Can the oil business have another boom?
(Article originally published in Jan/Feb 2018 edition.)
She loves me? She loves me not? She loves me? She loves me not? Usually while contemplating the answer to these questions, a daisy’s petals are being picked. The question has a binary answer – and hopefully the right one. Now if you’re into binary decisions and if it’s Mother Nature you’re talking about, the questions are more likely: Bitter cold? Extraordinary heat? Or maybe: Drought? Flooding rains?
For oil industry executives, the daisy-picking exercise is about commodity prices. Higher oil prices? Lower oil prices? Higher gas prices? Lower gas prices? This time those execs want to know: Industry boom or industry bust?
Hasn’t the energy industry been living through a bust for the past three years? Why would anyone think it could be facing another bust? For the first time in recorded history, the recent bust saw two consecutive years of capital spending declines. Capital spending is the lifeblood of the industry and critical for the future of global energy supply.
In fact, energy consultants are reporting that in 2017, due to the investment cutback, the smallest volume of new oil reserves was found since the 1940s. Think about that. After 70 years of hard work, we are back to the 1940s? What that means is a shock to the global economy is lurking when oil supplies cannot satisfy demand. Will governments let market prices allocate supply or will we revisit rationing?
In 2015 and 2016 the industry slashed spending by nearly 50 percent according to Barclays’ Upstream Capital Spending Survey. It spent nearly $330 billion less in 2016 on new wells than it had barely 24 months earlier. The oil price collapse from $100 a barrel in mid-2014 to just $26 a barrel in less than two years devastated the industry. Thousands of employees lost their jobs; hundreds of companies were forced into bankruptcy, and billions of dollars of value were destroyed.
Turning the Corner
If 2016 marked the low point for the energy business, 2017 brought improvement. While not a complete recovery, crude oil futures rising 12.5 percent last year certainly helped. More spectacularly, oil prices finished the year up a blistering 40 percent from their June lows. Improving fundamentals encouraged producers to boost spending by four percent. While not all sectors benefited, the industry avoided the abyss it was fast approaching.
Investment surveys suggest a doubling of last year’s four-percent spending increase in 2018. Optimists are even talking about double-digit gains this year. Driving more spending is the prospect of higher oil prices. Synchronized global economic growth, coupled with rigid adherence to OPEC and non-OPEC production cuts, has drained global oil inventories sharply. Wisdom says a more balanced oil market should support oil prices and ultimately drive them higher.
On 2017’s final trading day, West Texas Intermediate crude oil futures closed above $60 a barrel, the highest close in 36 months. This year, WTI futures have held above the magical $60 a barrel threshold, supported by lower inventories, increased geopolitical tensions in the Middle East and Venezuela’s collapsing output.
On everyone’s mind now is where does this recovery go? Are we headed back to $100 a barrel, or will higher oil prices begin sapping demand while encouraging additional supply? Industry players are hoping for the former but worried about the latter. They are haunted by fear of another failed price recovery. The answer will depend on the response of America’s shale oil producers to higher prices.
As oil executives wrestle with the 2018 outlook, lurking in the background are questions about long-term forces impacting oil consumption and supply. Apart from geopolitical events, for which making forecasts is impossible, industry executives are striving to understand the degree of disruption underway in the power and transportation sectors from environmental concerns and governmental edicts over the use of fossil fuels to power economies.
The transition to a new energy source to power the global economy has been speculated on for many years, but now people are becoming concerned that the transition is here and being driven, not by economics and technology, but rather by edict.
Since the 1800s the world has enjoyed a broadening slate of energy resources, ranging from super-clean to extremely dirty in terms of carbon emissions. For decades, fuel choice meant selecting the least costly but most efficient and reliable fuel available. The issue of carbon emissions was not a priority even though society has fought for cleaner air for decades. Will fewer fuel choices, and more expensive ones, be our future?
Until the 1990s, when climate scientists shifted their focus from global cooling to global warming and eventually embraced climate change, the role of carbon emissions in driving higher temperatures was ignored in favor of eliminating the particulates emitted by burning carbon-rich fuels. Those particulates contributed to human health problems, and cleaner air was considered more important than hotter temperatures.
That suddenly changed, aided by the development of climate models projecting cataclysmic outcomes for the globe if society did not stop and eventually reduce the amount of carbon injected into the atmosphere. The obsession with stopping carbon emissions is reshaping the energy world – from legal battles over what ExxonMobil knew about the potential risk to the value of its assets by restrictions on the use of oil and gas to simply banning vehicles using hydrocarbon power.
While environmental forces are playing a greater role in defining energy’s future, we cannot ignore how the shale revolution, which is revamping America’s oil and gas industry, is also radically altering the nation’s geopolitical role.
A new book, Windfall, by Meghan O’Sullivan of Harvard University’s Kennedy School of Government, outlines how this new energy abundance is upending global politics and strengthening America’s political power. Hailed as the equal of Daniel Yergin’s 2011 classic, The Quest, O’Sullivan’s book argues that, for a host of reasons, we are seeing “the broad contours of a new order in which the traditional boom-and-bust cycle of the old oil market will at least [be] greatly muted.”
This view dismisses a potential return to the traditional cyclical patterns that have marked oil’s history. O’Sullivan argues that reduced business volatility will result from (1) the shale revolution, (2) continued development of oilfield technology that brings new supplies while slowing the production declines of older fields, (3) the ability of some OPEC countries to boost their oil output, and (4) technology, in the form of increased efficiency or possibly greater electrification of transportation, thereby eroding fossil fuel demand.
Her long-term outlook calls for the world to be “flush with oil,” enabling supply and demand to balance at moderate but not rock-bottom prices for the foreseeable future. This means OPEC will no longer be dictating global oil prices.
The potential for a substantial weakening of OPEC’s pricing power is what lies behind the economic and social reset underway in the organization’s key member country, Saudi Arabia. The push to modernize Saudi Arabia’s economy is being driven by Crown Prince Mohammed bin Salman, soon to be the next ruler of the kingdom.
The 33-year old prince has taken the country’s government by storm, backed by his father, King Salman. From energy and economic policy to fighting corruption and ultraconservative religious factions, the young leader is pushing his country to modernize and build its future on a foundation that is not solely dependent on the global price of crude oil.
It will not be easy, especially given the aggressive timeframe envisioned due to the need to provide employment opportunities for large swaths of the population that are currently underutilized, such as young males and females. Without providing these youths with real futures, the Saudi Arabian treasury will soon be bled dry. That would prevent the government from fulfilling its obligation as the guardian of Islam’s holy sites. Without change, the requirement for higher oil prices to satisfy the country’s needs creates substantial risk to its current foundation and stability.
MBS, as the Crown Prince is known, has embraced Saudi Arabia’s religious leadership role in the Middle East, which means shouldering the resistance to Iran’s sponsorship of terrorism in the region. Changing geopolitics may force further obligations onto Saudi Arabia as the new energy dynamics possibly reduce U.S. influence, and its needs, in the Middle East. The pace of these changes may surprise observers.
A New Year
As we begin a new year, global economic, social and geopolitical forces are reshaping energy’s future. Defining that future is impossible. Will it be the muted-cyclical future set forth by Meghan O’Sullivan? Or will it reflect a traditional cyclical upturn? Quite possibly the current recovery evaporates, but the odds of that happening, in our opinion, are low.
Although history doesn’t repeat, cycles do. We are in the early stage of a new cycle, slowly digging out from a deep hole. Cycles often produce booms, but the weight of energy’s long-term challenges may limit one from forming anytime soon. – MarEx
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.