News at Smith

No Relief in Sight for Oil Companies

Dec 10, 2015
World Class Faculty & Research


SMITH BRAIN TRUST — The price of crude oil dipped below $40 for the first time since 2009 this week — a sign of the relentless pressure on oil companies caused by high global output. That followed a decision last Friday by OPEC not to decrease output, with Saudi Arabia and its Gulf allies outvoting Venezuela, Ecuador and others who think the price needs to come up to better balance the interests of suppliers and consumers.

Many investors, who anticipated a production decrease, had underestimated the Saudis' commitment to maintaining high output. "Everyone figured, 'It's time,' but the Saudis are sticking to their position," says Charles E. Olson, professor of the practice at the Smith School, who has lengthy experience in the energy industry. Investors also seem to have overestimated the clout of countries like Venezuela in OPEC. "They listened to everybody except the country that matters, Saudi Arabia," Olson says.

There has been much debate about the Saudi strategy, with some observers describing it as analogous to chemotherapy: Saudi Arabia inflicts damage on itself, but the policy fends off threats to that country's oil-centric economy, including U.S. fracking technology — which generally has higher costs than Saudi drilling techniques. The Saudis "think they have to slow down the renewable-slash-'other' technologies, so they can spread their income over a longer period of time," Olson says. The Saudis also have geopolitical goals not shared by all members of OPEC. Low oil prices punish Russia, for instance, whose meddling in the Middle East the royal family in Riyadh would like to keep in check. The Saudis are also wary of the mischief that Iran could make with the money that flows in once sanctions are lifted on that country; low prices could slow that country's rebound.

More than 250,000 people have lost their jobs in the oil industry worldwide over the past year, according to Graves & Co., a Houston consulting firm. But one surprise has been just how much efficiency U.S. companies have wrung out of their wells. While the number of rigs dropped 60 percent, for instance, oil production dropped by just 3 percent, by one estimate. Production per well is up by nearly two-thirds.

Olson says that there are plenty of U.S. wells that can operate at a profit even at the $40-per-barrel mark, a price point some observers had said was unsustainable. Moreover, some companies, including ExxonMobil, diversify their risk by operating both "upstream" (oil extracting) and "downstream" (processing and consumer distribution) businesses. Upstream enterprises are hit hard by low prices, but downstream businesses benefit. That hedging of risk explains why ExxonMobil's value, although down from a peak of $104 per share to $75, has not been hurt even more by the hyper-low prices.

Olson declines to hazard a guess about when oil prices might drift upward again. "I keep thinking an increase in price is coming soon," he says. But he's been thinking that for quite a while, as have many industry observers.


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