Oil Will Struggle to Break Past $60 a Barrel in 2016

Continued supply glut will continue to suppress prices, investment banks say

By GEORGI KANTCHEV and SARAH KENT
Updated Oct. 29, 2015 7:15 p.m. ET

Some of the world’s largest energy companies and investment banks are becoming more pessimistic about the ability of crude oil pricing to reach even $60 a barrel next year, reporting steep losses as they take hits on projects that no longer make financial sense.

A barrel of oil fetched more than $100 in June 2014, but a combination of ample supply and weaker demand has driven the international benchmark price to about $50 in the third quarter, the lowest sustained levels since the financial crisis.

Continued oversupply means that next year, Brent crude prices will average $58 a barrel and West Texas Intermediate, the U.S. oil benchmark, will average $54 a barrel, according to 13 investment banks polled by The Wall Street Journal. Many of the same banks were predicting $70 a barrel in 2016 just a few months ago.

The analysis comes as energy titans such as Royal Dutch Shell PLC and France’s Total SAon Thursday reported billions of dollars in write-downs after a quarter in which oil prices fell to the lowest since the financial crisis. BP PLC earlier this week said it had revamped its business to be cash-flow positive by 2017 at $60 a barrel.

On Thursday, Brent crude settled at $48.80 a barrel while WTI ended at $46.06 a barrel.

“The reality of the day is that we don’t know when and how this will balance out. We don’t even know if it really stabilizes,” said Ben van Beurden, Shell’s CEO, on Thursday. “If you have a high degree of uncertainty over the oil price, you have to have projects that are very resilient.”

While U.S. shale oil production, a driving factor in the supply glut, has started to fall, heavyweight producers like Saudi Arabia and Russia are still pumping at near-record levels at a time when the market is anticipating new crude from Iran. Though supply remains strong, demand growth is expected to weaken alongside a decline in the economy of China, the world’s No. 2 oil consumer.

Cheap energy is forcing other producers to give up on ventures that no longer make sense with prices below $50 a barrel. On Thursday, several oil companies reported sharply lower earnings because of the price decline.

Shell posted a $6.1 billion third-quarter loss over its decision to walk away from exploring the Arctic for oil and from exploiting Canada’s oil sands, which contributed to $7.9 billion in charges to earnings.

In the U.S., ConocoPhillips reported a loss of $1.1 billion and announced new plans to trim spending.

Petro China Co., the biggest oil-and-gas producer by volume in China, said its third-quarter profit fell by more than 80%. At Total, the French oil giant, the decline was 69% and partly the result of a $650 million write-down in its Canada oil-sands ventures.

Italy’s Eni SpA experienced a loss of €952 million in the third quarter and decided to sell 12.5% of its troubled oil-field services company Saipem SpA.

Shell’s about-face is among the industry’s starkest. The U.K.-Dutch giant had appeared optimistic about the future direction of oil prices, moving aggressively earlier this year to buy BG Group PLC for $70 billion.

Now, Shell is looking at about $55 a barrel as the break-even price for new projects and took billions of dollars in impairment charges in the third quarter after lowering its long-term oil and gas price outlook.

“Prices need to stay low in order to balance the market,” said Michael Wittner, global head of oil research at Société Générale. “Low prices encourage global oil demand growth and also assure a significant falloff in U.S. crude production.”

Declines in crude oil prices are benefiting refiners while prompting producers to take charges to earnings on projects no longer viable. PHOTO: RICK WILKING/REUTERS

U.S. production has started to tail off as low prices force drillers to shut rigs and shelve costly projects.

According to the U.S. Energy Information Administration, the nation’s output peaked in April at a multidecade high of 9.6 million barrels a day and since has fallen to around 9.1 million barrels.

Other major suppliers, including the Organization of the Petroleum Exporting Countries have kept producing at a high pace. Last November, the 12-nation oil cartel led by Saudi Arabia embarked on a policy of keeping output high in a bid to defend its market share. Iran, which holds 13% of the world’s oil reserves, is expected to ramp up oil exportswhen sanctions against the country are lifted following July’s nuclear agreement with major Western powers. While gradual, Iran’s return could add up to 500,000 barrels a day to the global oil market by the middle of 2016, analysts say.

Meantime, a string of weak economic readings in China has fueled fears about a slowdown in the world’s second largest economy, which could spill over to other emerging markets. China recently reported growth of 6.9% for the third quarter, the lowest rate since 2009.

“Most of the growth in oil demand next year will be driven by emerging markets so what happens to these economies and especially in China matters a lot,” Mr. Wittner said.

Continued cheap crude is extending problems for everyone from Russian budget officials to U.S. shale-oil drillers. It has also hurt investors, closing some hedge funds and burning other funds and private equity managers that over the past year poured billions into debt issued by troubled energy companies, hoping to profit off a reversal of oil’s slide.

But the likelihood of continued cheap oil next year will be welcome news for many consumers and businesses.

In the U.S., the price that consumers pay to fill their tanks with gasoline has fallen by around a third from last year. For airlines and shipping companies cheaper fuel has also proved an advantage. For many companies, the price has been a boon. German airlineDeutsche Lufthansa AG raised its full year earnings outlook on Thursday as lower fuel prices helped lift profit for the third quarter 41%. Refiners, which process crude oil into products like gasoline and heating oil, also are enjoying higher profits this year, benefiting from cheaper feedstock and healthy demand, and manufacturers are facing lower energy bills.

The extent of the crude prices’ effect on the oil industry will come into sharper focus on Friday when American giants like Exxon Mobil Corp. and Chevron Corp. reveal their third-quarter earnings. Their profits have fallen in the past year, though neither has posted a net loss like Shell and other European companies this year.

Many investors share analysts’ gloomy view that companies will continue to be hit by weak oil throughout next year.

“These things take at least two years to shake off,” said Michael Hulme, manager of the Carmignac Portfolio Commodities Fund, which manages $560 million.

—Eric Sylvers and Inti Landauro contributed to this article.