the above question lays on advanced technology introduced as well as better and efficient ways of producing the oil. Many companies are now focusing on increasing efficiency and productivity of their wells. More cheaper and efficient well intervention and well completion technology, targeting richer sections of shale plays as in the case of the Permain Region -where production is in a continous increase- as well as increasing the well productivity by using more sand in each hydraulic fracturing job. All these have offset the direct effect of falling rig count on oil production. Did OPEC expected that? Highly unlikely.

A Short-Term Lose Better Than Out

Another reason that explains the resilience of shale oil is the fact that many operators who are still losing despite all the cost cutting measures prefer to take a loss and wait, because they know the oil market is boom and bust by nature and they expect things to get better soon. According to a report by Wood Mackenzie, given the cost of restarting production especially in large projects,

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many operators prefer to continue producing oil at a loss in hope for a rebound in prices rather than to stop production.

What OPEC's Members didn't Expect

It seems now that when the OPEC's members decided not to cut their oil output back in 2014, they didn't really expect the current resilience of U.S. shale oil. They didn't expect the resilience of U.S. oil production despite the dramatic fall in rig count.

They didn't expect that technology will be able to offset the effect of low oil prices and rig count on oil production. And most of all, they didn't expect the oil prices to fall to its current levels. And this is not something new, they are not accurate at foreseeing the outcomes of their actions, if they were, they would have known that high oil prices will lead to the current shale oil boom in the first place.

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Dark predictions about North Sea oil look all too believable Written by Achim Ahrens, Antonio Carvalho & Marco Lorusso from The Conversation

The oil price is struggling to stay above US$30/barrel, little more than a quarter of the price 18 months ago. Recent forecasts for the UK industry have become much gloomier as a result. As recently as three months ago, industry association Oil & Gas UK predicted 79 platforms would close by 2024. Several major consultancies have since suggested that it might be more like twice that. So how pessimistic is it reasonable to be?

First the big picture. Since the first significant oil and gas production in the UK in the 1960s, 28 billion barrels of crude oil and more than 2.4 trillion cubic metres of gas have been extracted, mostly from the North Sea. According to the latest estimates, a further 3 billion barrels of oil and 0.2 trillion cubic metres of natural gas are proven to be recoverable - plus about the same again in probable reserves. That may be a fraction of what has gone, but it still amounts to revenues of around ÂŁ200 billion.

The viability of the sector fundamentally depends on the oil price. There are large discrepancies between what economists think will happen to the price next, but most agree it is unlikely to return to its pre-crisis levelof around US$110/barrel in the medium term.

The UK reaction

The immediate reaction of UK's oil and gas producers has been to continue production at the same pace. In the third quarter of 2015, total oil production increased by 7% year-on-year and drilling activity remained stable. That's not to say there has been no reaction - 65,000 out of 440,000 jobs had gone by last September and capital investment is thought to be falling substantially. Without question, the business climate has fundamentally changed.

The high operating costs in the North Sea are a central concern. Even under more favourable OilVoice Magazine – March 2016

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prices, the industry would have a competitiveness problem relative to other regions. It costs around £17 to extract a barrel of oil, among the highest in the world.

One telling statistic for the UK industry is that while its oil extraction cost was similar to that of Norway as recently as the mid-2000s, they have now sharply diverged (see chart below). One study has argued that this is primarily because the Norwegian state bears a higher fraction of the exploration costs and thus takes some of the risks from producers. The UK industry is currently trying to cut its unit cost to £15 by the end of this year, and has brought it down from a high of £20 in 2013, but even that may not be sufficient to sustain the industry in its current form.

Values in barrels of oil equivalent (£). Wood Mackenzie

Compared to Oil & Gas UK's November forecast of 79 platforms closing by 2024, consultancy Douglas-Westwood now predicts 146 platforms will go between 2019 and 2026, accounting for more than half of the removals between 2016 and 2040 (the total number of platforms is currently around 300). It says that ageing UK platforms 'are uneconomic at current commodity prices, as a result of high maintenance costs and the expensive production techniques required for mature fields'.

Meanwhile Wood Mackenzie, another consultancy, believes that 140 offshore UK fields will halt production in the next five years - even allowing for the oil price to rebound to US$85. One consolation, according to Douglas-Westwood, is that larger platforms are likely to keep pumping in spite of low oil prices until the 2030s. This is because they have an additional role as stations through which smaller, newer platforms route their petroleum back to shore.

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Critical condition

Either way, the situation is looking critical. It is not easy to say how negative it is right to be - the discrepancy in the different oil-price forecasts is a good indication of how hard it is to foresee the future of the industry. But with the consensus that prices are not going to rise much for some time, the fact that these forecasts for UK activity are getting worse is probably the correct direction of travel.

With around 375,000 jobs directly or indirectly affected by the North Sea oil and gas industry, the health of the UK continental shelf is of the utmost importance to the economy. This is putting increasing pressure on the Westminster government to reduce the tax burden and support investments to make the business proposition more attractive. It started to react last year by reducing the supplementary charge levied on oil producers from 30% to 20% and cutting the petroleum revenue tax from 50% to 35%. Time will tell if the UK government will do more at next month's Budget. We would only note that it hasn't done as much as Norway to help shoulder the burden of production costs.

