LMD - April 2015.PDF
1
N ot long ago, the benchmark Brent oil price peaked at US$ 116 a barrel – its highest level for 2014 – before it ventured on a relentless slide of over 60 percent. This drop in price has plunged the oil industry into crisis, with major international oil companies cancelling billions of dollars’ worth of projects planned for 2015/16. Oil prices have always resulted in agony at extreme ends. Although a number of reasons are attributed by economists for the outcome, if we had analysed the facts, we would’ve known it was coming. Extremely high prices lead to demand destruction and over- expenditure on exploration, which leads to oversupply and a downward price spiral. Similarly, extremely low prices lead to increased consumer spending on oil-based products and a withdrawal of EPC (Engineering, Procurement, Construction) companies, due to lower or negative margins which eventually lead to a decline in supply, stretching the prices northwards. Spooked by a rise in the price of oil to 55 dollars a barrel in 2005, from less than 20 dollars at the end of the 20 th century, ethanol-gasoline blending took priority. And in 2007, responding to further increases in oil prices, many countries raised fuel-economy standards for vehicles sold. Government regulations were introduced in many economies between 2004 and 2014, to promote energy conservation and reduce the demand for increasingly expensive imported oil. Massive demand destruction and petroleum conservation techniques have been adopted around the world. Such is the see-saw battle of oil economics. Soaring prices of petroleum products force motorists, truck operators and airlines to reduce fuel consumption. The number of vehicle journeys begins to fall, consumers purchase smaller and increasingly fuel-efficient cars, trucking companies rationalise their delivery schedules, and airlines revamp and streamline their networks and remove excess weight from aircraft. Gas-based fuels became increasingly popular as a cheaper alternative fuel for buses and trucks. Sustained low oil prices are also likely to cause stress on oil-producing countries. High prices did more than simply contain demand – they acted as a key catalyst for the so-called shale boom, which resulted in the fastest growth of oil production in history, in 2013 and 2014. Output surged, and currently stands above nine million barrels a day. Production growth has accelerated, as shale drillers become more efficient. Across the globe, high prices stimulated record investments in exploration and production. So much extra crude has come from shale and other sources that oil prices continued to free-fall. Recently, we have witnessed the global oil market at unsustainable levels, with stagnating demand and increasing supply. The only rational outcome was a sharp correction in prices, to curb demand destruction and curtail investments in new sources of production. But the need for lower prices was shrouded by two factors. Firstly, many observers doubted the shale revolution could last. Second, increased output from the US was offset by a loss of production across the Middle East and Africa, as a result of the Arab Spring and sanctions imposed on Libya, Syria, Sudan and Iran. In 2011, OPEC concluded that “shale oil should not be viewed as anything other than a source of marginal addition to crude oil supply.” By 2013, however, that position was no longer tenable, as shale production continued to accelerate. OPEC’s 2012 World Oil Outlook acknowledged that “shale oil represents a large change to the supply picture,” the scale of which is more obvious today. Until mid 2014, developments around oil-producing regions kept the world guessing. It seemed that unplanned outages might offset the continued rise of shale production. The perception of rising geopolitical risks to oil supplies encouraged hedge fund brokers to be bullish. But in the latter half of 2014, it became clear that geopolitics alone cannot interrupt the supply of crude any further. Oil continued to flow from all corners, and it became increasingly obvious that a sharp price correction was inevitable. Given that signs of a recovery in crude oil demand remain elusive, and a cut in supply is not visible, when the slide in prices might halt remains an unanswered question. The thought of prices dropping further is a cause for concern in oil-producing countries. The oil price slump is often portrayed as a straight fight between Saudi Arabia and shale drillers, but the real picture is more complicated. Shale production is more expensive than tapping conventional fields, but cheaper than some megaprojects. As a result, oil sands producers have found themselves caught in the crossfire between OPEC on the one hand, and shale entrepreneurs on the other. Oil prices must ultimately drop to a point at which the market rebalances. And there are signs that this adjustment is underway. 155 – APRIL 2015 – LMD The writer is a senior professional in the oil and gas industry. He is based in India. In the latter half of 2014, it became clear that geopolitics alone cannot interrupt the supply of crude any further… PRESS LOFT/TAPETENHANS REBALANCING ACT UNDERWAY Praveen Jaiswal reports on the see-saw battle for oil price supremacy THE OIL MARKET
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Not long ago, thebenchmark Brent oilprice peaked at US$116 a barrel itshighest level for2014 before itventured on a relentless slide of over 60 percent. This drop in price has plunged the oilindustry into crisis, with majorinternational oil companiescancelling billions of dollarsworth of projects planned for2015/16.
