Why '75' Is The Most Important Number For US Economic Hope

Tyler Durden's picture

US shale oil is now the marginal swing barrel in the new world oil order, and as Goldman Sachs warns (despite Larry Kudlow apparently knowing better), a decline in WTI to $75/bbl would start to significantly slow US shale growth (and thus employment, capex, and the entire US economy).


Via Goldman Sachs,

Our oil forecast calls for a slowdown in US shale oil production which our North American Energy equity research team led by Brian Singer estimates will occur at $75/bbl WTI prices.

They estimate that the WTI oil price at which average wells in the Eagle Ford, Bakken and Permian Basin plays achieve an 11% IRR ranges between $70-$80/bbl. More importantly, they believe that funding gap constraints below $80/bbl WTI will ultimately drive the slowdown in production. Specifically, balancing capex with cash flow is likely to be the key constraint for shale producers, which continue to outspend their cash flow. Historically, E&Ps under our equity research coverage have spent 120% of cash flow annually, with only 2012 above this threshold when several companies which have since changed strategy were large spenders. At our pre-oil price decline capex assumption for 2015, this 120% reinvestment rate would be reached at $80/bbl WTI prices.

Based on their analysis of key shale play production growth at various oil prices, we estimate that WTI prices will need to remain at $75/bbl in 2015 to achieve the required 200 kb/d slowdown in production growth. Given the lag of 4-6 months between when rigs are dropped and when there is an impact to production as well as the impact of hedging, this price forecast implies a larger slowdown in US production growth in 2H15 to 650kb/d yoy.

The uncertainty around this estimate remains elevated nonetheless:

Some cuts could occur prior to $80/bbl WTI as companies with below-average free cash flow hit reinvestment thresholds first and less well capitalized companies reduce activity. Further, non-core parts of each play have higher breakevens such as non-core Bakken, which represents 19% of total Bakken production and has breakevens above $90/bbl. Finally, the decline rate at major shale plays remains high, potentially exacerbating the production growth slowdown once capex is cut.


Conversely, balance sheets have strengthened over the past few years, leaving less pressure for some companies to cut back on spending during a downturn. Further, these estimates do not assume any service cost deflation that likely would occur in a lower price environment and could lower well costs and the threshold prices at which E&P budgets would fall. Finally, should the global oversupply be significantly larger than we expect, reaching a point of production shut-in would likely require meaningfully lower prices given the low variable costs of shale extraction.

Core-OPEC can cope with lower oil prices

Estimates of breakeven oil price above our 2015 Brent forecast of $85/bbl for many OPEC members raises the question of the fiscal sustainability of these countries.

First and foremost and as we discuss above, cutting production to maintain prices at a higher level is not the optimal (revenue-maximizing) alternative for core-OPEC swing producers, given the current size of shale.

Second, eliminating the primary deficit does not imply debt sustainability as it does not set new debt issuance to zero, but rather equal to outstanding debt service. From a sustainability point of view, what actually matters is not the level of debt, but the relative size of debt to GDP: countries with very low debt-to-GDP ratios might be able to afford running primary deficits for a few periods without compromising their position.

Third, for oil producing countries, a drop in oil prices– all else equal – reduces GDP and raises the debt-to-GDP ratio, potentially adding debt sustainability pressure.



As a result, we consider other breakeven metrics that provide a broader picture and account for these issues. We consider the following simple model across OPEC producers and Russia: we split the economy into two sectors, oil and non-oil, and let non-oil GDP grow at the going rate while fixing oil production constant at our 2015 expected level. We calibrate the fiscal sector to account for oil and non-oil revenue, expenditures and debt. We then look for: (1) the oil price that lets the debt-to-GDP ratio grow up to 40% over a given number of periods, and (2) how the oil price must evolve to keep the debt-to-GDP ratio constant at its current level. This analysis shows that in both scenarios core-OPEC producers require oil prices that are below our Brent forecast, comforting us in our expectation that they can implement such a change in strategy. In turn, Nigeria and Iran require oil prices well above current levels for either to contain their leverage.