Last month the UK government announced a £250m investment into Aberdeen to secure oil and gas jobs and help the economy to diversify - doubled by a parallel infrastructure investment from the Scottish government. The emphasis on diversification reflects the fact that the authorities are increasingly acknowledging that oil and gas will not be the same driver in future, irrespective of the governments' efforts. All the same, there is still an opportunity to soften the blow if the governments and the industry do what they can. Together with technological advances that have gradually made it possible to extract more oil more efficiently, the UK North Sea may still have some life in it yet.

Achim Ahrens, António Carvalho & Marco Lorusso - Research Associates, Heriot-Watt University Erkal Ersoy, manager of the Centre for Energy Economics Research and Policy at Heriot-Watt, also advised on this piece.

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Natural Gas Price Increase Inevitable in 2016 Written by Art Berman from The Petroleum Truth Report

Every week, the EIA proclaims a new record for natural gas production. But their own forecasts show that the U.S. will be short on supply by October of this year. A price increase is inevitable beginning later in 2016.

Popular Myth vs Reality

The popular myth is that gas production will continue to increase and that prices will remain low for years. In the myth, price has no effect on production. The reality is that price matters and production is down 1.2 bcfd1 since September 2015 (Figure 1).

Figure 1. U.S. dry gas production. Source: EIA and Labyrinth Consulting Services, Inc.

The production increases reported by EIA are year-over-year comparisons that don't reflect

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declines during the last 4 months.

Prices have fallen to less than half what they were in early 2014. The average price for the first quarter of 2016 is only $2.25 per MBTU2 (Figure 2).

Figure 2. Henry Hub daily and quarterly average natural gas prices. Source: EIA and Labyrinth Consulting Services, Inc.

Hedges made when prices were in the $5-range carried many companies through falling prices as they continued to produce like there was no tomorrow. Tomorrow has arrived and the hedges are gone.

Over-production in the Marcellus Shale means that producers have to compete for limited pipeline capacity by deeply discounting their sales price. The best core area locations are commercial at $4 per mcf3 but wellhead prices averaged only $1.75 per mcf in 2015.

No Simple Solution to Falling Supply

There is no simple solution to falling supply. That's because almost half of U.S. supply is

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conventional gas and it is in terminal decline. Now, shale gas is also in decline (Figure 3).

Figure 3. U.S. conventional and shale gas production. Source: EIA and Labyrinth Consulting Services, Inc.

Conventional gas supply has fallen 16.75 bcfd since July 2008. Until July 2015, increases in shale gas production more than offset those losses.

Conventional gas will continue to decline at about 5% per year because few companies are drilling those plays. Shale gas must, therefore, continue to grow by at least 15 bcfd per year just to offset annual conventional gas decline (~2.5 bcfd per year) and legacyshale gas production decline (~12.5 bcfd per year).

It will take 15 bcfd of new shale gas production in 2016 to keep U.S. production flat.

Shale gas production replacement and growth for 2015 were 14.5 bcfd, down from almost 18 bcfd in 2014. It will be difficult to match 14.5 bcfd in 2016 because shale gas production has been falling 0.72 bcfd (~2.2 bcfd annualized) for the last 4 months of data (Figure 4).

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Figure 4. Shale gas production. Source: EIA and Labyrinth Consulting Services, Inc.

The biggest declines since peak production are from the older 'legacy' shale gas plays namely, the Barnett, Fayetteville and Haynesville (Table 1).

Table 1. Summary table of shale gas volume changes since peak production. Source: EIA and Labyrinth Consulting Services, Inc.

Although additional reserves exist in the Barnett and Fayetteville plays, the core areas have been largely developed and marginal areas require substantially higher gas prices to be commercial.

There is only one horizontal rig operating in the Barnett and there are none in the Fayetteville.

Production in the Haynesville Shale has decreased by 3.64 bcfd since its peak. High costs and relatively low EURs make the play uneconomic below about $6.50 gas prices. Parts of the core areas remain under-developed at today's prices.

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Marcellus production declined 0.52 mcfd since July 2015. Most of this probably represented intentional shut-ins because of low wellhead prices. Marcellus production can grow but new pipelines are needed to turn reserves into supply. Even with additional infrastructure, production will peak in the next few years just like in the older plays.

Production in the Utica and Woodford plays is increasing but it is largely offset by declining associated gas from the Eagle Ford, Bakken and other tight oil plays.

A Supply Deficit Even In The Optimistic EIA Case

The EIA forecasts that net dry gas production will increase 1.4 bcfd in 2016 and 1.6 bcfd 2017.

Even with that optimistic forecast, their data still shows that the U.S. will have a supply deficit beginning in the last quarter of 2016 (Figure 5). A more realistic forecast implies a much greater deficit that begins sooner.

Figure 5. U.S. natural gas supply balance and forecast. Source: EIA and Labyrinth Consulting Services, Inc.

