Break-even and burn rates in the global oil market

FT Alphaville had a good discussion yesterday on the two most important questions for determining the fundamental bottom of the oil market. The burn rate for sovereigns and the break-even price for shale oil in the US. 

The burn rates tells us how long will reserve assets last before there will not any assets available to meet government expenditures. We know in many of these countries taxes  are not going to be raised to meet budget deficits. It is all about oil revenues. If oil revenues decline, there will be a budget deficit that has to be paid out of reserves.

If the burn rate is short, we know that production will have to be maintained or increase to offset price declines to stabilize revenue. If the burn rate is long, a country could cut production at lower prices and dip into reserve until prices increase. Nigeria's cash stockpile will only last about four months. For Russia, their stockpile will allow them to keep government expenditures the same for just under 4 years. Saudi Arabia has a cash stockpile that will last just under eight years. The Saudis can cut production. Nigeria cannot. This gives us some idea of production alternatives for state owned oil companies.

The break-even cost of production is important for shale oil which has seen the biggest marginal increase in production over the last few years. Shale oil production is the leading supply cause for lower prices. The latest research suggests that the break-even price is now $57 per barrel versus about $70 per barrel last year. This is a big difference and a big change in the calculus of production. Shale oil producers will still push production at current or even lower prices without the risk of losing money on every barrel.

The bottom line is that if you think there will be a significant supply response to the recent fall in price, think again.