The recent cut in demand for oil by the International Energy Administration (IEA) will lead to lower production growth for the giant integrated oil companies, as they will receive less oil under agreements with foreign countries. Production growth is something they have difficulty achieving already, due to sheer size, and this headwind is something they don't need.
IEA Cut
The IEA cut its oil demand forecast for the eighth straight month. Now, it believes that oil demand in 2009 will be 83.4 million barrels per day - the lowest demand number since 2004. The decline in demand is being caused by a contraction in global GDP growth in the industrialized and emerging economies. (For more, see Oil And Gas Industry Primer.)
If this demand slowdown is realized and the IEA has a spotty track record in this regard, it doesn't bode well for the price of oil over that time frame. The longer the price of oil stays in its current range, the more easily people will believe that the price (over $100 a barrel) was due to a fluke, and not because of fundamental reasons. If this belief takes hold, companies will start to lower, even further, price assumptions embedded into long-term projects to find oil and gas. This will mean less business for oil drillers like Transocean (NYSE:RIG), which owns and operates the largest group of offshore drilling fleets.
Integrated Giants
Also, the major international oil companies will be impacted if actual demand declines and the Organization of Petroleum Exporting Countries (OPEC) has to cut production to meet a lowered quota. Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.A) and BP (NYSE:BP) all have production sharing Contracts (PSC) with members of OPEC and contractually might receive less production.
This has a slight but noticeable impact on these companies' production growth, and they break it out in the quarterly earnings press releases.
Exxon Mobil said that production decreased 3% in the fourth quarter of 2008 on a year over year basis, but excluding the impacts of lower entitlement volumes, OPEC quota effects and divestments, production was down only 1%. (For more, see A Guide To Investing In Oil Markets.)
Royal Dutch Shell reported that oil and gas production for the fourth quarter 2008 was 3.415 million barrels of oil equivalent per day (BOE/D), unchanged from the fourth quarter of 2007. However, the company reported that, "excluding the impact of divestments, production sharing contracts (PSC) pricing effects, OPEC quota restrictions and hurricanes," production was up 2%.
BP had the biggest adjustment of all the majors. In 2008, its production was 3.838 million BOE/D, which was slightly higher than 2007. However, if you adjust for the effect of lower entitlement volumes, production would have been 5% higher.
Other companies don't separate out the effect of this on production, but an examination of earnings releases can give clues. Occidental Petroleum (NYSE:OXY) doesn't provide an adjustment in its earnings release, but the company does have production from fields in Libya and Qatar, both of which are members of OPEC.
The Bottom Line
The integrated major oil companies get much of its production from fields and reserves within OPEC countries, and if demand falls as the IEA predicts, and OPEC needs to cut quotas again, they will see lower production growth as a result. This will make it more difficult for them to grow production overall.