A supply deficit does not mean that there won't be enough gas. There is ample gas presently in storage to cover a supply shortfall for awhile. That is what happened during the supply deficit in

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2013-2014 (Figure 5). That deficit was created by flat production similar to what EIA predicts for the first 3 quarters of 2016.

What is different this time, however, is that net imports will reach zero in early 2017 because of decreasing imports from Canada and increasing exports. Add to that the challenge of replacing conventional gas depletion, and there is a much more serious supply problem than EIA's already questionable forecast suggests.

Another big difference is that in 2013-2014, capital was freely available with average oil prices above $90 per barrel and average gas prices more than $4 per MBTU. Today, the oil and gas industry is in financial shambles with both oil and gas prices at very low levels, and it is unlikely that companies can raise the capital necessary to ramp up gas drilling quickly if at all.

Export plans of at least 7 bcfd by 2020 are not helpful considering the challenges of meeting domestic supply in coming years (Figure 6).

Figure 6. U.S. net natural gas exports. Source: EIA and Labyrinth Consulting Services, Inc.

The prospect of exports increasing to 13 bcfd by 2030 is even more troubling absent some new shale gas play that we don't know about yet.

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Higher Gas Prices Are Inevitable

A few years ago, the oil and gas industry convinced the world that the U.S. had 100 years of natural gas. Some of us cautioned that it is worth reading the fine print, that there is a difference between a resource and a reserve. The harsh light of reality eventually reveals that what seems too good to be true usually is.

The obvious solution to declining gas supply is higher prices.

The EIA's STEO forecast calls for $3.17 per MBTU gas prices by December 2016 and for $3.62

by December 2017. Those prices will not support necessary drilling in legacy shale gas plays.

EIA's AEO 2015 reference case does not call for gas prices to reach $5 per mcf until 2025. We can't afford to wait 9 years.

It is, therefore, inevitable that natural gas prices must increase sooner, preferably in the next 12 to 24 months. If oil prices remain low, a shale-gas revival may save the domestic E&P business.

During the last supply deficit in 2014, gas prices averaged $4.36 per mcf compared to only $2.63 in 2015.

But it will take time for producers to reverse the decline in drilling and production. It may be difficult to raise capital for renewed drilling given the current distress in the oil and gas industry.

Something will have to give sooner than later. That will be natural gas export.

1 billion cubic feet of gas per day 2 million British thermal units, approximately 1000 cubic feet of gas 3 thousand cubic feet of gas

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How Saudi Arabia's grip on oil prices could bring Russia to its knees Written by James Henderson from The Conversation

When Saudi Arabia led an OPEC decision to end a restraint put on oil production in November 2014, it marked the beginning of a new era in oil economics. It has given us a tumbling oil price, prompted huge losses and job cuts at oil firms like BP and might yet give us economic and political drama in the heart of Moscow. To understand why, it's worth drilling down to the start of the whole process, and the costs of getting oil out of the ground in the first place.

Historically, the OPEC cartel of oil-producing nations has been able to manage oil prices because of the lack of flexibility in global supply. The whole business of setting up wells, operating pipelines and building rigs entails large and long-term investments which makes producers slow to respond to price movements. And a small cut in OPEC supply can have a significant impact on the global oil price.

The advent of the US shale oil boom changed this dynamic. The industry has lower fixed costs but higher variable costs and is more like an industrial process than a major one-off investment.

That makes it more responsive to price movements and more flexible in adjusting short-term output.

Overall though, shale is a relatively high cost source of oil, especially compared to Middle East production. As a result, when US shale threatened OPEC's market share, the cartel allowed a position of global oversupply to develop. It was a simple trick: make oil prices fall to make shale unprofitable.

The chart below is a useful guide to how production costs stack up as production heads towards 100m barrels a day (which is pretty much where we are now). Focus on the blue square in the bottom left, which shows onshore Middle East production costs at as little as US$10 a barrel, while US shale (the purple block) can come in at more than US$70.

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Rystad Energy/Morgan Stanley/Business Insider

Rigged game

The plan to cripple shale oil production has certainly had a significant effect. The price of benchmark Brent oil has fallen from a high of US$115 a barrel in mid-2014 to a low of US$27 in January 2016.

However, the reaction of producers to this collapse, in particular in the shale fields of the US, hasn't been as dramatic as you might think; business has carried on. What is evident is that supply continues to outstrip demand and, according to the International Energy Agency, will carry on doing so throughout 2016, putting even more pressure on the oil price.

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Oil supply and demand projections for 2016 in millions of barrels a day. IEA Oil Market Report January 2016, Author provided

So, why haven't US producers been laid low given that the oil price has already fallen below the cost of shale oil production? There are a number of answers. The first is that many companies managed to hedge their production when prices were higher, selling future supplies of oil at a high enough price keep profits coming in. A second is that many got bank loans to pay for investment. Loans need to be repaid, and so lower oil prices led to a need for higher output at almost any price.

A third, and important reason, is that the cost of US shale production has decreased thanks to efficiency gains, a focus on the most productive regions and a drive to sharply reduce costs. In some regions the cost of production has hit as low as US$30 a barrel.

