The oil producers are facing a perfect storm. Overproduction has nearly filled physical storage globally, at exactly the same time the coronavirus has driven demand straight off a cliff. Caltex Australia Limited (ASX: CTX) forecast a drop in aviation fuel demand by up to 90%.
The price of oil at the time of writing is at US$27.14. In many cases, this is below the break even costs of oil producers. Even if a deal could be brokered, there is no way for demand to soak up excess oil.
Oil producers slash costs
The dominoes started to fall when Woodside Petroleum Limited (ASX: WPL) announced it would defer a final investment decision on its $11 billion Scarborough project and its Pluto LNG expansion to 2021. An investment decision on its Browse project has also been deferred to an unspecified date.
Santos Ltd (ASX: STO) has also announced deferrals of large scale capital expenditure investments. Last Wednesday, US shale producer Whiting Petroleum Corp declared bankruptcy. In addition, Caltex has moved an outage from July to the start of May with Caltex management declaring "refinery operations will recommence when margin conditions have sufficiently recovered."
Oil Search capital raise
Into this hostile environment, Oil Search Limited (ASX: OSH) announced an extended trading halt yesterday while it prepares an offer for a capital raising. This company is clearly in a fight for survival.
Oil Search reported a high cash flow break even point of US$32–33 per barrel of oil equivalent (boe). It also has US$2.9 billion of debt.
In response, it has cancelled investment and expenditure by around $500 million and continues to look for efficiencies aggressively. Its share price has fallen by 65% since its YTD high price on 10 January. It would need to rise by 300% from yesterday's closing price to reach that price again.
Foolish takeaway
Oil producers are passing through a transformative phase. For companies with existing high debt the options become limited to capital raising, temporarily closing production or selling assets. For some it will mean calling in administrators.
This is a time to be very cautious for investors in the oil and gas sectors. Recovery of the sector will be linked to recovery from coronavirus.
