Why Citigroup Inc (C) Thinks Oil Is Going To $20

But given the lagged supply response, storage is needed to bridge the gap until the supply-demand overhang shrinks and reverses. This looks like it will be a major obstacle in 2Q’15, and could cause a production crunch in the US. When crude storage tank-tops look like there are within range of being hit, WTI is likely to move into steep contango, and the Brent-WTI price differential should blow out to reject foreign crude imports and incentivize US crude exports – this would be unless the Atlantic Basin struggles to absorb more barrels, but it looks like more floating storage is available with tanker rates taking a breather in 2Q due to refinery maintenance.

Aside from shale’s curtailment, the pullback of brownfield and maintenance capex is expected to accelerate global decline rates for current conventional production. Citi’s latest estimate for cuts to brownfield and maintenance capex is ~15% for Big Oil and with current decline rates of 5-6% we see global depletion rates increasing by ~1% by the end of 2015. A pull-back on maintenance capex feeds through to accelerated decline rates as spending is diverted away from more mature fields which are abandoned earlier than previously planned, lifting the aggregate amount of lost oil from producing wells. In mature conventional plays such as the North Sea, where inflating costs and high taxation are already an issue, this should be particularly impactful, and we expect 100-k b/d declines this year and the next, compared to flat growth at $100/bbl.

Meanwhile, the US has significant numbers of marginal oil wells that could be impacted by low oil prices, particularly in 2Q’15. There are now some 500,000 wells in the US that produce less than 15 b/d, averaging around 2 b/d, and altogether accounting for ~1-m b/d of the US’s over 9-m b/d of oil production. These are particularly concentrated in Texas, Oklahoma, Kansas, and California, but are also spread widely amongst other states (see table below). We factor in some 200-k b/d of US marginal well production that could be at risk of shut-in, though this could end up being higher.

Russia remains a special case, with the added complication of sanctions on drilling technologies and external debt financing along with previously anticipated Western Siberian field declines. In and of itself the oil price isn’t expected to directly hit Russian production given that the Ruble depreciation and Ruble-based costs of a large number of Russian oil firms act as a counterweight. External debt financing is an issue though, especially for Rosneft which has large short-term US dollar debt commitments and recent Ruble-based debt issuance has precipitated further Ruble depreciation in anticipation that the cash raised will be used to buy US dollars. A combination of decreasing oil (and gas) revenues, access issues to drilling rigs needed to maintain current production levels, difficulties in managing the acquisitions of BP-TNK and Bashneft, and Rosneft field declines lead us to expect Russian output to drop by 200-k b/d y/y in 2015. Further sanctions also can’t be discounted meaning further risks to this number to the downside.

Petrobras, along with a host of management issues, could see spending cut as much as 30% this year and Brazilian production growth is expected to slow to ~100-k b/d y/y. And Colombian production is expected to decline by ~100-k b/d due to investment grinding to a halt, a situation Venezuela also finds itself in.

Canadian production growth is also expected to slow, especially given where oil sands projects sit on the cost curve, but with the Sunrise energy project, Kearl’s expansion and the Nabiye project all coming online this year, output is still expected to grow by 110-k b/d y/y with perhaps another 50-k b/d next year. China is also likely to struggle with 30-40-k b/d declines in the Daqing field set for 2015 due to the high cost of development of the field.

Several OPEC suppliers are expected to have y/y declines as a result of the price drop. Venezuela and Nigeria, who rely so heavily on oil revenues, are hurting from the 50% decline in oil prices, particularly as they lack the FX reserves of the GCC and Russia. Venezuela, in particular, with a chronic lack of investment in up- and-downstream, is expected to see a 200-k b/d decline in output by year-end. The status quo remains in Libya with supplies likely to bounce around in the 0.3-0.5-m b/d range whilst Algerian production is expected to be down another 100-k b/d y/y. Iraq is the shining light in OPEC, and despite issues with ISIS and southern field and port infrastructure, output can grow by 300-400-k b/d y/y in 2015. This is predicated on the fact that relations between the Kurds and Baghdad at least stay as they are, allowing both Federal and KRG exports to rise from Ceyhan to perhaps 400-500-k b/d this year. Record Basrah loadings in December give cause for optimism but January data show declines of ~300-k b/d to 2.5-m b/d highlighting a consistency issue that has plagued Iraq.

How far can demand growth move the needle on global balances?

Just as low prices have a negative impact on supply, so too do they have a positive impact on demand, both directly through lower prices on petroleum products and indirectly through positive impacts on GDP. But the impact is likely to be muted and not nearly as robust as historical experience would indicate due to one-time and structural changes happening in the market. Citi expects oil demand growth to reach 1.3-m b/d y/y in 2015, with OECD growing by 0.12-m b/d and non-OECD growing by 1.19-m b/d; in 2016, demand could rise by 1.2-m b/d, as OECD demand could resume falling after a price increase y/y, down 0.15-m b/d y/y, partly offsetting stronger growth in non-OECD countries.

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