Oil prices are potentially set for a sharp increase and general unpredictability as global oil markets enter a “decade of disorder” in the 2020s. According to experts speaking Tuesday night on a panel hosted by Securing America’s Future Energy (SAFE), a combination of underinvestment in long-cycle conventional petroleum projects and rising geopolitical risk, alongside growing demand in emerging markets, will create an oil production capacity shortage unless final investment decisions on multiple large-scale oil projects are taken soon.
“The fact that our entire economy depends on oil is an existential challenge because oil prices are highly prone to volatility. We spend staggering sums on both domestic and imported oil,” said Leslie Hayward, SAFE’s VP of Content and Communications Strategy, during opening remarks.
The weak oil price environment of the past few years is discouraging oil companies from sanctioning the necessary investments in future capacity.
“The fact that our entire economy depends on oil is an existential challenge because oil prices are highly prone to volatility.”
“The lack of investment in conventional crude oil could lead to a supply gap as we move out to the 2020s,” said Adam Sieminski, former Energy Information Administration (EIA) administrator and now the James R. Schlesinger Chair for Energy and Geopolitics Center for Strategic and International Studies (CSIS). “And the geopolitics, in Venezuela or somewhere else, could be devastating. The decade of disorder is a short way of saying that we’ve been through these cycles before, and we’re probably not going to see prices stay low forever.”
Jonathan Chanis, SAFE’s Senior VP of Policy, highlighted challenges the industry has faced over the decades in trying to moderate the investment cycle. It has had to contend with periods of excess of supply followed by periods of underinvestment and then shortages. He argued that if a limited number of large projects, such as those in the offshore areas of Brazil and Norway, and in the U.S. Gulf of Mexico, are not sanctioned in the next 12-24 months, oil prices will again approach $100 per barrel. The world needs approximately 5 million barrels per day (mbd) of new supply every year just to compensate for the natural decline of existing fields and “stay in the same place.” He added that even more production growth is needed to keep up with rising demand. Chanis estimates that 40 mbd of new output will be needed in next 6-8 years to offset these natural declines and meet demand growth. “When it comes to large increases in production, the supply curve is essentially inelastic,” said Chanis. “You get to a point where the price can rise ever higher, and you don’t get that much more supply. The curve literally goes vertical.”
One of the largest misconceptions about today’s oil market is that growth in U.S. shale oil will continue to dampen volatility and keep prices low.
One of the largest misconceptions about today’s oil market is that growth in U.S. shale oil will continue to dampen volatility and keep prices low. However, Sieminski and Chanis warned against this viewpoint. “The Permian is not going to be enough” to meet the coming global oil supply gap, said Chanis, even if one accepts the most optimistic outlooks for U.S. shale. Shale has throughout this decade curbed OPEC’s power by bringing new supply to the market in a short period of time. However, the producer group has responded by increasing cooperation with a number of non-OPEC countries. OPEC’s ability to bring Russia into its production agreement is a “match made in heaven,” according to Chanis, leading to “unprecedented cooperation.” He added: “This is a collusive agreement by a group of producers to restrain supply and keep prices higher than they would normally be.”
Lack of data
Both panelists highlighted the problems of reliable and transparent data in the oil markets, and how that precipitates greater uncertainty for industry, governments, and consumers. Data collected in the OECD is increasingly trustworthy, but the explosion in demand growth is occurring in countries where data is not as dependable and timely, Sieminski pointed out. “We are probably going to have to invest in and work with other countries to improve the quality of data to have proper functioning markets,” he said.
Some market participants benefit from the lack of transparency, including OPEC producers. “The market in a way doesn’t want transparency. You don’t make money in transparent markets,” said Chanis. “You make money when markets are opaque.”
It’s not just data on current supply, demand, and prices that are deficient. There are also questions about proven reserves in major oil producers. “What’s the true reserves numbers for OPEC countries?” said Chanis.
Given the difficulties with gathering high-quality data, oil markets will likely have to contend with gaps in information. This ongoing problem is certain to negatively affect investment decisions.
Policy responses needed
The panelists emphasized the necessity for policy responses to help mitigate the effects of a sharp increase in prices. These include increased fuel efficiency, incentives to encourage alternatives in transportation, investments in new technologies, and greater domestic exploration and production.
“If you’re really going to push energy security, diversity is the first thing you look for—diversity in supply, diversity in demand.”
“In a broader sense, policy has a very strong role to play in energy security,” Sieminski told the audience. “Fuel efficiency standards, for example. They are significant in how they can change behavior…If you’re really going to push energy security, diversity is the first thing you look for—diversity in supply, diversity in demand.”
Increasing domestic drilling is also an important factor in improving U.S. energy security. Both see the possible opening of the Arctic National Wildlife Refuge (ANWR) in Alaska as a positive sign. And companies will be interested in producing there if it is opened, even though the first oil will not likely be produced for six or more years.
Both downplayed the possibility of oil demand peaking next decade despite improvements in battery costs, which will make electric vehicles attractive for consumers. “Keep in mind, the fleet generally only turns over once every 12 years,” said Sieminski, noting that even when electric vehicles achieve price parity with internal combustion engines, it will take a significant amount of time for them to become a large enough part of the fleet to substantially curb oil demand. “I’m a bit of a skeptic, not that we’ll sell electric vehicles, but that they will mark the end of oil demand,” Sieminski said.
Low prices since the middle of 2014 have obscured the increasingly dangerous situation occurring in the oil markets. As the panelists noted, the likelihood that we will see a period in the oil markets similar to the 2000s is increasing. Factors leading toward a decade of disorder are now in motion—growing geopolitical risks, continued under-investment, and rising demand. “There are so many contingent variables,” said Chanis. “Who’s going to be running Venezuela? Who’s going to be running Saudi Arabia? What’s going to happen to these critical final investment decisions?”