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Russia pressure

Low-cost producers have troubles of their own. Oil revenues are a major plank of many countries' budgets. Oil exports account for over 60% of export revenues, on average, for OPEC countries and account for as much as 90% of Saudi budget revenues. In Russia they account for around half of total federal budget revenues and a similar amount of total exports. Any fall in prices can lead to both fiscal and budget deficits.

Time for another chart then, which shows the 'fiscal breakeven' oil price per barrel for a variety of producers. The key observation is that all are above US$60 per barrel, with Saudi Arabia and Russia at around US$100.

Fiscal breakeven oil prices per barrel. IMF, Deutsche Bank, Author provided

Despite this apparent pressure, the gap between breakeven and actual price can be sustained at least for a while. Both Saudi Arabia and Russia have built up significant currency reserves during the period of high prices which are now being used to finance a budget deficit and sustain spending.

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Russia though is reaching the limits of its reserves (at the current rate of spending the funds allocated to deal with a low oil price will be exhausted by early 2017). Currency devaluation is a blunt tool for Russia and others to consider, but it too can help by reducing costs in dollar terms.

That said, a tipping point may now have been reached. The bankruptcy of US oil producers has begun as banks begin to call in loans, new financing gets harder to find and hedging programmes expire, leaving producers fully exposed to a lower oil price. Many OPEC countries have begun to despair that no end of the current oil price slump is in sight. And perhaps most interesting of all, it appears that Russia is becoming increasingly desperate to coordinate a production cut with OPEC, in stark contrast to its previous reluctance to engage with the cartel.

It may just be, then, that a US$30 oil price has brought many producers to their knees, with the resulting possibility that the majority of OPEC countries, plus Russia and the US, may all be set to reduce output in 2016 and bring the oil market back into some form of balance. Only Saudi Arabia, with the largest financial reserves (about US$600 billion at the last count) and an avowed strategy to maintain market share, appears firm in its resolve to maintain production and brutally test the economic robustness of its major competitors.

James Henderson - Senior Research Fellow, University of Oxford

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These Numbers Show How High Oil Must Go-and Fast Written by Keith Schaefer from Oil & Gas Investments Bulletin

What did Chevron accomplish in 2015 by outspending cash flow by $19 billion?

Increase production a paltry 2%. Barely replace reserves-107% of production.

That is what Chevron managed to achieve in 2015 by spending $31 billion while generating just $19 billion of cash flow. And that is actually incredibly bullish, despite the fact that the oil price has come down hard already in 2016.

Investor sentiment-from both the shareholders and the lenders-is forcing ALL producing companies to move closer to spending within cash flow.

What would Chevron's production and reserve growth look like if they do that? I'm guessing it would be MUCH less.

Their capex in 2016 is going down 22% $26.6 billion, but the savior for the company in 2015-its downstream refinery business-is getting crushed right now.

Refinery margins were huge through most of 2015-they contributed $7.6 billion in profits to Chevron in 2015-but crack spreads have recently fallen a lot. And with a glut of some 160 million barrels of refined products in the USA, that won't change much this year. (I got short refineries in January.)

This all reads like bad news, but it's actually very bullish. These numbers say how far the oil price must go up for western companies to make money. And now asset sales are slow, and lowly priced (everyone is a seller), debt is being reined in and equity is a non-starter for all but the best companies.

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If That Was 2015 What Is 2016 Going To Look Like?

If you want the truth you have to look directly at the numbers.

Chevron's Q4 and full year 2015 numbers speak volumes. They tell us that something has to give. And as I show you at the bottom here, that may be happening now. In Q4, they generated $4.6 billion in cash flow, and spent $9.4 billion on capital and dividends.

Here is how the full year 2015 cash inflows and outflows look for Chevron:

In Billions

2015

2014

Cash Generated By Operations

$19.5

$31.5

Capital Expenditures

($30.6)

($36.8)

Dividends Paid

($8.0)

($7.9)

Share Repurchases

$0.0

($4.4)

Net Cash Outflow

($19.1)

($17.6

It isn't a pretty picture.

When you include both capex spending and cash required for its dividends, Chevron spent $38.6 billion while generating only $19.5 billion from operations.

That is a net cash outflow of $19.1 billion!

Talk about living beyond your means. The obvious question is how did Chevron finance all of this outspending?

Well, they did it like anyone who lives beyond their means would.

First they dipped into their savings.

Chevron's cash and net working capital balances decreased by $2.6 billion in 2015.

Then they borrowed.

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In 2015 Chevron's long term debt increased by $10.8 billion. That is an increase from $27.8 billion to $38.6 billion in total debt.

And then they started selling off some of their belongings.

Proceeds from asset sales in 2015 totaled $5.7 billion.

Source of image: Chevron's Q4 2015 Earnings Presentation

By massively outspending cash flow, running up debt on its balance sheet and selling assets Chevron managed to maintain its dividend and keep its production basically flat. (At least they didn't spend any money on share buybacks, like the $4.4 billion they did in 2014. Watching these companies buy back stock during the good times when the stock prices are high and then buy back none now must be irksome to more than a few shareholders.)

If Chevron had lived within cash flow, you have to wonder what the dividend might have been and what production and reserve growth would have looked like.