It is worth highlighting that this simple exercise abstracts from FX dynamics as core OPEC members have a pegged exchange rate to the USD. Therefore our breakeven may be an overestimation for countries with a flexible exchange rate, such as Russia and Iran. In particular, Russia’s vulnerability to oil prices is lower than for OPEC members given: (1) a flexible ruble that can act as an automatic adjustment mechanism, and (2) a banking sector now in a positive net international asset position, less dependent on foreign funding, and benefiting from a stronger ruble funding base.

Shale is accelerating the deflation in production costs

We are lowering our long-term Brent oil price forecast from $100/bbl to $90/bbl as we believe that the shale revolution has shifted the global oil cost curve down by $10/bbl. In the next few years, moderate demand growth can accommodate a pull back from more expensive projects. Medium term, continued cost deflation should allow for today’s more expensive project to still come online.



Specifically, our European Energy equity research team led by Michelle della Vigna estimates that a slowdown in capex outside North America at a time of material expansion of oil service capacity will lead to a potential 5%-15% cost deflation across oil developments after a decade of 10% inflation. The oversupplied market that we forecast for 2015-16 is likely to lead to a curb in activity that is likely to accelerate these deflationary forces.

*  *  *

And just one more thing... for those that shun 'demand' weakness as a reason for the plunge in oil...

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666's picture

When they mentioned "75" I thought they meant Obama's IQ. I was surprised it went up!

motor_angel's picture

my roomate's half-sister makes $68 every hour on the laptop . She has been fired for five months but last month her pay was $19864 just working on the laptop for a few hours. pop over here... www.Yelptrade.com

CrazyCooter's picture

No one talks about debt when they talk about shale oil. These companies are shuffling paper faster that Auther Anderson's Enron department. Seriously, we have already had one amazingly huge, super gigantic, everyone on board with the fraud, energy shenanigan in the last ten years.

This system thrives on idiots with money who can't fucking count. The price decline in oil is simply going to hasten the demise. And I assure you the working class will take it right up the ass and the insiders will be perfectly positioned for the bounce ... in coal.



Renfield's picture

Tyer/Sacrilege, spammer alert.

I'm not one to favour banning words in general, but perhaps you could make the term 'yelptrade' (or the full addy) a single exception? In honour of this spammer arseholder being unable to type its spam website? Especially since it's grown enough tech savvy to begin upvoting its spam, more than once...

NoDebt's picture

Tylers aren't on duty at night or over the weekend.  You're pushing on a button not connected to anything.  I know because I pushed on that button hard and often the last few months.  They don't give a shit.  

CrazyCooter's picture

C'mon guys, this ain't rocket science. They don't give a shit, or they are getting paid.

Personally, I skip over the trolls, this one isn't any different.

If it keeps the lights on around here, I don't give a pinch of coon shit.

Just fucking ignore them and carry on with whatever shit rocks your big, black goat.



NoDecaf's picture

It could also be for comic relief, kind of like a mascot/punching bag. I take a few shots at it from time to time.

CrazyCooter's picture

We had RobotTrader back in the day (and a few others). He got "retired".

RobotTradersMom is still around though.



booboo's picture

But what about the booming titty bar business in ND, that should thrive and all, green shoots, pink boobies, they got that going for them, trailer rentals and stuff, yea?

CrazyCooter's picture

The history of oil/energy is so boom/bust it just proves that real money has to cycle.

The smart ones save their cash in the boom and buy assets in the bust. Everyone else is selling their sweat, one way or the other. Most people aren't smart. Dakota is going to be in a world of shit at some point ... unless inflation adjusted oil prices find their way to higher ground on a longer term basis.



pragmatic hobo's picture

there is no place for such derogatory remarks ... obama's iq, as we all know, is between 85 and 95 depending on the day of the week!

post turtle saver's picture

"... and the entire US economy"

good lord, how stupid do you have to be to come to that conclusion

ebworthen's picture

The shale oil "miracle" is yet another piece of the Ponzi puzzle (another lie).

Renfield's picture

heh, handy way to blame the economic collapse on everyone but the bankster keepers of the USD, though.

