That's great for consumers -- but what about investors?
It's too soon to buy many oil stocks, especially those in oil services, even though they're cheap. Here are some reasons why.
First, the U.S. is now the world's swing producer -- and its average cost of production is about $60, analysts and executives estimate.
When oil goes below $50, companies that need $60 to $70 a barrel to make money cut way back on drilling. You can see the carnage all over the oil sector: drilling-services companies like Baker Hughes (BHI) and Halliburton (HAL - Get Report) , which have already reported tough second quarter results, took the brunt of it.
That's what happens when the number of U.S. rigs producing crude drops to 495 from 1,112 in nine months. Integrated companies like Exxon Mobil (XOM - Get Report) and Chevron (CVX - Get Report) have been hit, but less hard, because demand held up for the refined products they make in divisions other than their exploration units. Pipeline companies have held up better still, with investors relying on contracts they have with producers that don't tie their revenue to the price of oil.
That lack of quantity in drilling is what has clobbered Baker Hughes and Halliburton, and held down their profits.
Baker Hughes managed to beat the analyst estimate for revenue of $3.88 billion with consolidated revenue of $4 billion, but its adjusted loss of 14 cents per share missed consensus forecasts by 5 cents. Revenue was down from last year.
Hallliburton reported revenue of $5.92 billion for the quarter, down 26.5% from $8.05 billion in the second quarter last year. Halliburton's revenue fell mostly because of slower North American drilling, which has has been declining since early this year. Its operating income fell 46% to $643 million. Both revenue and profit beat Wall Street estimates.
Some analysts argue that this is all relatively good news, especially after the decline in oil stocks in the last year. And the major services stocks have retraced some of their losses this year. Wells Fargo raised its price target on Schlumberger on July 20, arguing that it has cut costs and will benefit from customers in the Middle East who want to reinvest to cut their cost of production.
Still, the reeds are weak.
The Wells Fargo bullish argument on Schlumberger assumes a pickup in spending by clients, some fairly strapped for money, who are already lower-cost producers. And the markets that Mideast oil serves in Asia and Europe are either slowing their growth, as in China, or struggling to get out of recession. So the push for Schlumberger and other Mideast-focused players won't come from growth in oil demand.
The cost argument assumes that a burst of merger activity will bolster oil companies throughout the value chain, but those mergers are coming only slowly. The Halliburton-Baker Hughes deal announced last November is still in regulatory review. And aside from Royal Dutch Shell's (RDS.A - Get Report) deal to buy BG (BRGYY), the expected wave of takeovers in exploration and production hasn't happened yet.
The most important reason for that is there's still a difference of opinion between buyers and sellers about where oil prices will land.
"Without the Shell-BG merger... the value of deals in the second quarter of 2015 would have totaled $31 billion, $18 billion higher than first-quarter 2015, which was the lowest since at least 2008," said U.S. Energy Information Administration analysts Jeff Barron and Grant Nulle last week. "The 137 deals announced in the second quarter was the lowest number of deals since fourth-quarter 2008 and 42% below the 235 median quarterly number of deals over the previous two years, indicating less breadth of activity."
The U.S. is in the catbird seat in oil markets -- but that doesn't help stocks much. The power the U.S. now holds as the world's swing producer, along with Saudi Arabia, points to an oil market that doesn't get much past $60 a barrel. Until consolidation lets producers and services companies get more profitable at those levels, times will stay hard.
About 90 million barrels of oil are produced each day worldwide. Nearly every OPEC nation, plus Russia, has a problem: many can produce oil very cheaply, but have such expensive cross-subsidies and oil-funded social spending baked into their social contracts that they really need $100 oil.
When oil gets this cheap, they have a dilemma. Do they pump at a direct cost of $10 a barrel or less, and use the money they get to pay for what they can, or do they stop pumping in a bid to force prices higher, go on a diet and risk political turmoil at home?
We know OPEC will take the money at nearly any price, and except for Saudi Arabia, OPEC's countries don't even reduce production much. So they don't set the price any more, unless the Saudis do it for them.
But the U.S. and Canada now produce about 12 million barrels a day -- and they do it in a way that responds to prices.
Here's where you get to what's obviously wrong with predictions that crude is headed back to $100 soon. When oil hits $75 a barrel and production is back in the money, North American supply will revive. And that will set an upper limit on the price. This is exactly what has happened in the natural-gas market, where prices went from $13 per million BTUs to $1.70, up to $6, and then back down to $2.78 as supply re-emerged.
"We believe that should [U.S. oil] prices remain near $60/barrel, U.S. producers will ramp up activity given improved returns with costs down nearly 30% and producers increasingly comfortable at the current costs/revenue/funding mix," two Goldman Sachs analysts wrote this week.
So Halliburton and the rest can make money -- but they have to be prepared to do it at $60 a barrel. And they're not set up to recoup their former profits at those levels yet.
The thing pushing crude even lower for now is the Iran anti-nuclear deal. Reports coming out of research firms and brokerage houses suggest investors may be making too much of that, too soon. But over time, it, too, will conspire to keep prices at $60 or even $50 over the medium term.
Iran's oil exports to the world market have fallen by about 1.2 million barrels per day since 2011, according to the U.S. Energy Department. (None of it goes to the U.S.) Reports from Goldman Sachs and Rystad Research suggest it will take as long as two years to get even half of that capacity back online. (A good roundup of the analyst reports is found on Pakistani news site Dawn.com).
Goldman is telling oil traders the short-term action in oil is overdone -- but they should be careful about 2016 and 2017, when the renewed supplies will reach the market in earnest.
Put these together, and the thing you can say with the most conviction is that a sustained price rebound for crude is off the table for a long time. It will likely linger near these levels, albeit with some upward bumps toward $60, once Iranian crude comes back onto the market. If the U.S. cost of production falls further, as it has been doing while drillers get better at extracting tight oil from rocks, the lower prices that follow Iran's full re-entry could be persistent.
All the big oil companies, whether they're in exploration or services, will have to deal with these lower prices before things get materially better.