How Long Can Oil Prices Stay Down?

How Much Longer?

After my first post on why oil prices will go back up I've often been asked the obvious question, 'when exactly will they go back up?'. This obviously isn't a simple question to answer, which is why I didn't even try to address it on my first post, but I'll take a swing at it below.

Country Analysis

In order to determine how long the oversupply will last it's necessary to look at this from the perspective of every individual oil producer (ugh...) and try to predict their future actions. To simplify this process I'm only going to consider the largest producers and I'm going to lump them together as best I can. A good example of this is Russia. The Russian government does not actually 'own' all the companies producing oil in their country but given the closeness between the companies and the government I will treat them as a single actor (to further back this up Russia was actually asked to join OPEC). So without further adieu let's take a look at all the countries that have enough production and control of that production to be significant actors in the oil market.

In the chart above I've basically taken each country's debt and GDP from 2014 (stick tap to the CIA...) to get a sense of their financial well-being prior to the collapse in oil prices. Then I attempted to determine how much the oil prices have affected them (that's their estimated deficits) and lastly I computed how long they can keep going with these current deficits. To put this in simpler terms, if these countries were people the debt would be debt, GDP would be how much they make, deficits are how much more they spend above what they make and 80% Debt/GDP is the maximum amount of money the bank will lend them.

The world isn't this simple of course...not all debt is created equal (if it's owed to your own citizens and in your own dollars that is better than to outsiders), GDP changes every year, these countries could cut expenses significantly to reduce their deficits, and depending on circumstances some countries may not be able to borrow up to 80% of their GDP and others may be able to borrow more (Japan is over 200%!). All that aside, I still think this table is a reasonable approximation of how long each country can survive these low oil prices.

So what does the table tell us. Basically, OPEC countries are the ones least able to handle this downturn and the countries in the worst shape are Venezuela, Algeria, Libya and Iraq. Venezuela is obviously in serious trouble although this was happening prior to the drop in oil prices and is pretty well documented. However it doesn't change the fact that low oil prices haven't helped and the seriousness of their struggles should be pushing them back to the negotiating table. The other countries aren't in quite as much trouble as Venezuela but they still have plenty of incentive to make something happen (and by the way these countries produce more than 8 mmbbls/day combined). The last thing I'll point out is Saudia Arabia - despite the fact that they started this they can really only make it another ~5 years. This is obviously long enough to outlast a number of other cartel members (which is the whole point) but because of their size and financial position I believe this means that the absolute longest period of time that this can go on is 5 more years. That's obviously longer than most people in the oil industry would want to hear but hopefully having a cap (even if it's kind of far away) is somewhat comforting.

What About Companies?

Outside of the largest oil producing countries, the world also has some very large oil producing corporations (in fact some of them produce more than the smaller OPEC members!). So if five years is too long to wait for Saudi Arabia to break then maybe the largest oil companies will be forced to act sooner...

Fortunately or unfortunately, the largest oil companies in the world are in pretty good health (as you'll see in the table below) and are unlikely to do anything drastic to correct world oil prices. I'll also point out that most of these companies, often referred to as supermajors, operate in the western world and are subject to anti-trust laws, like the Sherman Act in the United States, that would prevent them from colluding to reduce production and increase price. For that reason I really doubt they'd take the risk required to increase prices unless it was absolutely dire and the table below shows that it's not...if you doubt how enforceable these laws are I invite you to read about Archer Daniels Midland and their lysine price fixing case. If you don't want to read about it you can even rent the movie, The Informant, starring Matt Damon!

So if the supermajors are unlikely to get together and increase price what about the shale oil producers? Lots of people blame them for oversupplying the world with oil and claim that their high production costs and hyperbolic decline curves mean that today's low oil prices will cause them to reduce production and even bankrupt them. The table below clearly shows that these producers are in worse shape than the supermajors but in a lot of cases they are still reasonably solid (Continental Resources for example still has an investment grade risk rating - although barely). Additionally, these companies are also subject to anti-trust laws and cannot collude to reduce production and even if they did go bankrupt that would not mean their production just stops. That production has value (even at these prices) and someone would simply acquire that production through bankruptcy.

So looking at this table you can see that most of the largest producers in the world (and in Canada) have sustainable debt/CF ratios (you can think of these as debt/GDP for countries or debt/income for individuals). You can learn more about debt/CF here but suffice it to say that numbers less than 4 are very safe and 11 (i.e. Chesapeake) is getting scary. So what you can see is that none of the largest oil producers in the world are in panic mode and even most of the largest US shale producers are going to make it for the foreseeable future.

What it All Means?

Looking at all of this information in its entirety tells me a couple things:

• Corporations are not going to fix this in the short term because:
• Anti-trust legislation prevents them from colluding.
• Their financial position is not as bad as you may think.
• Their production will slowly decline over time if these prices persist but this is unlikely to balance the market in the short term.

• OPEC countries are most likely to balance the oil market in the short term as:
• A number of these countries are in very poor financial positions.
• They do not face legal consequences if they collude to raise prices.

In terms of timing I believe that the longest this can last is another 5 years. If this persists beyond 5 years Saudi Arabia will be on the verge of bankruptcy and as they have the ability to change price overnight they will reduce production enough to prop up the price before that day comes. I don't believe it will get that far as a number of other OPEC members are in worse shape than Saudi Arabia and I suspect they want to come back to the bargaining table. In fact, a number of these countries are calling for an emergency OPEC meeting right now and I would bet that by the time 2016 ends these countries will find a way to cut production and increase price.

So to make a long story short, I think oil prices could rebound as early as the end of this year and could stay low for a maximum of 5 more years. They will not however stay this low for forever.