It is not a pretty picture. 2016 is shaping up to be significantly worse considering that oil prices in 2015 were on average $20 per barrel higher than where they sit today.

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Last year would have been much worse for Chevron if the company didn't have its own refineries.

Chevron's downstream operation (refineries=downstream, pipelines=midstream, producers=upstream) actually benefits from low oil prices and that helped significantly cushion the blow.

Chevron's downstream operations recorded a profit of $7.6 billion in 2015. Without that this company would be in far worse shape.

The Real Battle Is The Fed (Not The Shale Producers) Vs The Saudis

This is what life looks like for Chevron. A company with a very mature low decline production base and the benefit of a profitable downstream operation.

No wonder the shale guys are feeling so much pain. They have young, very high decline production and no diversifying downstream business segment.

Seeing how Chevron allowed its balance sheet to deteriorate in 2015 once again underscores the point....

The biggest threat to the Saudis is not from the shale producers, it is from the Federal Reserve and its ZIRP (zero interest rate policy). Can you imagine Chevron allowing its long term debt to increase by nearly 40% in just one year if interest rates were at 8%?

Chevron's massive outspending in 2015 is how the shale boom was built right from the start. The shale producers had access to billions and billions of dollars of low cost funding.

Low oil prices have ended that party. Reasonable interest rates would have done the same.

What is abundantly clear is that 2016 is going to be a year of very hard decisions for a lot of people in this industry. For Russia and OPEC it is about cutting production.

For Chevron, that hard decision could involve its dividend. If Chevron completely eliminated its dividend in 2015 it would still have outspent cash flow in by $11 billion. That was with

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considerably higher oil prices.

To me, the sign that the supermajors are really feeling the fiscal pain is a sign that investors can have realistic hopes of a re-balancing-and the ending of the (allegedly) big global production surplus.

We are potentially seeing that happen right now, as the American Petroleum Institute (API) issued its projection of a surprise 3.3 million barrel draw in crude inventories this week. The weekly EIA numbers could prove very interesting later this morning.

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Low oil prices, budget deficits and OPEC Written by Roger Andrews from Energy Matters

In November 2014 the OPEC countries met in Vienna and agreed to keep pumping oil to maintain their market share rather than cut production to support the oil price. In a post written a month later I addressed the question of how these countries were positioned to withstand an extended period of low oil prices and high budget deficits. More than a year has now passed, so it's time to take a look at how they have done so far and to see what their actions presage for the future.

Results to date:

OPEC is known to have suffered economic damage as a result of low oil prices, but exactly how much? I made the following estimates from the October 2015 IMF World Economic Outlook Database. They include all the OPEC countries except war-torn Libya, where the data are not particularly meaningful. All the figures given in this post are in (or estimated from) US dollars unless otherwise specified: 

GDP, 11 OPEC countries combined: Down from $3,392 billion in 2014 to $2,849 billion in 2015, a decrease of $543 billion.



Budget deficit, 11 OPEC countries combined: Up from $17 billion (0.5% of GDP) in 2014 to $278 billion (9.8% of GDP) in 2015, an increase of $261 billion.

The economic damage has clearly been serious, but how much of it was a result of lower oil prices? Data from the 2014 OPEC Annual Statistical Bulletin indicate that OPEC exported about 8.5 billion barrels of oil in 2015 at an average 'OPEC basket' price of $49.49/bbl. This is $46.80 lower than the $96.29/bbl average basket price in 2014 and represents almost $400 billion in decreased revenue. Allowing for the damping effect on other sectors of the OPEC economies it's reasonable to assume that most if not all of the damage was done by lower oil prices.

The next question is, which countries have suffered the most? According to Figure 1, which plots the percent decrease in GDP between 2014 and 2015 by country, Venezuela, Iraq - and Kuwait

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suffered the largest GDP decreases and Qatar, Iran and Ecuador the least. The rankings are, however, potentially skewed by country-specific factors and by devaluations, as discussed later:

Figure 1: Percent decrease in GDP, 2014 to 2015.

The question of greatest importance, however, is the impact of low oil prices on OPEC budgets.

The OPEC countries have historically used their oil wealth to keep their citizens happy by means of generous subsidies and handouts, and the Arab Spring highlighted the importance of keeping the citizens happy (as does the renewed unrest in Tunisia, where the Arab Spring began).

The impacts of the oil price collapse on OPEC budgets are summarized in Figures 2 and 3.

Figure 2 shows budget balances in 2014 as percentages of GDP, calculated from IMF revenue and expenditure data. Kuwait, Qatar, the UAE and Saudi Arabia ran healthy surpluses - Kuwait and Qatar very healthy ones - and Angola, Algeria, Iran, Nigeria, Ecuador and arguably Iraq had small but manageable deficits. Venezuela alone had a budget problem, but this was a result of economic mismanagement, not oil prices:

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Figure 2: Budget balance as percentage of GDP, 2014

Figure 3 now shows the 2015 data. Only Qatar and Kuwait were still in surplus. Iran, Angola, Nigeria, Ecuador and the UAE had small but probably still manageable deficits, but Algeria's deficit had increased from near-zero to almost 15% of GDP and the deficits of Saudi Arabia, Iraq and Venezuela had ballooned to over 20% of GDP. Collectively the 11 OPEC nations went from a 3% budget surplus to a 10% budget deficit between 2014 and 2015 according to the IMF data:

Figure 3: Budget balance as percentage of GDP, 2015

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Low oil prices have clearly left the OPEC nations with budget problems that pose a potential threat to their stability. In the next section we will look at what they have done about them.

