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When oil turns 40, the aches turn into real pain

Spencer Jakab | Wall Street Journal

The number 40, so significant for the religiously inclined, is meaningful for those praying for a rebound in energy prices too.

Brent crude, the global oil benchmark, broke through that psychologically important level Tuesday for the first time since February 2009. It may seem like it will take a miracle to turn things around, given the impasse in Vienna last week. Leaders of the Organization of the Petroleum Exporting Countries effectively threw up their hands and said “let the market sort things out.”

It will, but not before more pain for energy producers, both state-owned and private. About 40% of the market—that number again—comes from OPEC and is engaged in a war for market share. Their collective output is seen rising in 2016 as sanctions against Iran are lifted.

But another big chunk of the market, private companies that no longer quite deserve the name “big oil,” has an entirely different agenda. Those companies have already slashed investment over the past year. The latest leg down will only hasten that process.

It involves thousands of individual decisions in hundreds of boardrooms, but it boils down to two questions: How much cash is available to invest today and what return can be projected based on oil-price expectations. Both numbers are headed lower.

Compared with the summer of 2014 when prices last peaked, forecasts of earnings before interest, tax, depreciation and amortization for the world’s five largest, private integrated oil and gas companies have dropped by eye-popping $232 billion in 2015 and 2016 combined—or about 42%—according to FactSet. The five largest exploration and production companies have seen that proxy of cash flow drop by $83 billion, or close to 60%.

And those assumptions still are based on forecasts that Brent prices will bounce back to a less painful average of $60 a barrel or so in 2016. They might, but a producer wishing to lock in a price for a barrel a year from now will receive barely $48 in the futures market. Complicating matters, some large companies remain committed to stable or, in the case of Exxon Mobil and Chevron, rising dividends.

Guessing when oil prices will recover is even more complicated than it used to be when OPEC mattered. But an equally important question is now coming into focus: How sharply will prices rebound when they eventually do?

The psychological and financial impact of the continuing slump to multiyear lows is curtailing even more private projects that would have produced for years. That will make the rebound stronger for companies that can emerge from the wilderness.

The promised land isn’t in sight yet, but it’s looking better and better.