Global oil markets are increasingly looking like the embattled iron ore sector.
Despite crashing prices, not much appears to have changed on the supply side of the equation, with the International Energy Agency (IEA) calculating that total global supply was 3.2 million barrels per day higher in April 2015 than at the same time twelve months earlier.
This is particularly relevant when you realise that the total global oil market was roughly 93 million barrels per month over the last six months. Global supply is thus some 3% higher than April 2014, despite a 60% decline in the number of utilised drill rigs in the US since oil prices began declining.
According to May's IEA report, The Organisation of Petroleum Exporting Countries (OPEC) lifted its April production to 31.21 million barrels per day, the highest point since September 2012. There are a few things to take away from these developments:
Declining rig count and relatively constant US production says to me that producers are tapping high-flow wells first.
Trimming capital expenditure and prioritising higher output wells might maintain production (and cashflow) for companies like Senex Energy Ltd (ASX: SXY) while reducing costs in the short term, but it can come back to bite hard if a company's reserves dwindle faster than limited exploration and drilling programs can replace.
It's just this situation that has the world's major producers fearing we could see a global oil shortage from 2020 or so.
Supply remains stubbornly high
Production hasn't fallen to the extent you might expect based on such a dramatic decline in the value of crude oil. Linking in with my first point I expect that US producers, like their Aussie counterparts, are trimming exploration and development to prioritise their higher-reward wells first.
This cuts costs way down while maintaining high levels of production – for a while. Companies might not have the choice of slowing production; with competitors also increasing their output, companies might be forced to keep selling low-margin product on the basis that 'if we don't sell it, somebody else will.'
Prices still rely on supply and demand, but with demand growing slowly expect suppliers to control the market.
Supply increased by over 3% compared with a 0.7% rise in demand over the past twelve months.
Increases in OPEC production reflect that organisation's desire to win back market share that high-cost US shale gas has taken in recent years. Brazil is reportedly also making a strong showing, and Russian production has soared as a weak Ruble massively increases the reward for exporting.
Unfortunately, unlike in iron ore, Australian oil/LNG producers – including the majors like Woodside Petroleum Limited (ASX: WPL) and Oil Search Limited (ASX: OSH) – don't control enough production to have any influence over the price they receive for their goods. This ties in well with my next point:
Uncontracted production
Woodside shares have held their value phenomenally well, due in no small part to contracts which lock in prices for a fair portion of its product. Santos Ltd (ASX: STO) has been smashed because much of its product is uncontracted (and thus fully exposed to falling prices), but this is where Santos stands to benefit over the long term.
Contributor Regan Pearson noted here that a looming shortfall of oil or LNG in 2020 is the perfect opportunity for Santos to take full advantage of its uncontracted output.
As ever with investing it pays to take the long view, and a number of companies like Santos and Senex look well positioned to benefit over the long term if they can weather these short-term headwinds.
