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What I Revealed in My Windsor Briefings, Part I

Last weekend's annual meeting at Windsor Castle again brought together some of the world's leading energy authorities, policymakers, ambassadors, and officials. The Windsor consultation remains the most unique energy meeting in the world, featuring some high-level exchanges among a small number of heavyweights.

The last issue of Oil & Energy Investor discussed the geopolitical dimensions of our Windsor sessions. My two briefings this year had the responsibility of taking point on both production and financing expectations for 2017.

And here's what I told the assembled dignitaries about the real story unfolding between oil supply and demand…

The Most Important Factor Oil Analysts Are Missing

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Dr. Moors addressing the Windsor delegates, Vicar's Hall, Windsor Castle, March 4, 2017

The formation of a balance between supply and demand is well underway, both globally and in the United States. Despite some variations in U.S. production (the travails of the market over the last two days is a good case in point), that balance should arrive by June.

For the year, I estimate U.S. oil production to come in at an average 8.6 million to 9 million barrels a day, with the global daily surplus moving down to about 0.4%. Year-on-year production should increase worldwide by 1.3%.

U.S. natural gas production should average 75 billion cubic feet a day with the daily surplus at around 2.5 billion. That will be 12.5% lower than 2016 and 3.5% higher than the five-year average (but for the first time in years within the range of that average). While the ratio of new production to expected demand will be very tight (less than 0.5%), any anticipated shortage can be easily (and rapidly) met by increased production from large known excess reserves.

Both domestically produced crude oil and natural gas will comprise increasing exports from the United States. Oil exports already account for 1.2 million barrels a day, while some 2 billion cubic feet a day of gas will be exported at liquefied natural gas (LNG) in 2017. That figure is expected to triple by 2020.    

Of particular interest to those assembled were my views of "breakeven prices," both in various drilling basins in the United States and globally. My take is for a breakeven oil price of between mid-$50s and mid-$60s per barrel of oil and $3.50 per 1,000 cubic feet of natural gas.

However, these are usually misleading for two main reasons. First, companies actually receive "wellhead prices," the price of oil and gas as it comes out of the ground. The rest of the market price involves additions of wholesale and retail layers. Wellhead prices are currently, on average, 18% below market prices. In addition, at least a 10% internal rate of return (IRR) is needed to keep existing wells in production; expanding an existing field requires an IRR of at least 18%.

All of this means that some wells defined as "profitable" or "breakeven" on paper are catalogued as marginal barrels of production, absent a much higher market price for oil.

Second, breakeven in other countries means something quite different. When the vast majority of national budgetary expenditures are dependent upon the revenue gained from oil sales, the price needed rises significantly. Here, we are reconsidering breakeven as a budgetary necessity.

When you compare national breakeven prices per barrel with those from selected U.S. basins (where only the company's spread is considered), the difference is marked. Now the average OPEC requirement at the end of 2016 was $94 a barrel, $86 for Saudi Arabia. My current estimates put the OPEC figure at $98, now surpassed by the Saudis (at $107).  All of the U.S. basins, especially the unconventional plays we've been following, come in lower, often much lower.

Other matters of interest in my briefings included the decline in drilled but uncompleted wells (DUCs) as a significant factor in determining likely U.S. production levels, the reducing usefulness of hedging contracts forward to protect pricing levels (less than 6% this year, from 8% in 2016 and 15% in 2015), continuing bankruptcies (119 and counting in less than 18 months), and the impending rise in the cost of wells.

This last factor is important. U.S. producers had been able to realize improved efficiency in well cost of between 17% and 24%. However, the advances in technology contributing to some of this drop in cost are now built into the system. Meanwhile, the bulk of the savings resulted from oil field services (OFS) companies agreeing to cut charges to maintain service contracts. That is now over. OFS costs are increasing in an environment of rising oil prices.

I now estimate that less than half of the cost savings experienced in 2015 and 2016 will be permanent, with cost inflation kicking in especially in the drilling frenzy underway in the Permian Basin. Of more than passing interest is the fact that over 60% of present wells are coming in over schedule and over budget.

All of this will contribute to a higher market price being required to sustain additional U.S. production volume.

Kent-and-Paul-Tempest

Dr. Moors and Paul Tempest, former Bank of England principal and Director General of the World Petroleum Council, leading the ambassadors to the traditional Dungeon Briefing, Windsor Castle, March 4, 2017

However, it is on the finance side that my briefings generated the greatest interest, especially among several of the ambassadors from oil-producing countries. In that briefing, I discussed a new direction in private energy investment now underway globally that is likely to revise how many projects are financed and operated.

That will be the subject of next week's issue.

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle

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