Mexico And Brazil Oil Auction Failures Are Further Proof Of Peak Oil At Current Prices

Summary Mexico’s first attempt to open up its oil industry to foreign companies was a failure. Its auction only attracted $2.6 billion in potential investments, compared to $17 billion maximum potential. Brazil had a similar failure more recently, with only 10% of its blocks being auctioned receiving viable bids. These latest failed auctions, coupled with other facts point to a permanent peak in oil production at current prices, which is unfolding presently, which will only reverse once prices rise.

By far the most spectacular and talked about trend since the oil price collapsed more than a year ago, is the dramatic decline in drilling that occurred in the United States since the beginning of this year. For many months, we have been hearing about the resiliency of the shale industry, fueled by the delay in reaction of the industry in response to declining prices. At first, there was a delay in reaction to the price decline, most likely because companies were not entirely sure what to expect. Only some months later did the cuts in capital spending start to take a bite out of drilling activity. Then there was the delay between drilling activity and a corresponding decline in production. US production only started declining in May, which was almost a full year after the initial start of the oil price decline.

Since April, when US oil production reached 9.7 mb/d according to EIA data, production declined to about 9.1 mb/d, if we are to go by the EIA’s weekly report. The EIA weekly report is not known for being very accurate, but it still provides an indication of the fact that there is a trend of significant production decline in place for the past five months or so. The whole debate over shale resilience can be put to rest now, because we know that at current prices the industry will shrink.

If the current price of oil in the $50/barrel range were to last for a very long time, global petroleum supply would not be able to meet demand in the longer term. Production will shrink almost everywhere, even in some countries in the Middle East, unless the price of oil will increase significantly. We have new evidence of this being true from two major failed auctions from Latin America.

The Mexican auction was the first to flop. Mexico’s government put up for auction concessions that they estimated would result in maximum of $17 billion worth of investments. But only two out of fourteen blocks received qualifying bids, with an expected investment of only $2.6 billion. Mexico was hoping to restart its declining oil industry by inviting foreign investments. At current oil prices however, Mexico’s potential reserves do not seem to be very enticing. It remains to be seen at what price there will be more interest, but as of right now, it is looking like it will be a major oil producer which will continue down its path of decline.

Then came the Brazilian auction, which saw a similarly lackluster reaction of oil companies in response to Brazil’s offer of oil exploration concessions. It only managed to auction off 37 out of 366 blocks. The Campos basin, where there are billions of barrels in proved reserves received no bids. This auction failure may not show up in Brazil’s production right away, but in time it will have an effect on production. If oil prices remain this low, any future auctions in Brazil as well as in Mexico will most likely suffer a similar fate.

Global capital investments in oil & gas shrinking.

The failure of these auctions should come as no surprise, given the steep cuts in capital spending within the global oil industry.

Companies like Petrobras were not able to take part in Brazil’s auction, because it is already stuck with high levels of debt. Other international oil companies such as Exxon, Total and BP stayed away because they do not see the sense in investing at current price levels. They also want to prevent a deterioration of their debt situation, while protecting their dividends which are crucial to keeping the investors happy.

As a result, we have the following non-OPEC production profile developing:

Source: OPEC.

As we can see from the graph, OPEC recorded a four month trend of consecutive monthly declines since June. Other statistical measures, such as the EIA global data suggests that global production started declining perhaps in April, when US production also started declining. In the absence of a significant oil price increase I do not see how it is possible to reverse what now seems a permanent trend of production decline. The cuts in capital spending are set to continue, with companies constantly announcing cuts in current projects as well as future capital allocations. Total (NYSE:TOT) was one of the latest companies to implement a deep capital spending cut strategy. It went from $28 billion in 2013, to a plan to spend only $17-19 billion per year starting from 2017. Shell (NYSE:RDS.A) has been abandoning projects meant to unlock new frontiers, such as Kerogen in the Powder River Basin, and Arctic drilling. In Iraq, where just a few years ago, we were talking about potentially achieving 12 mb/d oil production capacity before 2020, production is still hovering around 4 mb/d and there are reports of cutbacks in investments.

We may still be far from a permanent peak in global oil production. The last few years have clearly shown that the global economy can still expand, albeit at a slower pace, even when oil prices hover in the $100/barrel range. We should be mindful of the fact that in the past few years we had some extraordinary measures in place meant to keep the economy afloat, including a very loose monetary policy and fiscal stimulus programs, therefore the real point of resilience of the global economy in face of higher oil prices may be considerably lower in the longer term. Nevertheless, I do think that the global economy can withstand oil prices in the $70-80/barrel range and at that price, I don’t think we have reached peak oil just yet. But at $50/barrel oil, all indications are that we are now at a peak and production will continue to decline as long as we are stuck in this price range.

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