I saw a very interesting post here on Oilpro.com this week. It illustrated the volume of crude oil that the world produces in one calendar year.
The world produces approximately one cubic mile of crude oil each year. I pointed out that if the cube was 2% smaller it would be 3 times as valuable. This is totally counter intuitive but given the 2% surplus and the 65% price crash, it’s true.
When the market was balanced the oil price was over $100. Now there is a 2MM bopd surplus on worldwide production of 95MM bopd the price has crashed from $110 to below $40. A 2% surplus means the price has fallen to 1/3 of what it was previously.
I thought it might be interesting to run some revenue numbers;
In 2014, we produced approx 93MM bopd at a price of $110
= 93,000,000 bopd * $100
= $10.33 billion / day
In 2015 there is a surplus, we now produce 95MM bopd at $40
= 95,000,000 bopd * $40
= $3.82 billion / day
Here is a nice picture to illustrate this:
So even though we are producing more oil, we as an industry are paid 1/3rd of the money we would be paid if we delivered slightly less oil.
Currently the industry is forgoing $2.3 trillion of lost revenue a year, 2.3 trillion! (with a ‘T’), all because there is 2MM bopd of surplus in the market. Everyone in the industry would be much better off if this surplus oil simply disappeared.
Here is a crazy idea… Why doesn’t the oil industry just buy back the surplus and flare it?
How much does it cost to buy back the surplus?
= 2MM bopd * $40 * 365
= $29.2 billion per year (how much revenue were we losing again?)
The US LTO industry produces 4MM bopd, what’s their revenue?
= 4MM bopd * $40
= $58.4 billion
As a hypothetical exercise, if US LTO’s got together and bought the global surplus what might that look like? In the current climate US LTO revenue is approximately $58.4 billion.
If the LTO’s alone bought the 2million barrels a day surplus and restored market balance, that would cost around $29.2 billion a year, but with the market balanced their gross revenue for the US LTO industry would be…
= 4MM bopd * $110
= $160 billion
less than the cost of buying the surplus…
= $160.6 billion – $29.2 billion
= $131.4 billion
So the US LTO industry could make an extra $73 billion a year (a 125% increase) simply by buying the surplus oil on world markets and flaring it off in order to restore world oil prices to their former glory.
Sounds expensive, but it’s actually profitable to do so.
If US LTO’s could collectively afford to do this then so could Saudi Arabia or Russia, or anyone producing a couple of million barrels a day, even a single supermajor could do it.
In fact anyone who is a net exporter of more than 2 million barrels a day could restore the world’s oil markets simply by buying the surplus and destroying it and watching the cashflow of their existing production recover as a result.
AND as crazy as that sounds the whole exercise would be net profitable for any individual entity that was bold enough to do it. Because destroying the 2 MM bopd surplus will triple the oil price back to where it was before the surplus emerged and the revenue from their original production would increase by more than the cost of buying the global surplus.
Any of the following countries can afford to buy the entire worldwide oil surplus of 2MM bopd, every day, and destroy it, every day…
6,880,000 – Saudi Arabia
4,720,000 – Russia
2,445,000 – Iran
2,390,000 – Iraq
2,341,000 – Nigeria
2,142,000 – UAE
1,928,000 – Angola
1,645,000 – Venezuela
1,602,000 – Norway
…And come out the other side with a net profit on the whole exercise.
Now, if we go back to the two cubes and the numbers…
When the market was balanced at 93MM bopd the oil price was $110 therefore oil producers generated $10.33 billion of revenue per day.
This year, with a 2MM bopd, surplus the oil price is $40 therefore oil producers generated only $3.8 billion of revenue per day.
Those extra 2 million barrels a day are costing oil producers $6.53 billion a day in lost revenue!
Therefore every single barrel of surplus oil is costing the global oil industry $3,265 in lost revenue!!! ($6,530,000,000 / 2,000,000) Yet everyone is rushing out to produce more and more oil.
If you can buy one of those surplus barrels for $40 and destroy it then so long as you have a global market share that is greater than ($40/$3,265) = 1.2% of the world oil market then you are actually improving your net profit and loss account by buying the oil and destroying it.
IF YOU HAVE BIGGER MARKET SHARE THAN 1.2%, IT MAKES RATIONAL BUSINESS SENSE TO CUT. IF YOU HAVE SMALLER MARKET SHARE THAN 1.2%, IT MAKES RATIONAL BUSINESS SENSE TO LIFT PRODUCTION TO MAKE UP SALES WITH VOLUME.
Saudi Arabia and many of the other entities with more than 1.2% global market share are doing the exact opposite of what they should be doing, every extra barrel they produce devalues their original production by more than the value they gain from selling the extra barrel. Therefore every extra barrel they sell loses them money overall. Their strategy is dead wrong.
Every extra barrel that Saudi Arabia puts on the market hurts Saudi Arabia more than anybody else because they are the largest market share and suffer the most lost revenue as each extra barrel erodes the price.
For example, if Saudi Arabia has 10% global market share, then every extra 1 bopd that they sell on world markets nets them $40 sales revenue but it devalues the other 10 million bopd they sell by (10% * $3,265) $326.50.
So overall each extra barrel of production they add to the surplus loses them $286.50 off their own pre-existing sales revenue.
Their current strategy is to produce flat out, and to put their 3 million barrels of spare capacity into full use! Don’t worry folks, with a business model like that they aren’t going to be around forever.
Whilst the smaller entities might not have the rock bottom lift costs of the Saudi’s. The smaller entities do not suffer such large nominal impairment of their existing production revenue, because their existing production revenue is comparatively small.
For example, if you only produced 100,000 bopd then your global market share is around 0.1%.
We already know from above that each individual bopd of the surplus has resulted in $3,265 of lost daily revenue to the global industry.
Therefore, if you have 0.1% market share (100,000bopd), every extra barrel anyone puts on the market reduces your daily sales revenue by $3.27.
So if you yourself put a surplus barrel in the market you will net a gain of $40 sales revenue minus $3.27 of lost sales revenue due to price errosion = $36.73 for that barrel.
A producer with 0.1 % world market share will gain $36.73 from adding one extra barrel to the surplus.
A producer with 10% market share will lose $286.50 from adding one extra barrel to the surplus.
WHO SHOULD CUT PRODUCTION??