Signs point to the oil markets setting themselves up for higher prices down the road, most analysts agree. Upstream capital expenditures will be slashed for the second straight year in 2016, with more cuts likely in 2017. Low oil prices have given an extra jolt to demand, particularly in the U.S. Global demand grew by a robust 1.8 million barrels per day in 2015 and forecasts for this year have been continually revised upward. Layoffs in the labor market will make it difficult for the industry to recuperate quickly when prices rise. Long-term projects that are capital intensive have been either delayed or completely shelved. Meanwhile, there’s not yet clarity on how quickly U.S. shale can respond when prices rise and geopolitical situations surrounding oil producing countries have worsened.
A general consensus has emerged that upstream investment cuts and rising demand will push prices upward, resulting in a potentially dramatic correction that rattles the global economy. But this outcome is not inevitable.
A general consensus has emerged that all of these forces, along with the general volatile nature of the oil markets, will push prices upward, resulting in a potentially dramatic correction that rattles the global economy. One of the clichés in oil markets is that “the cure for low prices is low prices,” since adjustments on both the supply and demand sides during a weak environment will eventually bring about a tighter market. Underinvestment and sustained low prices in the 1980s and 1990s set up the dramatic price increase seen over the past decade. Both the U.S. Energy Information Administration (EIA) and the International Energy Agency (IEA) see prices around $80 at the beginning of next decade, and continuously rising thereafter. Some analysts see a bull market starting earlier, with bold predictions of oil hitting $85 by the end of the year.
While current data, trends, and sentiment point toward tighter markets and structurally higher prices at some point in the future, this outcome is not inevitable. Given that conventional wisdom has erred repeatedly in oil market analysis, it’s worth looking at what could put a lid on the global oil markets for the foreseeable future and keep prices “lower for longer,” or perhaps even indefinitely.
“It’s certainly possible prices will hit $80 by 2020, but it’s a difficult call,” Andy Lebow of Commodity Research Group told The Fuse. “Non-OPEC supply is where a lot will be lost, but right now we have a big overhang in stocks getting in the way of prices rising substantially.” He added: “Some OPEC countries will still see supply growth, and technology developments could happen faster than expected on the demand side.”
“Be careful listening to prognostications on oil prices. In fact, run the other way if you get any analysis of [oil markets].”
“Clearly, the dynamics of the markets have changed completely,” Amos Hochstein, the special envoy and coordinator for International Energy Affairs, leading the Bureau of Energy Resources at the U.S. Department of State, told an audience last week at Carnegie Endowment for International Peace. “Be careful listening to prognostications on oil prices. In fact, run the other way if you get any analysis of [oil markets].” He pointed out current oil and gas market forces were not predicted five years ago and stated that he does not believe oil prices will return to their cyclical patterns.
Hochstein added: “Fundamental changes have happened in the energy sector that have changed it forever.”
Part 1 of this series examines developments on the supply side that could keep a price spike from occurring. Part 2 will look at demand risks that could cap prices.
OPEC supply growth continues at a rapid pace
OPEC supply is highly volatile, but if all the stars align, so to speak, more can be squeezed out of the cartel, particularly with the current strategy of pumping close to all-out. Most OPEC countries have an advantage in the current environment given that they have low-cost production and can therefore keep investing.
Against this backdrop, there is more upside risk to OPEC supply than there is to the downside. In a best-case scenario, the group’s output could be near 40 mbd in 2020, a 22 percent increase versus today’s levels, outpacing demand growth expectations. The EIA, in its latest long-term outlook, sees total OPEC crude output at 39 mbd by 2020 in its low oil price scenario, with output reaching 43 mbd when other liquids are included. According to the EIA, OPEC’s production would be stronger in the low-price scenario than in the outlook with high prices.
There is more upside risk to OPEC supply than there is to the downside.
