Early signs of capitulation for oil

Squeezed by falling oil prices, Russia is talking about privatizing its major companies to close its budget shortfall. Nigeria is seeking a World Bank loan to cover its $11 billion budget gap. Even Saudi Arabia has been drawing down reserves and discussing selling a stake in its national oil company Saudi Aramco.

There's no doubt the oil producing nations and energy companies are feeling the pain of a 75 percent drop in oil prices in the past 1½ years. Now their actions are being viewed as the early signs capitulation is coming.

Oil prices have been volatile for weeks but especially in recent sessions. West Texas Intermediate crude futures were slightly lower, just above $32 barrels Thursday. But oil moved several percent intraday, after rising 8 percent Wednesday and 5-plus percent moves lower Monday and Tuesday.

In the past week, a number of Russian oil officials have said they would talk to OPEC about a production deal, and the oil minister of cash-strapped Venezuela has been traveling from producing nation to producing nation, calling for a meeting between OPEC and non-OPEC countries. Saudi Arabia has said it would only cut back if all producers do, and Iran has said it will not cut back until it restores its exports

In the private sector, the pain is being felt from the smallest producing companies to the largest.

ConocoPhillips stunned Wall Street on Thursday when it became the first big oil company to slash its dividend. It cut its quarterly payout by two-thirds and shaved another 17 percent from its capital spending plan after reporting a $3.5 billion loss.

BP earlier this week announced a loss of $6.5 billion in 2015, its largest ever annual loss. Shale drillers are also suffering. Last week, Continental Resources said its output would fall by about 10 percent this year and it joined others in cutting its capital budget.

"That is capitulation. I know now that all companies are in capitulation. Nobody's pretending anymore," said Oppenheimer energy analyst Fadel Gheit.

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Conoco's dividend cut was a big deal for the industry and sends a strong message for a sector that has treated its ability to pay dividends as sacrosanct. "These companies were supposed to be cash cows that guaranteed income flow. You're not going to be getting it. The whole model is being upended," said John Kilduff, a partner with Again Capital.

"The dividend is at risk for most companies," Gheit said. "Even if oil prices go to $40 or $50, it's not going to save the dividends."

Gheit said he expects to see more bankruptcies and mergers, as companies struggle to survive a long stretch of weak prices.

All of this talk, however, is not reducing the amount of oil on world markets, with the U.S. continuing to show strong buildups in inventories and an unrelenting production level of about 9.2 million barrels a day.

It's also not alone as Saudi Arabia continues to produce at high levels. Russia, in fact, pumped 10.88 million barrels a day last month — the most since the fall of the Soviet Union. Even Iraq has upped production, reaching an output level of 4 million barrels a day last month.

"I think we're now into the desperation zone," said IHS Vice Chairman Dan Yergin. "What you saw coming down the road is now here, countries not only running out of money but running out of resilience. Virtually every country now is saying we really have to reform. We don't have the succor of high oil prices."

All this pain among producers may be nearing a threshold where a real capitulation will not be far behind — and oil can bottom because supplies will stop increasing. But even if oil prices are beginning to bottom, it is expected to be a long slow process, and prices are expected to remain at low levels for a long while.

"All this chatter tells you we've reached a pain threshold these guys can no longer handle," said Peter Boockvar, market analyst at Lindsey Group.

Venezuela, a country that has already seen a government ousted because of economic hardship, has been trying to spark talks between OPEC and non-OPEC nations in an effort to stanch the bleeding. Qatar is cutting back on spending after seeing its first shortfall in 15 years, and Kuwait, Abu Dhabi and Oman have all cut back on power subsidies. Africa's producers are suffering more, with the continent's second largest producer, Angola, introducing austerity measures as it copes with a shortfall in oil revenues.

What Saudi Arabia does will ultimately be the key. It drove the change in OPEC policy to market-based pricing in late 2014 in order to maintain its market share.

As a low-cost producer and biggest OPEC exporter, it has previously used production cuts to influence the market, but it has said it will not reduce its output if the cutback is not shared with OPEC and non-OPEC producers. But like other producers, Saudi Arabia needs a high price per barrel to meet its budget requirements, an estimated $70 per barrel more than current market prices.

