RE:RE:A barrel of WCS is priced below a gallon of premiumFantome, you raise excellent points. In its simplest terms, these producers must do everything to service their debts. If they shut down then it’s game over and the lenders liquidate. As long as you give lenders something the lenders likely allow you to continue. The lenders now decide when it’s over until bankruptcy decides.
The few producers (very few) simply cap the wells and wait for higher prices. The many high-cost, high-debt producers (very many) have to produce even more when prices go lower to satisfy lenders. It’s a viscous negative feedback loop that will end disastrously. JMHO GLTA.
Fantome wrote: An interesting but typical situation is emerging.
Right now the price of WTI and the other grades such as WCS are below the variable cost of production. In simple terms his means that producers are losing money on every barrel of oil that they produce...over and above the costs of replacing that barrel of oil production (exploration...drilling and well completion costs)....now...the math changes a bit depending on how much of the production is forward hedged at a higher price.
If you look at their financial statements it is safe to say that most E&P companies in Western Canada are not covering their variable costs of production and therfore losing money on every barrel that they produce right now.
The question then becomes...."Why are they still producing oil?"
The answer is a combination of economics and expectations..
To lower production rapidly would involve costs to cap the well and most of these companies are cash starved and very little or no working capital to do this work so it basically comes down the proverbial saying of being between a rock and a hard place. Now...production will gradually decline anyway just through natural decline rates but this is not an immediate thing...declining production from a well takes some time depending on the nature of the specific well.
The end result of this is continuing production until the decline rate kicks in.
In terms of expectations...if producers believe that the collapse in oil prices will short lived then they will continue to produce oil even if they are losing money to keep production up for the better days ahead.
It would seem right now that most producers...being eternal optimists...believe that the collapse will be short lived and so production levels are maintained...
It will be interesting to see how this plays out....given the shortage of storage space the most likely scenario IMHO is that the storage limit will be breached before prices recover and so in this sense...the points I made above effectively create a death sprial for Candian producers and also for the US shale producers...since once the storage limit is breached and there is nowhere to store oil....the oil price will collapse as producers will have little option but to give the oil away for nothing....ie zero price...
Sooo..what does this mean for the individual investor?
In simple terms it means that investing in E&P companies right now is a high risk decision and the balance of probabilities is that SPs will fall in the coming months and some companies will go bankrupt depending on their respective balance sheets...