Libya is one key for a strong increase in OPEC output. Libya’s current production is only 350,000 b/d, well below capacity of 1.6 mbd. OPEC in June pumped at 32.8 mbd, a record even with Libya’s woes, up from 30 mbd near the end of 2013. Libya could bounce back quickly. A political resolution there would bring about a wave of supply in a short period of time. In fact, Libya’s National Oil Company (NOC) rivals reached an agreement this week, a development that improves the outlook for the country’s production.
If all goes well for Iran and Iraq, they have potential to increase output from today’s levels before maxing out. Iran, now pumping 3.8 mbd, has talked about reaching 4.2 mbd in the near term, with ambitions to hit 4.8 mbd by the end of the decade. In Iraq, the ambition is to reach 6 mbd by 2020, up from about 4.4 mbd now. Nigeria’s volumes have been undermined by violence from militant groups and ongoing neglect and corruption, but it could boost volumes to previous levels of 2.2 mbd if a settlement occurs. Kuwait, meanwhile, is looking to add some 1.25 mbd of supply from now through 2020.
The Saudis are another wild card that may surprise with more production. With output at now 10.3 mbd, the Kingdom has roughly 2 mbd of spare capacity. Given the country’s clear goal to increase market share, particularly as it competes in Asia and Europe versus Iran and Russia, it may actually move the needle higher. Furthermore, Saudi Arabia has kept investment steady during the downturn unlike other producers. Recent discoveries in the Kingdom could allow it to add more volumes next year. What’s more, production of 500,000 b/d in the Neutral Zone, which it shares with Kuwait and is now offline, could return if a resolution between the two is struck. “Increasing production would give the Saudis what they want, the ability to keep prices stable and choke off more non-OPEC supply,” Jeff Quigley of Stratas Advisors told The Fuse.
“Increasing production would give the Saudis what they want, the ability to keep prices stable and choke off more non-OPEC supply.”
Prince Mohammed bin Salman has stated that the Kingdom can boost 1 mbd “immediately” and reach as high as 20 mbd if it invests over the longer term. Whether the Saudis can and will reach that goal is up in the air, but it has the resources to substantially increase supply—large output increases in the Kingdom, particularly since it (along with other OPEC members) is a low-cost producer, could also undermine or at least delay any price spike.
Non-OPEC supply surprises again
U.S. shale, the main factor behind the 2014 price collapse, is a major wild card moving forward. There’s no doubt the U.S. has ample resources—Rystad Energy, a Norwegian consultant firm, estimates recoverable oil from existing fields, discoveries and yet undiscovered areas at 264 billion barrels, above giants such as Saudi Arabia and Russia.
The big questions are how quickly and at what price they can be developed. Shale has fallen by about 1 mbd from the peak last April, and forecasts say it has further to drop. However, a substantial reduction in breakeven prices, structural reduction in costs, or technological breakthrough could alter the outlook. Moreover, capital market injections could keep production afloat even if fundamentals and economics don’t warrant it.
Unconventionals outside the U.S. could also bring about a structurally lower market in the long run, particularly if growth occurs in politically stable countries.
While U.S. shale, in an optimistic scenario, can possibly dampen an upturn in the near-to-medium term, unconventionals outside the U.S. could also bring about a structurally lower market in the long run, particularly if growth occurs in politically stable countries. Other countries replicating the U.S.’s shale success may take time, but such a scenario would alter the outlook over the longer term, keeping prices low and stable. The hottest spot right now is Argentina’s Vaca Muerta, a giant field where some reserve estimates are higher than 20 billion barrels. Other potential big markets for unconventionals include Mexico, Australia, Venezuela, Russia, Libya, China and the UAE, even though hurdles such as costs, politics, and infrastructure need to be overcome.
A price spike not yet a foregone conclusion
Oil prices faltered in 2014 because of supply-side developments. Although physical fundamentals are moving into balance, there is still a large stock overhang that will take time to draw down. Besides the inventory cushion, supply growth in both OPEC and non-OPEC countries, even with investment getting slashed, may end up keeping the market in check. A price spike, while possible, is not yet a forgone conclusion.