'Scotland's Oil' is now so cheap – but not to produce

On 15 October 2014, a Bloomberg Business News feature highlighted Citigroup's (Citi) estimate of a $1.1 trillion stimulus to the world economy after the dramatic fall in the price of crude oil over the preceding months. The previous day had seen Brent Crude, a major worldwide oil benchmark classification for sweet light crude oil, close at $83.78 a barrel in London. Although there had been a small rise at close of business on 15 October to $84.25, this still represented a fall of over 20 per cent on its previous three-year average.

Citi's Ed Morse, the corporation's head of global commodities, estimated that, providing the then current levels of output remained stable, the reduction in the cost of oil amounted to a direct saving of $1.8 billion per day and that this lower cost would feed through to other commodities. Mr Morse explained:

"A reduction in oil prices also results in a reduction in prices across commodities, starting with natural gas, but also including copper, steel, and agriculture. All commodities are energy intensive to one degree or another."

Hence the cumulative trillion-dollar plus total over a year.

The price of crude continued to fall during the last quarter of 2014 due to weakening demand from Europe where economies were growing painfully slowly, if at all, and China, where government, both national and local, are trying to adjust economic growth rates lower on to a more stable model which will emphasize quality over quantity.

A key factor however, was and continues to be, the position of the market in the United States, a country importing significantly less oil than before with increased supplies of the "home-grown" variety. Coming about and made commercially practicable because of the very high world oil price over the last decade, the increase in US domestic oil production is mostly due to that obtained from horizontal drilling and fracking.

During the autumn of 2014, the country produced some nine million barrels a day. Back in 2000, the figure was less than six million barrels, a production figure which stayed pretty constant until 2012. About 85 per cent of production came from just four States: Texas (25 per cent), Alaska (24 per cent), California (21 per cent) and Louisiana (14 per cent) and there will be no surprise to learn that seven of the ten largest refineries, are to be found in Texas and Louisiana – the largest of them capable of refining more than half a million barrels of crude per day.

America's Energy Information Administration (EIA) which had not expected current levels of production to be reached before 2017, noted that "tight oil" (shale) accounted for under one million barrels per day in 2010 but by the third quarter of 2013 had exceeded three million barrels per day.

Excluding biofuels, the USA in 2013 consumed 18.57 million barrels per day – that's right, nowhere close to self-sufficiency – so why the steep dive in the oil price? For a start, that consumption figure is a million barrels less than in 2000, even with a bigger population (281 million in 2000 and estimated at 317 million, end 2013). Then there's energy being generated by other means ("substitution") and advances in technology and design leading to greater efficiency in fields too numerous to mention, at least in the developed world. The upshot of it all for the world oil market is that by the third quarter of 2014 about 2.5 million barrels per day were fighting hard to find consumers.

If the price of oil had bottomed out on that mid-October close, it is likely that most of the world would have seen it as a welcome, long overdue correction but the price just kept on sliding as it became apparent that Saudi Arabia did not intend to intervene in the market by closing down some of its production – indeed, the Saudis cut their official selling prices to their Asian customers. Now all oil producers started to reach for their calculators to work out the breakeven point of each individual field – and even well.

On 06 November 2014, Business Insider published a chart compiled by Rystad Energy, Morgan Stanley Commodity Research which showed the breakeven price (average Brent-equivalent) of oil production from various main sources.

Lowest was Onshore Middle East: $27, followed by Offshore Shelf: $41; Heavy Oil: $47; Onshore Russia: $50; Onshore Rest of World: $51; Deepwater: $52; Ultra-deep Water: $56; N Am Shale: $65; Oilsands: $70; and Arctic: $75. These are averages it should be emphasized with some fields in Arabia able to produce at $10 per barrel and some fracking sites in the US happy at $38-$40.

At the New Year, Citi was predicting an average Brent crude oil price of $63 per barrel during 2015....Or is that $54? (it's estimate as of early February 2015). What can only be a gloomy headline for many a producer, quoted a Citi report on 09 February which stated that: "Oil Could Plunge to $20..." Bloomberg's Tom Randall:

"...oil production in the U.S. is still rising ...Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia. The market is oversupplied, and storage tanks are topping out."

The EIA on 06 February announced that U.S. production had grown to 9.23 million barrels per day.

With oil down by 50 per cent from its June 2014 price level and that of natural gas tumbling in sympathy, the not so good news is the accelerating investment slowdown and cancellations in both these industries with knock-on effects on related businesses and services.

Relatively slow at first, just in case the phenomenon of cheaper oil was temporary, there has been of late an acceleration of job losses in nearly all areas connected with the industry in Europe and North America. Maybe the worst affected country with jobs lost or in the pipeline, is Norway.

Twenty per cent of Norway's GDP is in its oil and gas sector with state-controlled Statoil accounting for 70 per cent of operations. Danske Bank A/S told Bloomberg on 10 February that overall spending cuts in the industry will amount to 20 per cent this year and a further 10 per cent in 2016 but Statoil said that they expect to make cost cuts of 30 per cent and reduce offshore investment by 15 per cent.

In a sector that employs 250,000 Norwegians (Norway's population in 2014, about 5.2 million), 10,000 jobs losses will be made in the near future with a further 30,000 expected during the rest of the year.

Only about two per cent of the UK's economy is affected by North Sea oil and gas with direct and indirect employment reported to be in the region of 450,000 and production around 1.3 million barrels per day. In production terms this, the North Sea, gets barely a mention.

Brent Crude dipped to $46 per barrel after the New Year when many analysts were suggesting it could drop as low as $31. Recent weeks have seen a recovery and at 13 February's close it reached $61.50. Energy analysts Wood Mackenzie warned in January that if the price dropped below $40, the operators "would consider closing down wells" and that even at $50, "oil production would cost more than its value in 17 countries, including both the UK and the U.S.".

In Scotland, Aberdeen, really the heart of the British oil industry, is a city on edge, many nervously awaiting the next development. To date, redundancies by large operators like BP, Conoco-Phillips, Shell and Talisman Sinopec, have numbered in the 200-300 range. Projects have been cut back or shelved and employees throughout the industry can expect pay freezes or cuts.

The latest company announcement on 11 February was fairly typical. KCA Deutag, an offshore drilling operator said that 230 staff are to go and that all other employees are "being asked" to take a five per cent cut in salaries.

The North Sea is marginal and government, whether in Edinburgh or London, has no influence on this global market commodity.

Some politicians more than others need to take that aboard.