"The Saudi plan is working. There's a lot of damage being wrought in the U.S. exploration and production sector. This is why you're not going to get a deal in the short term. The Saudis are going in for the kill," said Kilduff.

The U.S. industry, made up of dozens of independent oil companies, would not be willing or able to go along with a plan to cut back, so the only way to slow shale is with low prices. "Saudi Arabia has an objective, and their objective has not been met. They have to bring shale production down significantly, not by a half million, but by a million barrels a day. Yes, it's coming down but not as fast as predicted," said Gheit.

U.S production peaked at 9.6 million barrels a day last spring, but it has held steady at about 9.2 million or 9.3 million since.

"I always thought the first quarter was going to be the bottom. We are waiting to see that. The trend in U.S. shale, that is the key. If it looks like that is going down faster, that will be the bottom. The longer oil stays low, around $30 or lower, then the quicker we get to a bottom," said Chris Weafer, senior partner with Macro-Advisory. Weafer said the market also needs a realistic view of how much oil Iran will be able to export, now that sanctions have been lifted.

Citigroup energy analysts, in fact, said they believe it's likely oil prices have reached their lows, but they expect oil to stay in a low range between the upper $20s and mid to upper $30s for months more, before finally turning higher in the second half of the year. One part of their thesis is that Iran is not being as aggressive as expected in returning crude to market. It has promised an immediate 500,000 barrels a day, then another 500,000 later in the year.

"We're seeing some of these signs of stress among producing companies and producing countries, and that has all sorts of effects on supply, but mostly to pull it back," said Citigroup energy analyst Eric Lee.

"I think the key message we're trying to say here is it is still likely (the oil price is) going to zigzag around," said Lee. He said oil could trade lower than current levels but he believes it's likely to hold in a new range with a floor of around $27 per barrel for Brent and $26 for WTI.

"We're close to a floor," said Lee, noting it now depends on how much pain producers can take. "At the same time financial market positioning was very, very short, very stretched when we got down to $27. We see, as these shorts cover, we pull back to these levels," he said. "Positioning seems to suggest these levels are a little more neutral."

Lee said the range for WTI could be between the $26 low and the mid to upper $30s per barrel. By the second half of the year, oil could then start to turn higher, depending on the amount of production cut from the U.S. That will also be determined by how many oil sector companies need to file for bankruptcy and whether bank financing is pulled back when oil companies are reviewed in the spring.

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Lee added that the turning point for producers will depend on their individual breaking points.

"The tricky part is trying to say when is the breaking point and when does that filter through to supply declines. Really for the petrol states it's a little bit different in that if prices stay at this kind of level and can start to improve a little bit then most of the oil exporters' production is 'in the money,' just not the government budgets," Lee said. "If you're in that range where government oil revenues are challenged but the oil production is viable in itself, then you're caught in this quandary. You may try to stimulate as much production as possible to generate as much cash as possible."

Lee said an example would be Russia. "Let's say the Russian government's fiscal health is in trouble but the companies, especially with the ruble depreciation, are profitable. Then the government may look at more heavily taxing those companies, and it may put a drag on production," he said.

Russia, as the world's largest oil producer, is a wild card, but Weafer said it is unlikely to agree to any deal with OPEC to cut back production despite a willingness of officials there to hold talks. He said taxes for the Russian industry are possible, and the government is looking to cut spending as well as sell stakes in its major companies.

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"It's real and it's something the president (Vladimir Putin) will give strong support to because for him, he needs the deficit to be contained so they don't burn through their reserves and become more vulnerable. There is no intention to sell to the public listed market because they don't believe they'll get the valuation. They want to sell to strategic buyers," he said, adding likely buyers are either Chinese or Indian companies.

Russian oil giant "Rosneft is at the top of the list," said Weafer, adding a 15 percent stake could be sold. "It's going to come down to horse trading. The thing is both sides have both an advantage and a disadvantage. The Russian disadvantage is very clear. They need the money. They are in a weak position. On the other hand, India and China are very keen to boost their long-term energy supplies and there's no place else to get it. While Russia's position is weak, it's not as weak as it appears."

Gheit, too, said it's likely oil has bottomed but it should only reach into the $40s later in the year. "It's going to be a tug of war. There will be no smooth sailing up or down. Oil prices are dictated by fundamentals, geopolitics and by currencies," he said.