ANALYSTS SCRAMBLE TO LOWER OIL PREDICTIONS
Banks are scrambling to revise their oil-market forecasts to take account of plunging crude prices at a time when oil is at the top of every investor’s agenda, Christian Berthelsen reports. J.P. Morgan Chase & Co. reduced its first-quarter price forecasts for the second time in two months on Jan. 15. It expects global benchmark Brent to average $31.50 a barrel in 2016, down from a Dec. 18 prediction of $51.50, itself down from a view held in October of $54.75.
Personally, not surprising, as this has been the underlying basis of my believing that we are watching the launching of a credit contagion.
What is most important is that Lease Operating Expenses (LOE’s) are bloated to $15-$40 per barrel. Yes, LOE’s alone. Add finding costs for proven undeveloped reserves (PUDs) and those reserves become written off almost immediately. If one deducts from the above WTI benchmark of $31.50 even a modest $4.00 per barrel quality and basis differential, the margin squeeze (if there is any) because of high LOEs and field price differentials becomes catastrophic.
Bear in mind, that during the boom, short lease terms with stout continuous drilling commitments were the norm. Now those significant lease costs are written off.
The market place is replete with stories of litigation against third party engineering firms that are now chopping reserves and value more than dramatically.
Auditors will be highly mindful of this. The benchmark price for yearend reserves is an average NYMEX WTI based on the mandated use of a four quarter average is still $49 per barrel. Thus, expect to see inflated values and reserves at yearend, and very likely a tsunami of Going Concern qualified audit opinions.
Watch and see if auditors lean on their clients to supplement FASB 69 disclosures to a rerun of reserves at $31 NYMEX WTI. Again, it is margins, not prices alone one needs to judge. No question the fear of litigation against both engineering and audit firms will govern many decisions over the next 60 days.
What I find personally shocking is that only a small handful of companies stayed with conventional reserves, not wanting to be trapped in this margin squeeze. They were treated with benign neglect in the capital markets. By contrast, the thirst for deploying large pools of capital into unconventional reserves, the then current flavor of the day, became so intoxicating that it impelled almost the entirety of the industry to join in with the stampede—costs be damned.
Therein lies a huge issue. In my 35 years in the industry, this stampede was unmatched. It will cripple the industry with very long lasting consequences as capital formation evaporates in the face of bank needs to reduce borrowing bases.
Any way you cut it, energy banks are in a highly stressed and critical mode today.
The shoe has dropped.
Now the contagion begins.
By Mark Harrington on Oilpro.com