The propaganda writes itself:

"The USA was on the road to ENERGY INDEPENDENCE, amid SIX YEARS OF RECOVERY brought to us by the President, who some are now referring to as President Hope. Sadly, our hopeful future has now been derailed in its hopeful beginning by [Russia or China or Saud or Iran or any other of USA`s exponential enemies or any combination thereof], the enemy of hope and all that is good. Sheeple, make sure you hate [enemy] b/c they're the reason you poor and can't have nice things. You and your optimistic, hopeful and expert banker betters are all victims, and not at fault at all for the collapse of our currency which nobody saw coming. Oh, and ebola, which we are reassured by reliable experts is finally contained. But there is some hope on the horizon. Pew Research surveyed adults in countries all around the world and found a hopeful result: they all still love love love the USA which stands for freedom. And hope! And all those debbie downers out there can relax: most surveyed would rather live in the USA than anywhere else. Up next, we take you to a little girl who got her puppy back. For some people, hope really does come true. Yay!"

CrazyCooter's picture

Ever actually see, touch, or smell a cow? Heh, or a bull?

Humans aren't really all that smart. It only takes the very occasional one to really lift the rest of the herd ... which are dumb as a box of rocks.

I guess my point is "banksters" do it because "they can". If they have trouble, they just feed the herd well for a generation, then it is harvest time. Trying to change this is like trying to legislate teen pregnancy.

If you think about it, in the old days, one didn't really need to be smart to do the work that really had to be done. Nothing really changes. People think cell phones and all this other bull shit really matter. It don't.

Happiness for me has been getting further and further away from people so they fuck up less and less of what I have to live with every day.




Renfield's picture

<<Happiness for me has been getting further and further away from people so they fuck up less and less of what I have to live with every day.>>

And if you're there, you've found a little slice of heaven. That's my same goal in life.

CrazyCooter's picture

It is 600 to 900 milles to a population center larger than my own of about 30k. That radius could humble the state of Texas.

And I got 99% hydro power 99% of the time. When it comes around, the 1% is an ass whippin.

Do your homework and be crazy enough to do it if you think you got yer shit together. Ain't been a cake walk for me. Considering a second job again to flush bills and get over the hump.



NoDebt's picture

Most of us are consumers of oil and the lower it goes, the better.  As far as I'm concerned, I hope they all go broke ramping up production in a vain attempt to offset collapsing revenues and profits.  

OPEC is falling apart (give me a minute to shed a crocodile tear for that 'tragedy').  If you're not investing in energy companies (or working for one) this is nothing but a net net positive for you.

Back in the old days we called this process supply-and-demand.  Or "market forces".  Shit nobody cares about any more.  

BeanusCountus's picture

Agree. I could care less if oil goes to 20 a barrel for the producers. It wont, but would love it if gasoline falls to 1.50. But by the time gov adds another $2 a gallon to fix roads we'll never see the bennies. Look, Shale is what it is. It's never been about reducing what we pay. It's about giving USA the ability to not be held hostage by Saudi. And its a good thing. Who gives a shit if they need $80 a barrel to make it go? Nice to know we got it if we need it.

Oldwood's picture

Lots of pieces to this puzzle. Regarding oil, we have seen major spikes in prices over many decades, each time precipitating economic downturns. Each time we see these prices rise we also see massive investments in alternative energy programs, with our government leading the surge with taxpayer assets (cash and debt), and each time, at the moment when it seems to be working the price of oil falls, pulling the rug from under all of the alternatives, foreign oil providers again becoming our best friend. How much of this is deliberate and how much is just stupidity, I don't know. But its fucked up. We are supposed to have an energy department who's very existence is to resolve these issues, and while I'm not a big market interventionist, it would seem that some protectionist or at least nationalist policy should be in place. Instead we simply alternately bribe and bomb our oil suppliers, with those costs being hidden from we consumers. It would be far better to pay a oil tariff on imported oil, paying the costs up front rather than maintain this deadly charade indefinitely. But who am I fooling....transparency is like sunlight to vampires as far as most citizens are concerned.

CrazyCooter's picture

Always enjoy your comments OldWood.

Gov't ain't here to help, but I suspect you don't disagree with that.

They are simply pushing things around and making money for insiders.

For example, consider this (old) recap:




CrazyCooter's picture

I don't invest (right now) but if I did select (conventional) energy companies would be what I really analysed.

