The 2014 oil price crash A journalist’s view

Kevin Allison

Santa Fe Institute

Aug. 13, 2015

Firstname.lastname at thomsonreuters.comTwitter @kevinallison

About me:

30 columnists and editors around the world Agenda-setting financial insight Numbers-driven. Many columnists have finance background Timely views, rather than news Audience: global financial elite

The story:

Crude prices plunged more than 50% in late 2014. Before the crash, many forecasters had assumed that oil would stay above $100 per barrel for the indefinite future. In fact, a combination of technological disruption and political pressures left the price of the world's most important commodity vulnerable to sudden collapse.

Questions:

Are current low oil prices just a blip, or have we entered a new weaker price regime for crude?

How might a better understanding of the deeply complex underpinnings of energy markets have helped experts make better predictions?

What drives oil prices?

Industrial supply/demand

Geopolitics

Money supply Financial markets

Oil prices – recent history

$ per barrel of Brent crude. Source: Reuters Eikon

Libya civil war

Iran embargo

Recovery

Financial crisis and recession

Credit bubble

Start of US shale boom

Chinese demand surge

2014 crash

Fed signals end of quantitative easing

Source: US Energy Information Administration

Shale oil boombegins

+ 50%

Like adding another Iraq to global oil supply

Supply shock: U.S. shale revolution

Shale 101

Source: US Energy Information Administration data.

U.S. shale in context

World ex-U.S.

U.S.

“OPEC’s swing producer, Saudi Arabia, might have to cut production sharply to keep prices above $100 a barrel.”

“Longer-term, if the Saudis are unwilling to keep bearing the brunt of forgone production, or if the shale revolution spreads, oil prices might become more vulnerable to a sudden collapse.”

- Breakingviews, December 2013

The big loser: Saudi Arabia

Talk of ending U.S. crude export ban

Saudi Arabia signals oil strategy shift

OPEC says will not cut production to prop up prices

Banks cut Chinese growth forecasts

Iran nuclear deal struck

U.S. oil rig count falls

Quantitative easing ends

$ per barrel of Brent crude. Source: Reuters Eikon

Oilpocalypse Now

Source: Bernstein Research

“Last year’s collapse in oil prices was not built into the forward markets. Nor was it predicted, even as an outside possibility, by economists and oil analysts.”- Financial Times, Feb.

2015

Industry and markets blindsided

Typical Wall Street view, April 2014:

Financial crisis panic selling

Eerie calm

Low oil price volatility in the months before the crash.

Brent crude historical volatility. Source: Reuters Eikon

“Oil’s eerie calm cannot continue” – Breakingviews, May 2015

Source: EOG Resources Inc company reports

Increasing returns to shale

Source: EOG Resources Inc Q1 2015 earnings presentation

Increasing returns to shale

Counter arguments:

1. The market underestimated the importance of shale drillers’ increasing returns to scale before the crash and it’s still underestimating them now.

2. Other long-term pressures bearing down on fossil fuels have the potential to catch the market off guard just like shale did.

Conventional view: Shale drillers will struggle to maintain output at current low prices. As weaker producers cut production, prices will recover to around $80-$90/barrel, perhaps over the next year or two.

Blip or regime change?

Longer-term pressures:

Spread of shale revolution (Argentina, Russia, China)Falling cost of PV solar and battery storageNew financing mechanisms (e.g. residential rooftop solar)Increasing interest in energy efficiencyMore aggressive climate action – will public opinion hit a tipping point?

Rapid technological and political shifts can up-end forecasts rooted in linear thinking. This is, ultimately, is a good thing.

Source: International Energy Agency

Conclusion:

Santa Fe Institute

Aug. 13, 2015

Special thanks: John German

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Questions?