OPEC's actions to date

OPEC has had a number of budget-fixing options at its disposal, with the obvious one being to cut production to bring global oil supply and demand back into balance. This was of course politically impossible in 2015 but may become less so in 2016.

The second option was to increase government revenues. This, however, is also not a realistic solution in undiversified oil-dependent economies, where decreases in oil price inevitably send revenues in the opposite direction. Government revenues in fact decreased by more than 20% between 2014 and 2015 in all OPEC countries except Iran and Ecuador. The OPEC-wide decrease was 33% (Figure 4):

Figure 4: Percent change in government revenues, 2014 to 2015

The third option was to cut government spending, which is more easily done than increasing revenue although it does carry the risk of upsetting the public. As shown in Figure 5, however, results have still been mixed. Saudi Arabia and Iran actually increased spending between 2014 and 2015 and Qatar spent the same amount as it did in 2014. Modest cuts were achieved in Iraq, the UAE, Kuwait, Ecuador and Algeria but substantial ones only in Nigeria, Venezuela and

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Angola. Overall the OPEC governments cut their combined government expenditures by only 8% between 2014 and 2015.

Figure 5: Percent change in government spending, 2014 to 2015

Or did they even do that well? The Figure 5 numbers are in US dollars but national budgets are done in national currency, and when we convert to national currency we get the results shown in Figure 6. The numbers change for the four OPEC countries whose currencies are not pegged to the US dollar and which have responded to low oil prices by devaluing their currencies or by having the market it do it for them. The countries are Iran, which now shows a 26% increase in government expenditure between 2014 and 2015 rather than the 2% increase shown in Table 5, Algeria, which now shows a 9% increase instead of a 12% reduction, Nigeria, which shows a 7% reduction instead of a 22% reduction and Angola, whose spending reduction is now 27% rather than 40%. OPEC's total 2015 spending now shows effectively no change over 2014:

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Figure 6: Percent change in government spending, 2014 to 2015, national currency.

There are of course questions as to what these devaluation-adjusted numbers signify (Angola, which has an active black market that values the kwanza well below the official exchange rate, is a borderline case, and the devaluation-adjusted results for Venezuela, where the bolĂ­var is officially at parity with the dollar, are effectively meaningless and are omitted for this reason.)

Taken at face value, however, they indicate that the OPEC nations have so far made little real effort to reduce expenditures, possibly because they believed Saudi assurances that the US shale producers would soon be driven under and that no belt-tightening would be necessary.

Certainly none of the delegates who attended the November 2014 OPEC meeting foresaw that the oil price crash would be as deep as it was or last as long as it has. But devaluing a currency after unpegging it from the dollar does offer an option for managing a budget deficit, and OPEC countries with dollar-pegged currencies are coming under increasing pressure to consider it.

The fourth option is to draw on foreign reserves. Saudi Arabia is understood to have financed most of its official $99 billion 2015 budget deficit with gradual foreign exchange reserve withdrawals, as shown in Figure 7. (The data are from Trading Economics andKnoema/World Bank. The two data sets give very similar numbers and combining them maximizes monthly coverage, so both are plotted in the following figures):

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Figure 7: Monthly foreign exchange reserves, Saudi Arabia

As far as can be gauged from the incomplete data plotted on Figure 8 Algeria also probably financed its deficit with gradual foreign reserve withdrawals (Algeria's 2015 budget deficit is reported as being around 12% of GDP, which with a GDP of $175 billion works out to about $20 billion. Despite its pleas for help Algeria's healthy foreign reserve balance in fact puts it in a better position to withstand an extended period of low oil prices than most other OPEC countries):

Figure 8: Monthly foreign exchange reserves, Algeria

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Angola also slowly drew down its foreign reserves by about $5 billion between December 2014 and July 2015 (Figure 9), which would have financed some of its budget deficit over this period:

Figure 9: Monthly foreign exchange reserves, Angola

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But not all OPEC countries show clear evidence of systematic reserve withdrawals. As shown in Figure 10 monthly foreign exchange reserves in the UAE have remained essentially unchanged while reserves in Kuwait and Qatar have oscillated up and down with no clear trend visible.