Oil prices have alwaysresulted in agony at extremeends. Although a number ofreasons are attributed byeconomists for the outcome, ifwe had analysed the facts, wewouldve known it was coming.
Extremely high prices lead todemand destruction and over-expenditure on exploration,which leads to oversupply and a downward price spiral.Similarly, extremely low priceslead to increased consumerspending on oil-based productsand a withdrawal of EPC(Engineering, Procurement,Construction) companies, dueto lower or negative marginswhich eventually lead to adecline in supply, stretching the prices northwards.
Spooked by a rise in the priceof oil to 55 dollars a barrel in2005, from less than 20 dollarsat the end of the 20th century,ethanol-gasoline blending took priority. And in 2007,responding to further increasesin oil prices, many countriesraised fuel-economy standardsfor vehicles sold.
Government regulations wereintroduced in many economiesbetween 2004 and 2014, topromote energy conservationand reduce the demand forincreasingly expensiveimported oil.
Massive demand destructionand petroleum conservationtechniques have been adoptedaround the world.
Such is the see-saw battle of oil economics.
Soaring prices of petroleumproducts force motorists, truckoperators and airlines to reducefuel consumption. The numberof vehicle journeys begins to fall, consumers purchasesmaller and increasingly fuel-efficient cars, truckingcompanies rationalise theirdelivery schedules, and airlinesrevamp and streamline theirnetworks and remove excess
weight from aircraft. Gas-basedfuels became increasinglypopular as a cheaper alternativefuel for buses and trucks.
Sustained low oil prices arealso likely to cause stress onoil-producing countries. Highprices did more than simplycontain demand they acted asa key catalyst for the so-calledshale boom, which resulted in the fastest growth of oilproduction in history, in 2013and 2014. Output surged, and currently stands above nine million barrels a day.Production growth hasaccelerated, as shale drillersbecome more efficient.
Across the globe, high pricesstimulated record investmentsin exploration and production.So much extra crude has comefrom shale and other sourcesthat oil prices continued to free-fall.
Recently, we have witnessedthe global oil market atunsustainable levels, withstagnating demand andincreasing supply. The onlyrational outcome was a sharpcorrection in prices, to curbdemand destruction and curtailinvestments in new sources of production.
But the need for lower priceswas shrouded by two factors.Firstly, many observers doubtedthe shale revolution could last.Second, increased output fromthe US was offset by a loss ofproduction across the MiddleEast and Africa, as a result of
the Arab Spring and sanctionsimposed on Libya, Syria, Sudan and Iran.
In 2011, OPEC concluded thatshale oil should not be viewedas anything other than a sourceof marginal addition to crudeoil supply. By 2013, however,that position was no longertenable, as shale productioncontinued to accelerate.OPECs 2012 World OilOutlook acknowledged thatshale oil represents a largechange to the supply picture,the scale of which is moreobvious today.
Until mid 2014, developmentsaround oil-producing regions
kept the world guessing. Itseemed that unplanned outagesmight offset the continued rise of shale production.
The perception of risinggeopolitical risks to oil suppliesencouraged hedge fund brokersto be bullish. But in the latterhalf of 2014, it became clearthat geopolitics alone cannotinterrupt the supply of crudeany further. Oil continued toflow from all corners, and itbecame increasingly obviousthat a sharp price correctionwas inevitable.
Given that signs of a recoveryin crude oil demand remainelusive, and a cut in supply isnot visible, when the slide inprices might halt remains anunanswered question. Thethought of prices droppingfurther is a cause for concern in oil-producing countries.
The oil price slump is oftenportrayed as a straight fightbetween Saudi Arabia and shale drillers, but the realpicture is more complicated.
Shale production is moreexpensive than tappingconventional fields, but cheaperthan some megaprojects. As aresult, oil sands producers havefound themselves caught in the crossfire between OPEC on the one hand, and shaleentrepreneurs on the other.
Oil prices must ultimatelydrop to a point at which themarket rebalances. And thereare signs that this adjustment is underway.
155 APRIL 2015 LMD
The writer is a senior professional in the oil and gas industry. He is based in India.
In the latter half of 2014, itbecame clear that geopoliticsalone cannot interrupt thesupply of crude any further
PRES
S LO
FT/T
APE
TEN
HA
NS
REBALANCING ACT UNDERWAY Praveen Jaiswal reports on the see-saw battle for oil price supremacy
T H E O I L M A R K E T
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