I really think coal is going to shine after the shale oil boom (which is oddly absent everywhere else in the world - despite being a tech from the 80s) goes tits up.

NatGas will crater and utilities will run right back to coal.

I think the real tell is coal assets going through BK processes to shed their liabilities so they come out clean ... and profitable when customers show up with cash.

Fucking the working guy (pensions), and property owners (environmental dammage), but that is the same old story.



rickv404's picture

Hokum. This isn't about oil. It's about the Fed temporarily suspending QE for the sake of the election. Janet serving her party. Those oil/gas prices will rise again after the eleciton, no doubt about it.

new game's picture

shocker, thanx goldman, wow, (awestruck) gdp charts overlay oil/bbl, great fucking research, oh and thanx for the heads up that marginal players will stack out around 75, whooo'd a thunk. and these fucking brainiachs make 1/2 mil/ yrs, fucken-eh...

robnume's picture

Because...we're gonna party like it's 1975!!

ekm1's picture


So, sell prices float but costs are constant right?

People, learn some economics, learn what money is how it is created


In deflation, all prices go down, both costs and sell price. Even $60 per barrel, shale oil is profitable.

Renfield's picture

ekm, I agree with you about costs decreasing too. But I downticked you b/c of what Cooter mentions above:

<<No one talks about debt when they talk about shale oil. These companies are shuffling paper faster that Auther Anderson's Enron department.>>

(I think the 'shale miracle' is a fraud, but not just b/c of high costs alone. 'Unsustainable' is my best description of how the industry looks to me.)

ekm1's picture

government will subsidize

CrazyCooter's picture

Always enjoy butting horns with you EKM1, but to correct your statement "government *is* subsidizing". The moment of truth comes around when rates move to historical norms (and we all know they will overshoot when they correct).

These "shale/fracking companies" will simply explode. Timing? Who fucking knows at this point.

The only way to support shale/fracking development, which is ABSENT in every other country on the planet (?because they don't have shale formations or 1980s drilling tech or can't write a check for it on borrowed cash or HELL even foreign majors want a piece of the sweet pie?) is continued subsidies via cheap mainlines of credit from an expansionary monetary policy that has to park its heroin dick in the prettiest whore it can find.

But that never leads to household formation, at least in the productive sense. Just more wards of the state on the backs of the taxpayers.

A'int progress.



LostandFound's picture

Half right and half wrong.

The business plan for shale is based on capital and operational costs, like any other business plan. The model no doubt is based on optimistic revenue price on Shale oil sales (in order to get the government funding), when the revenue gets monkey hammered down, then as a business you have already incurred your setting up costs (technology and infrastructure) so the only thing left to deflate is the operational costs and this doesnt happen over night, no way near as quick as the price of oil falling!

You dont just cut 1.5% from salaries over night....

I agree with Oldwood here and you in terms of the intent of OPEC and in particular KSA, this is about control of the spice. Table 13 in this thread is dynamite and says everything it needs to.

WTFUD's picture

This has got fuck all to do with the Real price of oil. It's the double tax probation the government of the uk wish to serve upon its serfs, significantly and strangely beaten by the triple tax probation served up to the Norwegians ( which is very fucking strange with them being a producer and serfs being charged at the pump 40% more per litre than say a non producer like spain or portugal ).


Haager's picture

Oil at or better below 75. They want it, they'll get it.

Notsobadwlad's picture

Blah, blah, yeah ... that is only with the current cost and capital structure which is very wasteful.

Banking analysts always seem to want to find a way to justify what they want to happen, whether it makes logical sense or not ... or maybe that is simply human nature.

viator's picture

Cheaper oil is going to lower costs in many places, a good thing. Hydrocarbon prices follow each other to some extent.

Cheaper oil means cheaper gas, fuel oil, and diesel.

Industrial feed-stocks will be cheaper, transportation costs will fall, heating costs will fall, electrical generating costs from gas and fuel oil will fall, all good outcomes.

Lower costs means more money for other uses. For example, if your heating and gas costs decline you have more discretionary income.

This is not the first time the oil and gas industry has experience a price drop.