Oil prices below LatAm production costs spurs cuts and assurances
March 24, 2020 |
How long prices remain depressed could result in an industry facelift
The Latin American oil landscape, already changed by Venezuela’s years long production collapse, is facing an even bigger upheaval as it suffers the double whammy of global oil price war and the novel coronavirus causing a sudden stop to the global economy, causing a plunge in demand while stockpiles grow.
On Monday the price of benchmark Brent Crude stabilized with $0.56 per barrel increase to settle at $27.54, still well below where governments and drillers can equally fund their budgets or meet production costs. Brent is down roughly 60 percent year-to-date. Meanwhile, the price for US gasoline tumbled to a record low on the falling demand for transportation in the No. 1 use of motor fuel.
“At current prices, major Latin American oil producers will lose money because their all-in costs average from $30 to $35 a barrel,” said Anne Milne, head of emerging market corporate credit research at Bank of America in New York.
“I don’t think oil prices can stay this low for a super long period of time,” Milne said, adding: “The length of this very low-price scenario will determine whether there is not more serious damage.”
The all-in cost of producing a barrel of oil includes everything from taking the oil out of the ground or the ocean floor, to processing and getting it to clients.
A breakdown in an agreement between Russia and Saudi Arabia for controlling the flow of oil has resulted in the price collapse, which impacts the smaller and higher cost producing nations in Latin America particularly hard as they look to the commodity to help them build their economies and fund budgets.
MEASURES, DRASTIC YET?
Regional oil companies have announced several cost-cutting measures, adjusted and delayed investments as well as asset sales in an effort to reassure investors they can cope with the financial carnage.
Analysts expect declines in production and eventual mergers of smaller companies, adding that the dimensions of the damage will depend on the length of the price break down. Prices for Brent crude have not spent this much time below the $30 per barrel point since 2003, according to data provider Refinitiv.
Colombia’s Ecopetrol announced last week measures that included a COP2 billion ($478 million) expenditure cut, new commercial strategies to maximize value, and a decrease in investments by $1.2 billion dollars, according to a securities filing.
However, the company also said that it had the resources to manage current market risks, reminding the market that in December it had a debt to equity ratio of 1.2, access to a $665 million credit line with international banks and could tap an additional COP990 billion facility with local banks.
“Colombia is a country with high production costs,” said Francisco Monaldi, fellow in Latin American energy policy of Rice University’s Baker Institute for Public Policy. “So Ecopetrol is going to have difficulties because its fields are relatively small, and transportation costs are high. When prices are low, they have a particularly difficult situation.”
Ecopetrol's 4.125% 2025 bond traded flat on Monday at 84, yielding 8.21%.
Brazilian state-owned oil company, Petrobras, announced on Friday that as a preventive measure in the context of the coronavirus the company was postponing the divestment of eight refineries. The company has been executing an aggressive divestment plan since early 2019, and was continuing to press forward until Friday’s announcement.
Petrobras is viewed by some analysts as the best positioned company at this moment, underlining its strong balance sheet, good cash position, well managed operations, and efficient offshore production of light oil. But even the company’s efficient offshore production is expected to be affected at current prices.
“Petrobras’ offshore production is highly efficient, but it’s based on heavy initial investments. Operating them is not expensive and they can continue doing so with very low oil prices, but this will affect new investments,” Monaldi said.
Petrobras’ 5.093% 10-year debt traded flat on Monday at a price of 77.50, yielding 8.52%.
Brazil’s PetroRio recently said it was reviewing its business plan and postponing investments to adjust to the new COVID-19 scenario. In January it hedged a significant volume of its estimated production to protect its financial commitments due in the first half of 2020. “With expected offtakes of approximately 1.5 million barrels in March alone, the hedge’s net proceeds could reach an estimated $39 million to $41 million, assuming Brent prices varying between US$ 32 and US$ 28 per barrel, respectively,” the company said in a March 18th statement.
Mexico’s state-run oil company, Pemex, said on March 13 that given uncertainty it would initiate a cost cutting program and that it had the liquidity to guarantee the payment of all obligations in time to its suppliers and contractors.
The company pointed out it had refinanced $5 billion at the beginning of the year, that it had a $7.85 billion revolving credit line, and a revolving credit line for MXN20 billion ($843 million) in the local market. In January the Ministry of Finance put out a statement saying that it had hedged its oil revenue at an average price of $49 per barrel. “These market operations were executed in a timely manner with the aim of contributing to macroeconomic stability and protecting the country's public finances during the current year,” the government said in January.
“Pemex won’t have problems this year, but next year it will,” said a US based oil and gas banker who requested anonymity because the firm does business with the Mexican government. “Pemex is heavily indebted, and the company has been running losses.” Bonds maturing in 2020 will require payouts of about $6 billion. The 6.84% January 2030 Pemex bond traded down 0.021 points in price on Monday to 75.158, yielding 11.04%, according to data provider Refinitiv.
The current situation however will disrupt the strategy that Argentina’s YPF had traced out for itself, analysts say.
“YPF had put its bets on Vaca Muerta, which has a great growth potential, but its costs are of about 40 to 45 dollars a barrel,” Monaldi said. “At current prices, this project loses economic sense.”
“This is worse than the 2008 global financial crisis for the oil industry. We’re only seeing the tip of the iceberg,” said Ramon Key, head of the International Center of Energy and the Environment at IESA in Caracas, Venezuela.
“Not only because OPEC has failed cut supply this time around. But because coronavirus has put a stop on individual and commercial transportation, which accounts for a large portion of oil demand,” said Key.
The worldwide transportation sector accounted for 59% of total end-use liquid fuels consumption in 2018, according to the US Energy Information Agency’s latest international energy outlook. And the American transportation sector accounted for 69% of petroleum consumption in 2018, according to the latest US Department of Energy data book.
The crunch will hit small and middle-sized private operations so hard, that mergers and acquisitions are expected to come soon, analysts said. “We will be seeing asset consolidations and mergers because market signals say a low-price scenario is not temporary,” said Key.