Nigeria's reserves declined through March 2015 but have remained stable since. (Monthly reserve data for Iraq are incomplete and there are no data for Iran):

Figure 10: Monthly foreign exchange reserves, Kuwait, Nigeria. Qatar and United Arab Emirates

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Finally we have Ecuador and Venezuela (Figure 11). If Ecuador continues to deplete its foreign reserves at post-July 2015 rates it will run out of cash by May. Venezuela, on the other hand, has somehow managed to leave its foreign reserves intact since June despite its accelerating economic meltdown:

Figure 11: Monthly foreign exchange reserves, Ecuador and Venezuela

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Ecuador and Venezuela now bring us to the fifth budget-balancing option - borrow money from China, OPEC's lender of last resort. Venezuela's oil industry has been kept afloat by the $46 billion in oil-for-cash it has received from China over the last decade. So to a lesser extent has Ecuador, whose foreign reserves dwindled rapidly in the second half of 2015 most likely because it expected to receive $4.2 billion from China this year but as of May had received only $900 million (although having just signed a $970m credit line with the Industrial and Commercial Bank of China it has now 'breathed a sigh of relief'.) When 'a halving of oil prices left a gaping hole in Angola's finances in this year President Jose Eduardo dos Santos knew exactly where to turn '.

And Algeria , 'hit by oil price drop', is now seeking Chinese help too. (Nigeria has also received loans from China, but for infrastructure development, not oil.) Whether China plans to continue bailing out OPEC countries is uncertain, but its bailouts to date have given it some measure of control over a substantial fraction of the world's oil reserves.

What will happen in 2016?

The table below compares the oil prices assumed by OPEC countries in their 2016 budgets with the prices they assumed in their 2015 budgets (data from numerous sources). If nothing else the numbers will be of interest to those in the oil price prediction business. No data are available for Libya or the UEA, which notes only that a 2016 price of $80/bbl would be 'ideal' and leaves it at that.

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If the 2016 OPEC basket oil price does average around $35/bbl it will be about $15/bbl lower than the $49.49/bbl average basket price in 2015, meaning that OPEC will lose yet another $130 billion in annual oil revenues if it maintains production at current levels. Can OPEC survive another hit like this? Well, those waiting for a prediction are going to be disappointed because I'm not going to make one. There are just too many unknowns. We'll just have to wait and see.

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The Saudi-Russian oil gambit has little to do with prices Written by Nafis Alam from The Conversation

Saudi Arabia and Russia, the world's two most powerful oil producers, have reached a tentative agreement to freeze oil production at its current levels. As the first deal between an OPEC and non-OPEC member in 15 years, it marks a significant declaration of intent. But it is not geared toward buoying oil prices, as some might hope. Rather, it has much more to do with blocking Iran's re-emergence as a global oil exporter.

The agreement between the two countries to keep output at January levels led to much noise of a market rally, with little to show in the way of gains. The benchmark price of Brent crude jumped briefly from US$33.4 to US$35.55 a barrel but it will not lead to a sustained rise in prices.

For starters, the agreement is not a cut in production levels. In January, Saudi production was sky high; significantly up from December. So the announcement of the freeze in production was part of a strategy to merely stabilise prices.

Geopolitics at play

The story is about much more than just prices. The current state of play is that both Russia and Saudi Arabia, the number one and two oil suppliers, respectively, are trying to stop Iran from making any further inroads into the global oil market.

Saudi Arabia has always been at loggerheads with Iran when it comes to oil production - and everything else besides. It is aware that oil prices will fall further when sanctions on Iran are completely lifted. By acting now, it is hoping to pressure other major producers to follow suit, and that Iran will fall into line with the other members of OPEC.

Another concern for Saudi Arabia is losing its position as the main strategic partner of the US to

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Iran, especially after failing to dissuade the US from removing economic sanctions against Iran for its nuclear program. It is hoping to put Iran in its place by limiting the gains it can make from the uplift in economic sanctions.

It is difficult to understand the reasoning behind the Saudi-Russia friendship. They are, after all, the two biggest oil producing rivals who are now presenting a united front on oil supply. They are also backing opposite sides in the Syrian civil war, all the while trying to convince the world that they share a common cause in stopping the global oil market rout.

But the 70% drop in oil prices has hit the economies of both countries hard. Saudi Arabia is running a budget deficit close to more than 15% of national income and burning through its cash reserves to plug the gap in oil revenues. Russia too is expanding its deficit to cover its costs.

The shared pressure seems to have brought the two rivals together. The Saudi Arabian promise to curtail production is part of a strategy with the US to pressure Russia to drop its support for Bashar al-Assad, the Syrian president, at a time when the Russian government is suffering from the effects of low prices.

'If oil can serve to bring peace in Syria, I don't see how Saudi Arabia would back away from trying to reach a deal', a Saudi diplomat told the New York Times.

Persistent production

It is evident that the output freeze could bring stability to the market, but it will not lower record high oil supplies. The only thing that is certain is the suffering of high cost producers, including the US shale industry, which is set to continue.

Markets have been rightly sceptical of Saudi Arabia and Russia's announcement of a production freeze. Although Iran welcomed the deal, it has made no promise of curtailing its production. And when it comes to OPEC's commitment to a production freeze, the potential for 'quota cheating' (where struggling members overproduce to increase revenues) is as high as ever.

How long we can trust the Saudi-Russia deal to last is open to question too. While Russia and Saudi Arabia appear to have put aside their differences for the time being, their longstanding

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mutual distrust could well change things. Russia has always shunned OPEC, the Saudi-led oil exporters cartel and historically resisted any binding coordination with it to bolster global oil prices. There is little reason to expect a real change of heart.

