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Oil Prices: Have We Finally Reached the Breaking Point?

By Matthew DiLallo - Jan 23, 2016 at 9:04AM

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The first signs that producers are throwing in the towel have started to emerge.


Image source: Flickr user Alan Paone.

It seems like the oil market is finally getting to the point where it is breaking the will of oil producers to keep pumping. With oil recently falling below $30 a barrel, producers from around the world are not only turning off drilling rigs, they are starting to shut down oil wells, too. Meanwhile, others are more open to shutting down than they've been in the past. If more shutdowns occur, it could finally allow the market to begin to use up some of the glut of oil in storage, which would put the firm bottom under the price of oil that the market so desperately needs.

Flipping the switch
The price of crude falling below $30 a barrel in 2016 has caused some significant regional price dislocations, with Canada particularly hard-hit because of its lack of export pipeline capacity. In fact, the price of its oil benchmark, Western Canadian Select, has fallen below $20 a barrel. At that price, a growing portion of the country's oil production is uneconomic, which is forcing producers in the country, including Baytex Energy (BTEG.F -1.07%) and Canadian Natural Resources (CNQ 0.38%), to have already shut in more than 35,000 barrels a day of oil production.

In fact, even before crude fell to its most recent level, producers were shutting down drilling rigs and turning off oil pumps. Baytex Energy, for example, announced last quarter that it had not only suspended heavy oil drilling in Canada, but shut in 2,400 BOE/d of uneconomic production, while Canadian Natural Resources shut in 5,700 Boe/d due to "unfavorable economic conditions." For Baytex Energy, the shut-ins resulted in its production declining from 84,770 BOE/d in the second quarter to 82,170 BOE/d in the third quarter.

Further, given additional production shut-ins and a significant capex reduction, the company only expects to produce between 74,000 to 78,000 BOE/d in 2016, which, at the mid-point, is a 10% year-over-year decline in production. Meanwhile, as a result of its production shut-ins and reduced drilling activity, Canadian Natural Resources' convention production has already decreased 8% year over year and 2% sequentially.

In addition to that, China's biggest offshore producer, Cnooc, recently announced that it will reduce its production for the first time in more than a decade. The company plans to cut its spending by more than 10%, which could cause its production to fall by as much as 5%. Further, because of these cuts, it doesn't expect its production to regain last year's level for at least two more years because it's a lot harder to reverse a production decline once it sets in.

Ready to pull the plug
On top of the production cuts already in motion, other producers are getting ready to reduce their production. Russia, for example, could cut its crude oil exports by as much as 6.4% in 2016, according to a report. This is based on applications that the country's oil pipeline monopoly, Transeft, has received from Russian producers and amounts to upwards of 460,000 barrels of oil per day coming off the market. The country, which has said in the past it wouldn't join OPEC in a coordinated production cut, now appears poised to reduce its oil supply. However, that reduction isn't by choice, but is largely due to the impact of western sanction, which have frozen the development of new oil projects in the country, making it harder for producers to overcome the 8%-11% average decline rate of its oil fields in Siberia.

In addition to that, Oman became the first non-OPEC member to signal its willingness to join a coordinated production cut with OPEC. In fact, the country is willing to slash its output by up to 10% if other countries do the same. Having said that, the major sticking point to a coordinated cut between OPEC and other non-producers has always been Russia. So, it remains to be seen whether the export reduction Transeft is seeing means it intends to wave the white flag and join in on a coordinated effort, or if the applications are down simply due to normal field decline. However, with the price of crude down by roughly a third since OPEC's last meeting, it is causing many market participants to worry that oil might not bottom until OPEC leads a coordinated effort reduce supply so that the market can eat into its burgeoning inventory levels.

Investor takeaway
The oil price has gotten so low that some wells have reached the breaking point and are no longer economic and need to be shut down. At the same time, it's breaking the will of a lot of producers to continue to pump at maximum capacity, which is why we're seeing some signs that producers are either cutting, or willing to cut output. That might finally finally lead to an effort to stop overproducing so that the market has some time to work off the glut, which appears to be what's needed for the price of oil to finally hit bottom.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Baytex Energy Corp. Stock Quote
Baytex Energy Corp.
$4.57 (-1.07%) $0.05
Canadian Natural Resources Limited Stock Quote
Canadian Natural Resources Limited
$52.69 (0.38%) $0.20

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