If crude oil prices slide further to around $40 a barrel or less – they closed yesterday at $46.59 on UK markets – oil companies will start shutting down production wells.
That was the warning last night from Wood Mackenzie, the long-established Edinburgh-based energy analysts.
As oil prices continue to slide downwards, Wood Mackenzie has assessed at what price the operating cash flow from producing oil fields turns negative. Negative operating cash flow can be an immediate brake on production.
While Wood Mackenzie does not think this floor will necessarily be triggered, this latest analysis serves to gauge where it is and how much supply would be affected at what level.
Wood Mackenzie concludes that a Brent price of $40 a barrel ($/bbl) or below would see producers shutting in production at a level where there is a significant reduction of global supply. US onshore ultra-low production volume 'stripper wells' could be first to be cut.
Robert Plummer, Corporate Research Analyst for Wood Mackenzie explains: "The cash operating cost for oil fields becomes very important as prices producers can achieve for the oil they produce nears the marginal point. It can be a more immediate brake on production, although when and how that might be reached is never easy to predict.
"The point at which producing oil fields become cash negative is key in assessing how far the oil price could fall. Once the oil price reaches these levels, producers have a sometimes complex decision to continue producing, losing money on every barrel produced, or to halt production, which will reduce supply."
Wood Mackenzie analysts mined a global database of 2,222 oil producing fields, which account for total liquids production of 75 million barrels a day (b/d) and determined at three oil price points, the impact on oil production and percentage of global supply which will turn cash negative:
Being cash negative simply means that the production is more costly than the price received. This does not necessarily mean that production will be halted. The first response is usually to store oil produced in the hope that the oil can be sold when the price recovers. For others the decision to halt production is complex and raises further issues.
Plummer added. "Thus, there is no guarantee these volumes would be shut-in. Operators may prefer to continue producing oil at a loss rather than stop production – especially for large projects such as oil sands and mature fields in the North Sea."
Wood Mackenzie says the key question for oil price watchers seeking to identify a floor for the oil price is where will production be shut-in first? Concentrating on a scenario of Brent oil price of $40, its analysis highlights where and what type of production is most likely to be examined:
Some platforms share their cost burden with other linked fields, and satellite fields are dependent on a mother platform. Consequently, the economics of a group of fields have to be considered. A company seeking to reduce its expenditure for the next two to three years, may prefer to operate with a small loss, rather than start the decommissioning process which may cost hundreds of millions of dollars.
Meanwhile, in the case of Brent crude, some the world's biggest oil traders booked supertankers to store at least 25 million barrels at sea in recent days to try profit down the line if prices recover.
At least 11 supertankers have been reported as booked with storage options, shipping sources and fixture lists show, rising from around five vessels at the end of last week. Each tanker can hold a maximum of two million barrels of oil.