“Get ready for $10 oil,” says A. Gary Shilling at Bloomberg View, and he’s not kidding:
What is the price at which major producers chicken out and slash output? Whatever that price is, it is much lower than the $125 a barrel Venezuela needs to support its mismanaged economy. The same goes for Ecuador, Algeria, Nigeria, Iraq, Iran and Angola.
Saudi Arabia requires a price of more than $90 to fund its budget. But it has $726 billion in foreign currency reserves and is betting it can survive for two years with prices of less than $40 a barrel.
Furthermore, the price when producers chicken out isn’t necessarily the average cost of production, which for 80 percent of new U.S. shale oil production this year will be $50 to $69 a barrel, according to Daniel Yergin of energy consultant IHS Cambridge Energy Research Associates. Instead, the chicken-out point is the marginal cost of production, or the additional costs after the wells are drilled and the pipes are laid. Another way to think of it: It’s the price at which cash flow for an additional barrel falls to zero.
Last month, Wood Mackenzie, an energy research organization, found that of 2,222 oil fields surveyed worldwide, only 1.6 percent would have negative cash flow at $40 a barrel. That suggests there won’t be a lot of chickening out at $40. Keep in mind that the marginal cost for efficient U.S. shale-oil producers is about $10 to $20 a barrel in the Permian Basin in Texas and about the same for oil produced in the Persian Gulf.
Which is not to say that there might not be creatures other than poultry in this farmyard: we still don’t know what effect ISIS will have on the Iraqi oil fields, and it’s been suggested more than once that ISIS’ major goal on the way to Caliphate is to knock out the Saudi royals. Not that we should be shedding any tears for Riyadh, of course.
(Via Fausta, who notes that Venezuela is already broke, and will be much, much broker with oil below $40.)