So the output freeze may stabilise the market for the time being and send a clear message to Iran that there is still a long way for it to regain back its economic glory. But it is a long way from ensuring the struggling economies of oil producing countries survive the biggest crisis in the global oil market.

Nafis Alam - Associate Professor of Finance, Director- Centre for Islamic Business and Finance Research (CIBFR), University of Nottingham

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Geopolitical impact of oil's drop shows why there's no end in sight Written by Isabelle Chaboud from The Conversation

The price of crude oil resumed its slide this week, falling below US$29 a barrel and approaching the 12-year low reached last month.

The International Energy Agency is warning oil's fall has further to go. So what factors suggest the price of oil will continue to drop? And what will be the economic and geopolitical fallout? The answers to these two questions go hand in hand, as we shall see.

First let's recap what's behind the plunge in the first place.

Supply and demand

In short, supply is up; demand is depressed.

Oil production in the U.S. has increased markedly since 2012, in part thanks to new technologies that have made it possible to extract more oil at a faster pace and deeper than was possible even a few years ago.

At the same time, the Organization of the Petroleum Exporting Countries (OPEC) has raised its production quota to 31.5 million barrels per day. For many, this decision is largely due to Saudi Arabia, which wishes to protect its market share and limit the development of shale gas in the U.S.

Demand, on the other hand, has not increased as quickly.

This is in part due to China's economic slowdown and the ripples it is sending across the world, while the devaluation of the yuan has made oil more expensive.

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In addition, due to mild December weather in most European countries, Russia and the U.S. (where it was 73 degrees Fahrenheit/22 degrees Celsius in New York City on Christmas Eve), oil consumption for heating has also been muted.

Iran the game-changer

For the geopolitical implications and a key reason we can expect the price of oil to continue to drop, let's first look at Iran.

The nuclear agreement the country signed with the U.S. and other world powers last July was a game-changer, allowing Iran to return to the international market after years of tough sanctions.

The extra oil on the market could cause the price of crude to drop by $10 a barrel, according to a report by the World Bank. Iran confirmed on January 18 that the country's daily oil production of 2.9 million barrels would be immediately increased by half a million, and another million by the end of the year.

In other words, Iran's return will change the current international dynamic, elevating its influence in the region and beyond, potentially at the expense of adversaries like Saudi Arabia.

In addition, the rupture of diplomatic relations between Saudi Arabia and Iran following the former's execution of 47 prisoners (including the outspoken Sheikh Nimr al-Nimr, described by Iran's Supreme Leader as a 'martyr') suggests that neither country will be willing to reduce production and might even do everything within their power to increase market share.

Bad news for other oil producers

Other oil-producing countries have been hit hard by the 70 percent drop in oil prices since mid2014. Many countries are affected by the drop in oil prices, and each will likely need to take quick action and implement reforms to avoid a liquidity crisis or even bankruptcy.

Venezuela, for one, is on the verge of bankruptcy, and its $125 billion debt load may force a reckoning after the government has failed for years to institute reforms. Russia, whose economy has also been battered by sanctions, is slashing spending and trying to avoid a second year of

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recession. Its dire situation also shows the consequences of putting off economic reforms, as oil still represents half of its budget revenues.

Kazakhstan, Central Asia's largest economy, risks depleting the fund it uses to invest in the country's infrastructure and industry. The fund, which was down to $64 billion in January from $77 billion in 2014, could run out within six to seven years as the government withdraws cash to make up for the lack of oil revenue.

Norway is also suffering. Statoil, the Norwegian oil and gas company, has already cut 20,000 jobs. Given that Norway's oil industry employs one out of every nine Norwegians, the country could soon see an increase in its unemployment rate.

Saudi the reformer

For Saudi Arabia, even as it keeps production levels high and slowly drains its own reserves, the price drop has led the country to initiate widescale reforms and begin to rein in the generous water and power subsidies it gives to its citizens.

Oil exports make up 90 percent of the kingdom's income, and the shortfall has created a deficit of $89.2 billion.

The government has already increased the price of gas by 50 percent and said that it will reduce other subsidies as well. In addition, a value added tax (VAT) of 5 percent was implemented for nonessential goods.

If prices stay low, they may completely transform the Saudi economy as the private sector grows at the expense of the public sector. One sign of that is the hint from Muhammad bin Salman, the son of King Salman, that the kingdom's oil company Aramco might go public and allow outside investors.

If this occurs, it would inject badly needed new money into Saudi Arabia's purses and confirm the desire for radical reform. It would also signal an economic revolution among the major oil companies.

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Forcing reforms

The prolonged drop in oil prices is forcing countries to pursue economic reforms - in some cases ones that remake their economies by bolstering the private sector; in others drastically reducing spending just to stave off insolvency.

Yet the Chinese economic slowdown, the return of Iran to the oil market and the world's elevated reserves suggest that supply will continue to outpace demand and keep prices low - and even push them down to $20 a barrel.

The result will be nothing short of a reorganization of political power. How it will shake out is still unclear.

Editor's note: This article is based on an earlier version published in French.

Isabelle Chaboud - Professeur d'analyse financière, d'audit et de risk management, Grenoble Ecole de Management

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